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Author:Durham, J. Benson 

Working Paper
Sacrifice ratios and monetary policy credibility: do smaller budget deficits, inflation-indexed debt, and inflation targets lower disinflation costs?

A growing empirical literature addresses the determinants of the sacrifice ratio, an imperfect measure of the tradeoff between inflation and aggregate output. This study endeavors to advance previous studies in three ways. First, the literature does not satisfactorily examine key fiscal and monetary policy practices that arguably affect policymaking credibility. These include the stock (and flow) of government debt, the issuance of inflation-indexed bonds, and the existence of explicit inflation targets. Second, previous studies unfortunately exclude non-OECD countries. Third, the literature ...
Finance and Economics Discussion Series , Paper 2001-47

More on U.S. Treasury term premiums: spot and expected measures

Several studies that use affine term structure models (ATSMs) or survey data suggest that subdued nominal U.S. Treasury yields during the global financial crisis and its aftermath primarily reflected exceptionally low, if not negative, term premiums as distinct from depressed anticipated short rates. However, this literature pays little attention to the length of time market participants anticipated low term premiums to prevail, as captured by the ?forward? or ?expected? term premium over a given horizon, distinct from the ?spot? term premium. Besides the implications for investors at the ...
Staff Reports , Paper 658

Betting against beta (and gamma) using government bonds

Purportedly consistent with ?risk parity? (RP) asset allocation, recent studies document compelling ?low risk? trading strategies that exploit a persistently negative relation between Sharpe ratios (SRs) and maturity along the U.S. Treasury (UST) term structure. This paper extends this evidence on betting against beta with government bonds (BABgov) in four respects. First, out-of-sample tests suggest that excess returns may have waned somewhat recently and that the pattern seems most pronounced for USTs given data on ten other previously unexamined government bond markets. Second, BABgov ...
Staff Reports , Paper 708

Momentum and the term structure of interest rates

A vast literature reports excess returns to momentum strategies across many financial asset classes. However, no study examines trading rules based on price history along individual government-bond term structures?that is, with respect to duration buckets across the curve?as opposed to across sovereign markets or individual term structures as a whole over time. Under duration-neutral and long-only constraints as well as low trading costs, this paper reports excess annualized returns of up to 120 basis points and information ratios as high as 0.79 using U.S. Treasury total return data from ...
Staff Reports , Paper 657

Arbitrage-free affine models of the forward price of foreign currency

Forward foreign exchange contracts embed not only expected depreciation but also a sizable premium, which complicates inferences about anticipated returns. This study derives arbitrage-free affine forward currency models (AFCMs) with closed-form expressions for both unobservable variables. Model calibration to forward term structures of eleven U.S.-dollar currency pairs from the mid-to-late 1990s through early 2014 fits the data closely and suggests that the premium is indeed nonzero and variable, but not to the degree implied by previous econometric studies.
Staff Reports , Paper 665

Working Paper
Jump-diffusion processes and affine term structure models: additional closed-form approximate solutions, distributional assumptions for jumps, and parameter estimates

Affine term structure models in which the short rate follows a jump-diffusion process are difficult to solve, and the parameters of such models are hard to estimate. Without analytical answers to the partial difference differential equation (PDDE) for bond prices implied by jump-diffusion processes, one must find a numerical solution to the PDDE or exactly solve an approximate PDDE. Although the literature focuses on a single linearization technique to estimate the PDDE, this paper outlines alternative methods that seem to improve accuracy. Also, closed-form solutions, numerical estimates, ...
Finance and Economics Discussion Series , Paper 2005-53

Working Paper
The extreme bounds of the cross-section of expected stock returns

Several empirical studies report violations of the asset-pricing model of Sharpe (1964), Lintner (1965), and Black (1972). But, there is no consensus on specification in this literature, as such studies typically consider only a limited number of explanatory variables and do not satisfactorily control for previous findings. Extreme bound analysis (EBA), an imperfect but useful remedy for model uncertainty, suggests that comparatively few factors are robust. Given the cross-section of expected stock returns from July 1963 through December 2000, three of 23 variables - market size as well as ...
Finance and Economics Discussion Series , Paper 2002-34

Working Paper
What do financial asset prices say about the housing market?

This paper examines the first three moments of investors' expectations for the housing sector. That is, first, what do financial markets imply about expected future home prices? Second, how much confidence do investors have in their forecast? And, third, do market participants see more downside than upside risk? Housing futures and options, which trade on the Chicago Mercantile Exchange (CME), are not yet deep and liquid, and derivatives on homebuilders' shares reflect considerable idiosyncratic information and are therefore an imperfect proxy. Nonetheless, prices suggest that investors ...
Finance and Economics Discussion Series , Paper 2006-32

Working Paper
An estimate of the inflation risk premium using a three-factor affine term structure model

This paper decomposes nominal Treasury yields into expected real rates, expected inflation rates, real risk premiums, and inflation risk premiums by separately calibrating a three-factor affine term structure model to the nominal Treasury and TIPS yield curves. Although this particular application seems to produce expected real short rates and inflation rates that are somewhat static, there are theoretical advantages to calibrating the model to nominal and real yields separately. Moreover, the estimates correlate positively with back-of-the-envelope measures of the inflation risk premium. ...
Finance and Economics Discussion Series , Paper 2006-42

Working Paper
Does monetary policy affect stock prices and Treasury yields? An error correction and simultaneous equation approach

This study pursues two addenda to the practitioner and academic on the effect of monetary policy on asset prices. First, this paper applies cointegration theory, and, second, relaxes the stringent assumption in the literature that changes in 10-year Treasury yields, stock returns, and changes in the stance of monetary policy are exogenous. Given quarterly data from 1978:Q4 to 2002:Q3, two-stage least squares (2SLS) regressions suggest that changes in the exogenous component of the federal funds rate affect changes in Treasury yields but not stock returns, ceteris paribus. However, this result ...
Finance and Economics Discussion Series , Paper 2003-10