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Working Paper
\"Peso problem\" explanations for term structure anomalies
We examine the empirical evidence on the expectation hypothesis of the term structure of interest rates in the United States, the United Kingdom, and Germany using the Campbell-Shiller (1991) regressions and a vector-autoregressive methodology. We argue that anomalies in the U.S. term structure, documented by Campbell and Shiller (1991), may be due to a generalized peso problem in which a high-interest rate regime occurred less frequently in the sample of U.S. data than was rationally anticipated. We formalize this idea as a regime-switching model of short-term interest rates estimated with ...
Working Paper
State-contingent bank regulation with unobserved action and unobserved characteristics
This paper studies bank capital regulation under deposit insurance when bank attributes and actions are private information. Banks are heterogeneous in quality and choose both the mean and variance of their investment strategy. Regulatory tools include capital regulation and state-contingent fines. We use numerical methods to study the properties of the model with two different bank types. Without fines, capital requirements only have limited ability to separate bank types. When fines are added, separation is much easier. Fine schedules and capital requirements are tailored to bank type. ...
Journal Article
Monetary policy shocks and long-term interest rates
Exogenous shocks to monetary policy strongly affect short-term interest rates, but have little or no effect on longer-term interest rates.
Working Paper
Consumption-based modeling of long-horizon returns
Numerous studies have documented the failure of consumption-based pricing models to explain observed patterns in stock and bond returns. This failure has sometimes been attributed to frictions, transaction costs or durability. If such frictions are important, they should primarily affect the higher frequency components of asset returns. The long-swings, or lower-frequency comovements should be less affected. Consequently if transaction costs are important, tests of the consumption based asset pricing model which concentrate on lower-frequency components may be more successful.
Newsletter
Explaining the decline in the auction rate securities market
Auction rate securities are an example of a relatively obscure financial market instrument that has been caught up in the recent negative sentiment affecting the financial markets. This article examines these securities and sheds some light on recent events.
Working Paper
Bank capital standards for market risk: a welfare analysis
We develop a model of commodity money and use it to analyze the following two questions motivated by issues in monetary history: What are the conditions under which Gresham's Law holds? And, what are the mechanics of a debasement (lowering the metallic content of coins)? The model contains light and heavy coins, imperfect information, and prices determined via bilateral bargaining. There are equilibria with neither, both, or only one type of coin in circulation. When both circulate, coins may trade by weight or by tale. We discuss the extent to which Gresham's Law holds in the various cases. ...
Discussion Paper
Solving nonlinear rational expectations models by parameterized expectations: convergence to stationary solutions
This paper develops the Parameterized Expectations Approach (PEA) for solving nonlinear dynamic stochastic models with rational expectations. The method can be applied to a variety of models, including models with strong nonlinearities, sub-optimal equilibria, and many continuous state variables. In this approach, the conditional expectations in the equilibrium conditions are approximated by finite-dimensional classes of functional forms. The approach is highly efficient computationally because it incorporates endogenous oversampling and Monte-Carlo integration, and it does not impost a ...
Journal Article
The crisis of 1998 and the role of the central bank
Following the Russian default and devaluation in August 1998, financial markets were characterized by a withdrawal of liquidity, a flight to the safest assets, increased concerns about credit quality, and large declines in asset values. However, the crisis ended following a rather modest interest rate cut by the Federal Reserve. Why did the central bank's action have this effect? This article argues that the crisis was an episode of potential coordination failure, triggered by, but distinct from, the events in Russia. The Federal Reserve's action signaled a policy change that serve to ...
Journal Article
Cleared Margin Setting at Selected Central Counterparties
Interviews with senior personnel at six of the world?s largest central counterparty clearing houses and research by financial markets staff shed light on regulations, principles, and best practices in margin setting for derivatives.