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Working Paper
Incorporating Diagnostic Expectations into the New Keynesian Framework
L’Huillier, Jean-Paul; Singh, Sanjay R.; Yoo, Donghoon (2023-03-01)
Diagnostic expectations constitute a realistic behavioral model of inference. This paper shows that this approach to expectation formation can be productively integrated into the New Keynesian framework. Diagnostic expectations generate endogenous extrapolation in general equilibrium. We show that diagnostic expectations generate extra amplification in the presence of nominal frictions; a fall in aggregate supply generates a Keynesian recession; fiscal policy is more effective at stimulating the economy. We perform Bayesian estimation of a rich medium-scale model that incorporates consensus ...
Working Paper Series , Paper 2023-19

Report
Dealer Capacity and U.S. Treasury Market Functionality
Fleming, Michael J.; Keane, Frank M.; Duffie, Darrell; Van Tassel, Peter; Nelson, Claire; Shachar, Or (2023-08-01)
We show a significant loss in U.S. Treasury market functionality when intensive use of dealer balance sheets is needed to intermediate bond markets, as in March 2020. Although yield volatility explains most of the variation in Treasury market liquidity over time, when dealer balance sheet utilization reaches sufficiently high levels, liquidity is much worse than predicted by yield volatility alone. This is consistent with the existence of occasionally binding constraints on the intermediation capacity of bond markets.
Staff Reports , Paper 1070

Working Paper
Mind Your Language: Market Responses to Central Bank Speeches
Ahrens, Maximilian; Erdemlioglu, Deniz; McMahon, Michael; Neely, Christopher J.; Yang, Xiye (2024-02-21)
Researchers have carefully studied post-meeting central bank communication and have found that it often moves markets, but they have paid less attention to the more frequent central bankers’ speeches. We create a novel dataset of US Federal Reserve speeches and develop supervised multimodal natural language processing methods to identify how monetary policy news affect financial volatility and tail risk through implied changes in forecasts of GDP, inflation, and unemployment. We find that news in central bankers’ speeches can help explain volatility and tail risk in both equity and bond ...
Working Papers , Paper 2023-013

Discussion Paper
How Has Treasury Market Liquidity Evolved in 2023?
Fleming, Michael J. (2023-10-17)
In a 2022 post, we showed how liquidity conditions in the U.S. Treasury securities market had worsened as supply disruptions, high inflation, and geopolitical conflict increased uncertainty about the expected path of interest rates. In this post, we revisit some commonly used metrics to assess how market liquidity has evolved since. We find that liquidity worsened abruptly In March 2023 after the failures of Silicon Valley Bank and Signature Bank, but then quickly improved to levels close to those of the preceding year. As in 2022, liquidity in 2023 continues to closely track the level that ...
Liberty Street Economics , Paper 20231017

Working Paper
An Empirical Analysis of Futures Margin Changes: Determinants and Policy Implications
Abruzzo, Nicole; Park, Yang-Ho (2014-09-02)
Margin regulation raises two policy concerns. First, an alignment of margins to volatility can amplify procyclicality, leading to a build-up of excess leverage in good times and a forced deleverage in bad times. Second, competition among central counterparties (CCPs) can result in lower margin levels in order to attract more trading volume, which is referred to as a "race to the bottom." Motivated by these issues, we empirically analyze the determinants of margin changes by using a data set of various futures margins from Chicago Mercantile Exchange (CME) Group. We first find that CME Group ...
Finance and Economics Discussion Series , Paper 2014-86

Report
Liquidity and volatility in the U.S. treasury market
Fleming, Michael J.; Nguyen, Giang; Engle, Robert; Ghysels, Eric (2012-12-01)
We model the joint dynamics of intraday liquidity, volume, and volatility in the U.S. Treasury market, especially through the 2007-09 financial crisis and around important economic announcements. Using various specifications based on Bauwens and Giot?s (2000) Log- ACD(1,1) model, we find that liquidity, volume, and volatility are highly persistent, with volatility having a lower short-term persistence than the other two. Market liquidity and volume are important to explaining volatility dynamics but not vice versa. In addition, market dynamics change during the financial crisis, with all ...
Staff Reports , Paper 590

Report
Global variance term premia and intermediary risk appetite
Van Tassel, Peter; Vogt, Erik (2016-08-12)
Sellers of variance swaps earn time-varying risk premia for their exposure to realized variance, the level of variance swap rates, and the slope of the variance swap curve. To measure risk premia, we estimate a dynamic term structure model that decomposes variance swap rates into expected variances and term premia. Empirically, we document a strong global factor structure in variance term premia across the U.S., U.K., Europe, and Japan. We further show that variance term premia are negatively correlated with the risk appetite of hedge funds, broker-dealers, and mutual funds. Our results ...
Staff Reports , Paper 789

Working Paper
Mind Your Language: Market Responses to Central Bank Speeches
Ahrens, Maximilian; Erdemlioglu, Deniz; McMahon, Michael; Neely, Christopher J.; Yang, Xiye (2023-05-31)
Researchers have carefully studied post-meeting central bank communication and have found that it often moves markets, but they have paid less attention to the more frequent central bankers’ speeches. We create a novel dataset of US Federal Reserve speeches and use supervised multimodal natural language processing methods to identify how monetary policy news affect financial volatility and tail risk through implied changes in forecasts of GDP, inflation, and unemployment. We find that news in central bankers’ speeches can help explain volatility and tail risk in both equity and bond ...
Working Papers , Paper 2023-013

Report
Nonlinearity and flight to safety in the risk-return trade-off for stocks and bonds
Vogt, Erik; Adrian, Tobias; Crump, Richard K. (2015-04-01)
We document a highly significant, strongly nonlinear dependence of stock and bond returns on past equity market volatility as measured by the VIX. We propose a new estimator for the shape of the nonlinear forecasting relationship that exploits additional variation in the cross section of returns. The nonlinearities are mirror images for stocks and bonds, revealing flight to safety: expected returns increase for stocks when volatility increases from moderate to high levels, while they decline for Treasury securities. These findings provide support for dynamic asset pricing theories where the ...
Staff Reports , Paper 723

Working Paper
Reforming Fiscal Institutions in Resource-Rich Arab Economies: Policy Proposals
Selim, Hoda; Nugent, Jeffrey B.; Mohaddes, Kamiar (2018-09-04)
This paper traces the evolution of fiscal institutions of Resource-Rich Arab Economies (RRAEs) over time since their pre-oil days, through the discovery of oil to their build-up of oil exports. It then identifies challenges faced by RRAEs and variations in their severity among the different countries over time. Finally, it articulates specific policy reforms, which, if implemented successfully, could help to overcome these challenges. In some cases, however, these policy proposals may give rise to important trade-offs that will have to be evaluated carefully in individual cases.
Globalization Institute Working Papers , Paper 346

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