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Journal Article
Financial Engineering Versus Cancer
Neely, Christopher J. (2015)
If financial engineering can distribute the pecuniary risk of medical research, then it can play a role in curing cancer.
Economic Synopses , Issue 18

Working Paper
Term Premium Variability and Monetary Policy
Mau, Ronald; Fuerst, Timothy S. (2016-05-06)
Two traditional explanations for the mean and variability of the term premium are: (i) time-varying risk premia on long bonds, and (ii) segmented markets between long- and short-term bonds. This paper integrates these two approaches into a medium-scale DSGE model. We consider two sources of business cycle variability: shocks to total factor productivity (TFP), and shocks to the marginal efficiency of investment (MEI). The ability of the risk approach to match the first moment of the term premium depends upon the relative importance of these two shocks. If MEI shocks are an important driver of ...
Working Papers (Old Series) , Paper 1611

Report
Changing Risk-Return Profiles
Hundtofte , Sean; Giannone, Domenico; Crump, Richard K.; Everaert, Miro (2018-06-01)
We show that realized volatility in market returns and financial sector stock returns have strong predictive content for the future distribution of market returns. This is a robust feature of the last century of U.S. data and, most importantly, can be exploited in real time. Current realized volatility has the most information content on the uncertainty of future returns, whereas it has only limited content about the location of the future return distribution. When volatility is low, the predicted distribution of returns is less dispersed and probabilistic forecasts are sharper.
Staff Reports , Paper 850

Report
Flighty liquidity
Giannone, Domenico; Boyarchenko, Nina; Shachar, Or (2018-10-01)
We study how the risks to future liquidity flow across corporate bond, Treasury, and stock markets. We document distribution ?flight-to-safety? effects: a deterioration in the liquidity of high-yield corporate bonds forecasts an increase in the average liquidity of Treasury securities and a decrease in uncertainty about the liquidity of investment-grade corporate bonds. While the liquidity of Treasury securities both affects and is affected by the liquidity in the other two markets, corporate bond and equity market liquidity appear to be largely divorced from each other. Finally, we show that ...
Staff Reports , Paper 870

Report
Bank Economic Capital
Hirtle, Beverly; Plosser, Matthew (2025-03-01)
Conventional measures of bank solvency fail to account for the unique liquidity risks posed by deposits. Using public regulatory data, we develop a novel measure, economic capital, that jointly quantifies the impact of credit, liquidity, and market risk. We validate that economic capital is a more timely and accurate indicator of bank health than standard solvency measures. Using our framework, we examine the evolution of banking sector solvency and find that following the GFC low interest rates depressed economic capital even as liquidity and market risks grew. We conclude with several ...
Staff Reports , Paper 1144

Report
Simple and reliable way to compute option-based risk-neutral distributions
Malz, Allan M. (2014-06-01)
This paper describes a method for computing risk-neutral density functions based on the option-implied volatility smile. Its aim is to reduce complexity and provide cookbook-style guidance through the estimation process. The technique is robust and avoids violations of option no-arbitrage restrictions that can lead to negative probabilities and other implausible results. I give examples for equities, foreign exchange, and long-term interest rates.
Staff Reports , Paper 677

Working Paper
Mandatory Disclosure and Financial Contagion
Alvarez, Fernando; Barlevy, Gadi (2014-04-28)
This paper analyzes the welfare implications of mandatory disclosure of losses at financial institutions when it is common knowledge that some banks have incurred losses but not which ones. We develop a model that features contagion, meaning that banks not hit by shocks may still suffer losses because of their exposure to banks that are. In addition, we assume banks can profitably invest funds provided by outsiders, but will divert these funds if their equity is low. Investors thus value knowing which banks were hit by shocks to assess the equity of the banks they invest in. We find that when ...
Working Paper Series , Paper WP-2014-4

Working Paper
End of an Era: The Coming Long-Run Slowdown in Corporate Profit Growth and Stock Returns
Smolyansky, Michael (2023-06-26)
I show that the decline in interest rates and corporate tax rates over the past three decades accounts for the majority of the period’s exceptional stock market performance. Lower interest expenses and corporate tax rates mechanically explain over 40 percent of the real growth in corporate profits from 1989 to 2019. In addition, the decline in risk-free rates alone accounts for all of the expansion in price-to-earnings multiples. I argue, however, that the boost to profits and valuations from ever-declining interest and corporate tax rates is unlikely to continue, indicating significantly ...
Finance and Economics Discussion Series , Paper 2023-041

Journal Article
The equity risk premium: a review of models
Rosa, Carlo; Duarte, Fernando M. (2015)
The authors estimate the equity risk premium (ERP)?the expected return on stocks in excess of the risk-free rate?by combining information from twenty models for the period 1960-2013. They begin their analysis by categorizing the models into five classes: trailing historical mean, dividend discount, cross-sectional estimation, regression analysis using valuation ratios or macroeconomic variables, and surveys. They find that an optimal weighted average of all models places the one-year-ahead ERP in June 2012 at 12.2 percent, close to levels reached in the mid- and late 1970s, when the ERP was ...
Economic Policy Review , Issue 2 , Pages 39-57

Working Paper
Financial variables and macroeconomic forecast errors
Barnes, Michelle L.; Olivei, Giovanni P. (2017-10-31)
A large set of financial variables has only limited power to predict a latent factor common to the year-ahead forecast errors for real Gross Domestic Product (GDP) growth, the unemployment rate, and Consumer Price Index (CPI) inflation for three sets of professional forecasters: the Federal Reserve?s Greenbook, the Survey of Professional Forecasters (SPF), and the Blue Chip Consensus Forecasts. Even when a financial variable appears to be fairly robust across sample periods in explaining the latent factor, from an economic standpoint its contribution appears modest. Still, several financial ...
Working Papers , Paper 17-17

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