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Working Paper
Bubbles as Payoffs at Infinity
We define rational bubbles to be securities with payoffs occurring in the infinitely distant future and investigate the behavior of bubble values. We extend our analysis to a setting of uncertainty. In an infinite-horizon arbitrage-free model of asset prices, we interpret the money market account as the value of a particular bubble; a similar interpretation holds for other assets related to the state-price deflator and to payoffs on bonds maturing in the distant future. We present three applications of this characterization of bubbles.
Discussion Paper
Is Cheaper Oil Good News or Bad News for U.S. Economy?
Oil prices have declined substantially since the summer of 2014. If these price declines reflect demand shocks, then this would suggest a slowdown in global economic activity. Alternatively, if the declines are driven by supply shocks, then the drop in prices might indicate a forthcoming boost in spending as firms and households benefit from lower energy costs. In this post, we use correlations of oil price changes with a broad array of financial variables to confirm that this recent fall in oil prices has been mostly the result of increased global oil supply. We then use a model to assess ...
Discussion Paper
Lower Oil Prices and U.S. Economic Activity
After a period of stability, oil prices started to decline in mid-2015, and this downward trend continued into early 2016. As we noted in an earlier post, it is important to assess whether these price declines reflect demand shocks or supply shocks, since the two types of shocks have different implications for the U.S. economic outlook. In this post, we again use correlations of weekly oil price changes with a broad array of financial variables to quantify the drivers of oil price movements, finding that the decline since mid-2015 is due to a mix of weaker demand and increased supply. Given ...
Report
Asset price effects of peer benchmarking: evidence from a natural experiment
We estimate the effects of peer benchmarking by institutional investors on asset prices. To identify trades purely due to peer benchmarking as separate from those based on fundamentals or private information, we exploit a natural experiment involving a change in a government-imposed underperformance penalty applicable to Colombian pension funds. This change in regulation is orthogonal to stock fundamentals and only affects incentives to track peer portfolios, allowing us to identify the component of demand that is caused by peer benchmarking. We find that these peer effects generate excess ...
Report
Intergenerational Redistribution in the Great Recession
We construct a stochastic overlapping-generations general equilibrium model in which households are subject to aggregate shocks that affect both wages and asset prices. We use a calibrated version of the model to quantify how the welfare costs of big recessions are distributed across different household age groups. The model predicts that younger cohorts fare better than older cohorts when the equilibrium decline in asset prices is large relative to the decline in wages. Asset price declines hurt the old, who rely on asset sales to finance consumption, but benefit the young, who purchase ...
Working Paper
International Asset Markets and Real Exchange Rate Volatility
The real exchange rate is very volatile relative to major macroeconomic aggregates and its correlation with the ratio of domestic over foreign consumption is negative (Backus-Smith puzzle). These two observations constitute a puzzle to standard international macroeconomic theory. This paper develops a two country model with complete asset markets and limited enforcement for international financial contracts that provides a possible explanation of these two puzzles. The model performs better than a standard incomplete markets model with a single non-contingent bond unless very tight borrowing ...
Working Paper
Turnover Liquidity and the Transmission of Monetary Policy
We provide empirical evidence of a novel liquidity-based transmission mechanism through which monetary policy influences asset markets, develop a model of this mechanism, and assess the ability of the quantitative theory to match the evidence.
Working Paper
Monetary policy through production networks: evidence from the stock market
Monetary policy shocks have a large impact on stock prices during narrow time windows centered around press releases by the FOMC. We use spatial autoregressions to decompose the overall effect of monetary policy shocks into a direct effect and a network effect. We attribute 50 to 85 percent of the overall impact to network effects. The decomposition is a robust feature of the data, and we confirm large network effects in realized cash-flow fundamentals. A simple model with intermediate inputs allows a structural interpretation of our empirical strategy. Our findings indicate that production ...
Discussion Paper
How Unconventional Are Large-Scale Asset Purchases?
The large-scale asset purchases (LSAPs) undertaken by the Fed starting in late November 2008 are widely considered to be a form of ?unconventional? monetary policy. Although these interventions are certainly unprecedented, this post shows that their effect on financial conditions is not that unconventional, in the sense that the relative effects of the LSAPs on returns across broad asset classes?nominal and real government bonds, stocks, and foreign exchange?are quite similar to those of more conventional policies, such as a reduction in the federal funds rate (FFR).
Journal Article
Asset Bubbles: Detecting and Measuring Them Are Not Easy Tasks
Market bubbles are linked to many historic financial crises, but asset price run-ups can reflect both fundamental value changes and psychological contagion. Using historic values of commonly held assets (stocks and real estate), a novel ?exuberance index? offers a way to compare bubbles.