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Empirical evaluation of asset pricing models: arbitrage and pricing errors over contingent claims

In a 1997 paper, Hansen and Jagannathan develop two pricing error measures for asset pricing models. The first measure is the maximum pricing error on given test assets, and the second measure is the maximum pricing error over all possible contingent claims. We develop a simulation-based Bayesian inference of the pricing error measures. Although linear time-varying and multifactor models are widely reported to have small pricing errors on standard test assets, we demonstrate that these models can have large pricing errors over contingent claims because their stochastic discount factors are ...
Staff Reports , Paper 265

Price setting 'perfect competitors'

Staff Report , Paper 29

Working Paper
Residential mortgage default: the roles of house price volatility, euphoria and the borrower's put option

House price volatility; lender and borrow perception of price trends, loan and property features; and the borrower?s put option are integrated in a model of residential mortgage default. These dimensions of the default problem have, to our knowledge, not previously been considered altogether within the same investigation framework. We rely on a sample of individual mortgage loans for twenty counties in Florida, over the period 2001 through 2008, third quarter, with housing price performance obtained from repeat sales analysis of individual transactions. The results from the analysis strongly ...
Working Paper , Paper 10-02

Working Paper
Can standard preferences explain the prices of out-of-the-money S&P 500 put options?

The 1987 stock market crash occurred with minimal impact on observable economic variables (e.g., consumption), yet dramatically and permanently changed the shape of the implied volatility curve for equity index options. Here, we propose a general equilibrium model that captures many salient features of the U.S. equity and options markets before, during, and after the crash. The representative agent is endowed with Epstein-Zin preferences and the aggregate dividend and consumption processes are driven by a persistent stochastic growth variable that can jump. In reaction to a market crash, the ...
Working Paper Series , Paper WP-2011-11

Working Paper
Pricing-to-market, trade costs, and international relative prices

Data on international relative prices from industrialized countries show large and systematic deviations from relative purchasing power parity. We embed a model of imperfect competition and variable markups in some of the recently developed quantitative models of international trade to examine whether such models can reproduce the main features of the fluctuations in international relative prices. We find that when our model is parameterized to match salient features of the data on international trade and market structure in the U.S., it reproduces deviations from relative purchasing power ...
Working Paper Series , Paper 2007-26

Working Paper
Exchange-rate pass-through in the G-7 countries

This paper examines the current thinking on exchange-rate pass-through to both import prices and consumer prices and estimates the extent to which they have fallen in the G-7 countries since the late 1970s and 1980s. For import-price pass-through we find that all countries experience a numerical decline in the responsiveness of import prices to exchange-rate movements; for nearly half of these countries the decline between 1975-1989 and 1990-2004 is statistically significant. We estimate that while a 10 percent depreciation in the local currency would have increased import prices by nearly 7 ...
International Finance Discussion Papers , Paper 851

Working Paper
Reconciling Full-Cost and Marginal-Cost Pricing

Despite the clear prescription from economic theory that a firm should set price based only on variable costs, firms routinely factor fixed costs into pricing decisions. We show that full-cost pricing (FCP) can help firms uncover their optimal price from economic theory. FCP marks up variable cost with the contribution margin per unit, which in equilibrium includes the fixed cost. This requires some knowledge of the firm's equilibrium return, though this is arguably easier a lower informational burden than knowing one's demand curve, which is required for optimal economic pricing. We ...
Finance and Economics Discussion Series , Paper 2015-72

Imperfectly credible disinflation under endogenous time-dependent pricing

The real effects of an imperfectly credible disinflation depend critically on the extent of price rigidity. Therefore, the study of how policymakers' credibility affects the outcome of an announced disinflation should include an analysis of the determinants of the frequency of price adjustments. In this paper, we examine how credibility affects the outcome of a disinflation in a model with endogenous time-dependent pricing rules. Both the initial degree of price rigidity, calculated optimally, and, more notably, changes in the duration of price spells during disinflation play an important ...
Staff Reports , Paper 355

State-dependent pricing under infrequent information: a unified framework

We characterize optimal state-dependent pricing rules under various forms of infrequent information. In all models, infrequent price changes arise from the existence of a lump-sum "menu cost." We entertain various alternatives for the source and nature of infrequent information. In two benchmark cases with continuously available information, optimal pricing rules are purely state-dependent. In contrast, in all environments with infrequent information, optimal pricing rules are both time- and state-dependent, characterized by "trigger strategies" that depend on the time elapsed since ...
Staff Reports , Paper 455

Working Paper
Deliverability and regional pricing in U.S. natural gas markets

During the 1980s and early '90s, interstate natural gas markets in the United States made a transition away from the regulation that characterized the previous three decades. With abundant supplies and plentiful pipeline capacity, a new order emerged in which freer markets and arbitrage closely linked natural gas price movements throughout the country. After the mid-1990s, however, U.S. natural gas markets tightened and some pipelines were pushed to capacity. We look for the pricing effects of limited arbitrage through causality testing between prices at nodes on the U.S. natural gas ...
Working Papers , Paper 0802


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