1. Internal
versus External Habits: Why Does the Distribution of Stock Returns have
ARCH Properties?.
Written with Yu Chen and Alex Himonas.
Abstract: We develop an explicit
formula for the distribution of U.S. returns that explains many of its
observed characteristics: excess kurtosis, volatility clustering,
leverage effects, volatility feedback, and the equity premium.
Researchers have often made the assumption of ARCH distributions to
capture these characteristics; ARCH models were developed expressly for
this purpose. The most important contribution of this paper is that our
model depends on fundamental factors, cash flows and
investor preferences, to explain these characteristics, rather than
depending on an assumed distribution of returns. Our solution also
explains about 66% of the rise in returns volatility during
the Depression.
View
paper .pdf
2. By Force of
Habit: An Exploration of Asset Pricing Models using Analytic Methods.
Written with Yu Chen and Alex Himonas.
Abstract: Complex analysis is used to
explore a new solution method for asset pricing models. Campbell and
Cochrane's (1999) habit persistence model provides a prototypical
example to illustrate these methods. Using complex analysis we
are able to find the maximum radius of convergence so that the
price-dividend function can be expressed as a Taylor series for any
consumption growth within [-8, 8] standard deviations per month.
While the numerical method used by Campbell and Cochrane does not
provide an accurate approximation, moderate adjustment in their
parameters recover their general implications. Finally, the
distribution of stock returns mimics the kurtosis and time varying risk
premium found in monthly data.View
paper .pdf
3. Solving Ramsey Problems with Nonlinear Projection
Methods.
Forthcoming Studies in
Nonlinear Dynamics & Econometrics, Vol. 9, Spring 2005.
Written with Mike Gapen.
Abstract: This paper
examines the usefulness of nonlinear projection methods in solving
Ramsey problems by investigating welfare enhancing properties of debt
through policy smoothing. The presence of nonlinear distortions in the
Ramsey problem requires the use of a solution procedure which captures
these effects. The nonlinear projection method, even with low-order
Chebyshev polynomials as employed in this paper, is able to capture a
significant portion of the Jensen's inequality effects. In an explicit
monetary economy we examine Barro's (1987, 1979) conjecture that
welfare gains are available from policy smoothing with debt. Increases
in
the volatility of distortionary monetary policy are more than offset by
declines in the volatility of distortionary labor taxes so that
introduction of debt is welfare enhancing..View
paper .pdf
4. Optimal
Fiscal and Monetary Policy with Nominal and Indexed Debt.
Written with Mike Gapen.
Abstract: This paper
focuses on the
importance of debt composition in the setting of optimal fiscal and
monetary policy over both short-run business cycles and
the long-run. The main conclusion is that nominal debt as
state-contingent debt can be a significant policy tool to reduce
volatility of distortionary government policy, thereby reducing
macroeconomic volatility while increasing equilibrium output and
consumption. The gain in welfare from using nominal debt to hedge
against shocks to the government budget is equivalent to a .6% increase
in consumption growth for the United States which is nearly as
large as the gain in welfare from the ability to issue debt. In
addition the gain in welfare for a country with twice the U.S. debt is
similar to a 2% increase in consumption growth.View
paper .pdf
5. Solving
Asset Pricing Models when the Price-Dividend Function is Analytic. Including unpublished Appendix.
Forthcoming Econometrica.
Written with Ovidiu Calin, Yu Chen and
Alex Himonas. .View
paper .pdf
Solving
Asset Pricing Models when the Price-Dividend Function is Analytic
(Longer Version).
Written with Stefano Athanasoulis,
Ovidiu Calin and Alex Himonas
Abstract: We present a new method for
solving asset pricing models, which yields an analytic price-dividend
function of one state variable. To illustrate our method we give a
detailed analysis of Abel's asset pricing model (see Theorem 1).
A function is analytic in an open interval if it can be represented as
a convergent power series near every point of that interval. In
addition to allowing us to solve for the exact equilibrium
price-dividend function, the analyticity property also lets us assess
the accuracy of any numerical solution procedure used in the asset
pricing literature.
Mathematica
Programs for Solving
Asset Pricing Models when the Price-Dividend Function is Analytic.
6. OPTIMAL
EXPERIMENTATION
AND THE PERTURBATION METHOD IN THE NEIGHBORHOOD OF THE AUGMENTED LINEAR
REGULATOR PROBLEM.
Abstract: The
perturbation
method is used to approximate optimal experimentation problems. The
approximation
is in the neighborhood of the linear regulator problem which has a
well-defined
solution procedure. The first order perturbation of the optimal
decision
under experimentation is a combination of the linear regulator solution
and a term that captures the impact of the uncertainty on the agent's
value
function. An algorithm is developed to quickly implement this procedure
on the computer. As a result, the impact of optimal experimentation on
an agent's decisions can be quantified and estimated for a large class
of problems encountered in economics.
7. MONETARY
POLICY WITH A TOUCH OF BASEL(Previous title "The Conduct of Monetary
Policy
under the Basel Accord")
Written with Ralph Chami
Abstract: Monetary policy impacts
banks under the Basel Accord through its influence on the net interest
margin between loan and deposit rates. The net interest margin is above
the marginal cost of loans because of anti-competitive pricing by
banks.
If the central bank raises the treasury rate, there is a corresponding
change in the deposit rate both this quarter and in the future, which
leads
to an increase in the marginal cost of loans. The higher marginal cost
of loans results in the bank setting a smaller net interest
margin
which reduces loans and profits. In anticipation of a reduction in the
use of total capital in the future, the bank chooses to reduce total
capital.
The lower total capital implies that the bank is less likely to meet
unanticipated
increases in loan demand in the future. Thus, contractionary monetary
policy
under the Basel Accord acts through its restriction on bank's total
capital.(View
paper .pdf)
8. DISCRETIONARY DISCLOSURES OVER TIME
Written with Bjorn Jorgensen and
Ram Ramanan
Abstract: We formulate the multi-period problem of discretionary disclosures of the value relevant component of earnings when disclosure of earnings is mandatory. We establish that there only exists partial disclosure equilibrium characterized by a disclosure threshold, such that discretionary disclosures arise if and only if the information is above the threshold. This disclosure threshold is increasing in the mean and decreasing in the variance of earnings. Further, the threshold can either increase or decrease over time.
Recent Publications
1. CAPITAL TRADING, STOCK TRADING, AND
THE
INFLATION TAX ON EQUITY
Written with
Ralph Chami and
Connel Fullenkamp
Review of
Economic
Dynamics, July 2001
NOTE:
Review of Economic
Dynamics, October 2003 Written with Scott Baier,
Charles Carlstrom, Ralph Chami, Timothy Fuerst, and Connel Fullenkamp.
Abstract: A market for used
capital goods, or financial instruments that represent the ownership of
th used capital goods, induces inflation taxes on wealth and on the
norminal
income flows they provide. This paper explicity introduces
trading
in either used capital goods or financial instruments into the standard
stochastic growth model with money and production. These two
monetary
economies are equivalent. The value of the firm is equal to the
firm's
capital stock divided by inflation. The resulting asset-pricing
conditions
indicate that the effect of inflation on asset returns differs from the
effects found in the literature by the addition of a significant wealth
tax. (View
paper .pdf)
2. Financial
Institutions and Trustworthy Behavior in Business Transactions Journal
of Business Ethics 52(2), (2004) 179-188.
Abstract: This paper uses the
bankruptcy proceedings for Enron to discuss the role of financial
institutions in business transactions. Using recent work by Dixit a
business transaction is portrayed as a prisoners’ dilemma problem
between competing firms. The financial institution’s role in this world
is to provide information and enforce contracts so that the parties to
the business deal act cooperatively. This role is recognized in the law
under the heading of Fiduciary Responsibility. In the Enron case the
bankruptcy examiner has argued that the Tier 1 financial institutions
for Enron failed to carry out their fiduciary responsibility. As a
result, the examiner has asked a fact finder to subordinate the claims
of the Tier 1 financial institutions to other debt holders for Enron.(View
paper .pdf)