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This paper explores the optimal financial contract for a large investor with potential control over a firm's investment decisions. The authors show that an optimally designed menu of claims for a large investor will include features resembling a U.S. version of lender liability doctrine, equitable subordination. This doctrine permits a firm's claimants to seek to subordinate a controlling investor's financial claim in bankruptcy court, but only under well-specified conditions. Specifically, the authors show that this doctrine allows a firm to strike an efficient balance between two concerns: (i) inducing the large investor to monitor, and (ii) limiting the influence costs that arise when claimants can challenge existing contracts in bankruptcy court.
The paper also provides a
partial rationale for a financial system in which powerful creditors do not
generally hold blended debt and equity claims.
(686 KB, 36 pages)
This paper presents new evidence on the benefits of conditioning
quarterly model forecasts on monthly current-quarter data. On the basis of a
quarterly Bayesian vector error corrections model, the findings indicate that
such conditioning produces economically relevant and statistically significant
improvement. The improvement, which begins as early as the end of the first
week of the second month of the quarter, is largest in the current quarter, but
in some cases, extends beyond the current quarter. Forecast improvement is
particularly large during periods of recessions but generally extends to other
periods as well. Overall, the findings suggest that it is rational to update
one's quarterly forecast in response to incoming monthly data.
(580 KB, 60 pages)
A large body of literature documents that returns from currency
speculation are highly volatile and possess a predictable component, which is
itself highly volatile and serially correlated. Explaining the returns from
currency speculation through the presence of a risk premium has proven
difficult, however. In particular, models with complete markets and
time-separable preferences generate risk premia that are nearly constant. This
paper solves a model consisting of two monetary economies with incomplete
markets, in which agents are subject to borrowing constraints. The paper
investigates if such a framework is able to account for the volatility and the
size of the foreign exchange risk premium. The model succeeds in increasing
substantially the volatility of the risk premium to about 30 percent of that in
the data. However, this more volatile risk premium does not translate into
sufficiently large predictable excess returns. It thus appears unlikely that
excess returns from currency speculation can be uniquely explained by a
time-varying risk premium in an incomplete-markets economy with borrowing
(356 KB, 32 pages)
00-4 Joseph P. Hughes, Loretta J. Mester, and Choon-Geol Moon, "Are Scale Economies in Banking Elusive or Illusive? Evidence Obtained by Incorporating Capital Structure and Risk-Taking into Models of Bank Production"
This paper explores how to incorporate banks' capital structure and risk-taking into models of production. In doing so, the paper bridges the gulf between (1) the banking literature that studies moral hazard effects of bank regulation without considering the underlying microeconomics of production and (2) the literature that uses dual profit and cost functions to study the microeconomics of bank production without explicitly considering how banks' production decisions influence their riskiness.
Various production models that differ in how they account for capital structure and in the objectives they impute to bank managers — cost minimization versus value maximization — are estimated using U.S. data on highest-level bank holding companies. Modeling the banks' objective as value maximization conveniently incorporates both market-priced risk and expected cash flow into managers' ranking and choice of production plans.
economies are found to depend critically on how banks' capital structure and
risk-taking is modeled. In particular, when equity capital, in addition to
debt, is included in the production model and cost is computed from the
value-maximizing expansion path rather than the cost-minimizing path, banks are
found to have large scale economies that increase with size. Moreover, better
diversification is associated with larger scale economies while increased
risk-taking and inefficient risk-taking are associated with smaller scale
(221 KB, 47 pages)
The authors argue for a shift in the focus of modeling production
from the traditional assumptions of profit maximization and cost minimization
to a more general assumption of managerial utility maximization that can
incorporate risk incentives into the analysis of production and recover
value-maximizing technologies. The authors show how this shift can be
implemented using the Almost Ideal Demand System. In addition, the authors
suggest a more general way of measuring efficiency that can incorporate a
concern for the market value of firms' assets and equity and identify
value-maximizing firms. This shift in focus bridges the gap between the
risk-incentives literature in banking that ignores the microeconomics of
production and the production literature that ignores the relationship between
production decisions and risk.
(168 KB, 35 pages)
This paper describes a real-time data set
for macroeconomists that can be used for a variety of purposes, including
forecast evaluation. The data set consists of quarterly vintages, or snapshots,
of the major macroeconomic data available at quarterly intervals in real time.
The paper explains the construction of the data set, examines the properties of
several of the variables in the data set across vintages, and provides an
example showing how data revisions can affect forecasts.
(461 KB, 32 pages)
authors develop a model of costly technology adoption where the cost is
irrecoverable and fixed. Households must decide when to switch from an existing
technology to a new, more productive technology. Using a recursive approach,
the authors show that there is a unique threshold level of wealth above which
households will adopt the new technology and below which they will not. This
threshold is independent of preference parameters and depends only on
technology parameters. Prior to adoption, households invest at increasing
rates, but consumption growth is constant. The authors also show that richer
households adopt sooner and that income inequality increases over time. Both
these results are consistent with the evidence from the Green
(455 KB, 42 pages)
This paper investigates trend and cycle dynamics in per capita
income for the major U.S. regions during the 1956-95 period. Cointegration and
serial correlation common features information are used in jointly decomposing
the series into trend and cycle components. The authors find considerable
differences in the volatility of regional cycles. Controlling for differences
in volatility, the authors find a great deal of comovement in the cyclical
response for all regions but the Far West. Possible sources underlying
differences in regional cycles are explored, such as the share of a region's
income accounted for by manufacturing, defense spending as a proportion of a
region's income, oil price shocks, and the stance of monetary policy. Somewhat
surprisingly, the authors find that the share of manufacturing in a region
seems to account for little of the variation in regional cycles relative to
national cycles, but manufacturing share differentially affects trend growth
for four of the seven regions studied.
(236 KB, 36 pages)
Horvath and Verbrugge (1996) argue that when
investigating the sources of aggregate fluctuations, it is important to use the
highest frequency data available. Using monthly data for the U.S. economy they
show that industry-specific shocks are more important in explaining
fluctuations in industrial production than are common aggregate shocks. With
the exception of Coulson (1999) studies that examine the issue at the
subnational level have used low frequency, spatially aggregated data. The
authors examine the relative importance of national disturbances versus local
industry shocks for employment fluctuations using monthly data on five
metropolitan statistical areas (MSAs). Input-output tables are used to quantify
the strength of interindustry linkages, which are then used to help identify a
structural VAR model for each MSA. Within-MSA industry shocks are found to
explain considerably more of the forecast-error variance in industry employment
growth (87-94 percent) than do common national shocks to productivity and
monetary policy, and the manufacturing, services, and government sectors make
the largest individual contributions to local employment variance. The authors
also find that the measured importance of national shocks for employment
fluctuations increases as the level of spatial aggregation increases.
(197 KB, 28 pages)
Using an equilibrium business
cycle model, the authors search for aggregate nonlinearities arising from the
introduction of nonconvex capital adjustment costs. The authors find that while
such adjustment costs lead to nontrivial nonlinearities in aggregate investment
demand, equilibrium investment is effectively unchanged. This finding, based on
a model in which aggregate fluctuations arise through exogenous changes in
total factor productivity, is robust to the introduction of shocks to the
relative price of investment goods.
(544 KB, 50 pages)
00-11 Sylvain Leduc, "Exchange-Rate Puzzles in a Model with Arbitrage"
This paper documents the implications of arbitrage costs on the behavior of exchange rates in an open-economy liquidity model. The main motivation behind the paper is the growing evidence that the well-documented departures from purchasing power parity are due to a failure of the law of one price. The paper quantifies the importance of arbitrage costs for the variability, persistence, and autocorrelation of real and nominal exchange rates and compares the results with those of a model with nominal rigidities and firms pricing to market; second, the paper studies the impact of currency risk due to the failure of the law of one price on uncovered interest parity.
The authors investigate the impact of the tax treatment of owner-occupied housing on urban form in an economy in which high- and low-income households choose among city and suburban communities. Because housing tax policies differentially affect the relative, after-tax price of housing for high- and low-income households, and because the extent of capitalization of housing tax policies can differ across city and suburban communities, their analysis finds that housing tax policies can affect not only the density of the metropolitan area, but also can influence where rich and poor households choose to live.
The authors also show that the impacts of housing tax policies differ depending upon whether land use constraints such as suburban large lot zoning exist. If there are no land use constraints present, increasing a subsidy to home ownership that is positively correlated with the income of the owner tends to lead to the decentralization of both rich and poor, although there are conditions under which the rich would choose to concentrate in the central city. The ambiguity of the effect on the choices of high income households suggests that impacts of the federal tax treatment of housing may differ across metropolitan areas.
In the presence of
binding large lot zoning in the suburbs, the rich have a greater incentive to
decentralize while the poor are constrained to the city. Thus, housing tax
policy that affects the relative price of land differentially for the rich and
poor could have helped exacerbate the intense residential sorting by income
that we see in many parts of the United States. Importantly, our analysis of
community choice is not driven by different preferences for city or suburb that
may be associated with the income elasticity of housing demand. Rather, it
results from changes in relative after-tax housing prices faced by poor and
rich households. Determining the empirical relevance of prices versus
preferences in this matter should be an urgent task for future research.
(128 KB, 30 pages)
Over the course of the 20th century, the U.S. economy has moved
from rote to creativity, from a mass production workforce to a white-collar
workforce whose focus is developing new products for sale. In the process,
economic change has been accelerated, so that our educational process and goals
are increasingly inappropriate. As an example, even the intensive education of
medical doctors is inadequate to the current pace of change. In this paper, the
author delineates the impact of the electronic revolution that has automated
routine and made creativity more profitable and therefore more powerful. The
author examines the high school movement (1910-1940) and the college movement
(1940-1970) as successful responses to technological challenges that increased
equality. The author then attempts a tentative discussion of the electronic
revolution's impact on the educational process.
(253 KB, 41 pages)
The authors' aim in this paper is to obtain a
measure of the potential benefit of reducing the likelihood of economic crises.
The authors define an economic crisis as a Depression-style collapse of
economic activity. Based on the observed frequency of Depression-like events,
the authors estimate this likelihood to be approximately once every 83 years
for the United States. Even for this small probability of moving into a
Depression-like state, the welfare gain from setting it to zero can range
between 1.05 percent and 6.59 percent of annual consumption, in perpetuity.
These large gains arise because even though the probability of encountering a
Depression-like state is small, it is highly persistent once it occurs. The
authors also find that for some calibrations of the model, uninsured
unemployment risk contributes significantly to the size of these gains.
(371 KB, 47 pages)