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Briefing
Mortgage Spreads and the Yield Curve
Mortgage spreads — the 30-year mortgage fixed rate minus the 10-year Treasury rate — have a history of increasing sharply in times of economic stress. While often viewed as a measure of financial stress, I argue they are mostly explained by changes in expected mortgage duration arising from changes in the yield curve. Economic stress leads to a downward-sloping yield curve, which increases expected refinance activity, shortening mortgage durations. This shorter duration makes mortgages prices reflect short (rather than long) Treasury rates. But with a downward-sloping yield curve, this ...
Briefing
Tracking College Tuition Growth
Previous research analyzed the rapid tuition growth that occurred from the late 1980s to 2010. That research indicates that several key factors drove the rise in college tuition: large expansions in the federal student loan program, a dramatic increase in the college-earnings premium, steady increases in average parental income, and state support of public schools that did not keep pace with tuition. Where that analysis stops, this analysis begins, showing that tuition growth slowed markedly from 2010 to 2022. We highlight several factors contributing to this pivot, interpreting those factors ...
Working Paper
Efficient VAR Discretization
The standard approach to discretizing VARs uses tensor grids. However, when the VAR components exhibit significant unconditional correlations or when there are more than a few variables, this approach creates large inefficiencies because some discretized states will be visited with only vanishingly small probability. I propose pruning these low-probability states, thereby constructing an efficient grid. I investigate how much an efficient grid improves accuracy in the context of an AR(2) model and a small-scale New Keynesian model featuring four shocks. In both contexts, the efficient grid ...
Journal Article
Computing Dynamic Heterogeneous-Agent Economies: Tracking the Distribution
Theoretical formulations of dynamic heterogeneous-agent economies typically include a distribution as an aggregate state variable. This paper introduces a method for computing equilibrium of these models by including a distribution directly as a state variable if it is finite-dimensional or a fine approximation of it if it is infinite-dimensional. The method accurately computes equilibrium in an extreme calibration of Huffman's (1987) overlapping-generations economy where quasi-aggregation, the accurate forecasting of prices using a small state space, fails to obtain. The method also ...
Working Paper
Sovereign Debt and Credit Default Swaps
ow do credit default swaps (CDS) affect sovereign debt markets? The answer depends crucially on trading frictions, risk-sharing, arbitrage violations, and spillovers from secondary to primary markets. We propose a sovereign default model where investors trade bonds and CDS over the counter via directed search. CDS affect bond prices through several channels. First, CDS act as a synthetic bond. Second, CDS reduce bond-investing risks, allowing exposure to be unwound. Third, CDS availability increases trading profitability, which induces entry and reduces trading costs. Last, these direct ...
Working Paper
Incarceration, Earnings, and Race
Briefing
The Effects of Higher Borrowing Costs: Insights from Sovereign Default Models
According to sovereign default models, debt becoming more expensive for a sovereign entity results in several significant effects. The government deleverages, capital investment falls for a prolonged duration, GDP and labor decline gradually with capital, and consumption can drop sharply. Outcomes are asymmetric, as positive shocks compress spreads slightly, but negative shocks can increase spreads substantially. The current account tends to increase due to reduced government borrowing from international lenders. The real exchange rate depreciates, which boosts net exports, but also tends to ...
Working Paper
Dynamics of investment, debt, and default
How does physical capital accumulation affect the decision to default in developing small open economies? We find that, conditional on a level of foreign indebtedness, more capital improves the sovereign?s ability to meet its obligations, reducing the likelihood of default and the risk premium. This effect, however, is diminishing in the stock of capital because capital also tames the severity of the contraction following default, making autarky more appealing. Access to long-term debt and costly capital adjustment are crucial for matching business cycles. Our quantitative model delivers ...