Search Results
Journal Article
Special repo rates: an introduction
Transactions involving repurchase agreements (known as repos and reverses) are important tools the Federal Reserve uses in implementing monetary policy. By undertaking such transactions with primary dealers, the Fed can temporarily increase or decrease the quantity of reserves in the banking system. The focus of this article is the repo market, especially the role the market plays in the financing and hedging activities of primary dealers. The author explains the close relation between the price premium that newly auctioned, or on-the-run, Treasury securities command and the special repo ...
Journal Article
Forces that shape the yield curve
The yield curve shows how the yield on a government bond depends on the bond's maturity. Monetary policymakers and observers pay special attention to the shape of the yield curve as an indicator of the economic impact of current and future monetary policy. Without the proper analytical tools, however, drawing inferences from the yield curve can be difficult. This article uses high-school algebra to introduce those tools in a rigorous but accessible way. ; The author develops the basic ideas about the yield curve using an analogy. Next, he discusses bond pricing in a world of perfect ...
Working Paper
Consumption and asset prices with homothetic recursive preferences
When preferences are homothetic, utility can be expressed in terms of current consumption and a variable that captures all information about future opportunities. We use this observation to express the differential equation that characterizes utility as a restriction on the information variable in terms of the dynamics of consumption. We derive the supporting price system and returns process and thereby characterize optimal consumption and portfolio decisions. We provide a fast and accurate numerical solution method and illustrate its use with a number of Markovian models. In addition, we ...
Working Paper
Around and around: the expectations hypothesis
We show how to construct arbitrage-free models of the term structure of interest rates in which various expectations hypotheses can hold. McCulloch (1993) provided a Gaussian non-Markovian example of the unbiased expectations hypothesis (U--EH), thereby contradicting the assertion by Cox, Ingersoll, and Ross (CIR, 1981) that only the so-called local expectations hypothesis could hold. We generalize that example in three ways: (i) We characterize the U--EH in terms of forward rates; (ii) we extend this characterization to a class of expectations hypotheses that includes all of those considered ...
Journal Article
Happy hour economics, or how an increase in demand can produce a decrease in price
The standard supply-and-demand model is typically an economist?s most important analytical tool, but in some situations it does not capture the features of interest. For example, during ?happy hour,? bars near workplaces sell a higher-than-usual quantity of alcoholic beverages at a lower-than-usual price. This practice makes little sense using the standard competitive model, but an alternative model?the model of monopolistic competition?provides the needed analytic framework. ; This article provides a step-by-step construction of a monopolistic competition model in which many firms each ...
Working Paper
Consumption and asset prices and recursive preferences
We analyze consumption and asset pricing with recursive preferences given by Kreps--Porteus stochastic differential utility (K--P SDU). We show that utility depends on two state variables: current consumption and a second variable (related to the wealth--consumption ratio) that captures all information about future opportunities. This representation of utility reduces the internal consistency condition for K--P SDU to a restriction on the second variable in terms of the dynamics of a forcing process (consumption, the state--price deflator, or the return on the market portfolio). Solving the ...
Journal Article
Modeling the term structure of interest rates: an introduction
The yield curve, or the term structure of interest rates, plays a central role in the economy. Monetary policy is conducted by targeting rates at the short end of the curve, and longer-term yields reflect expectations of future changes in short rates. ; This article presents a model of the term structure that builds on a simpler model outlined in one of the author?s earlier Economic Review articles. The more complex model presented here takes into account the ongoing uncertainty about an asset?s price over time. The article focuses on modeling the dynamics of the state-price deflator, which ...
Working Paper
Consumption and asset prices with recursive preferences: Continuous-time approximations to discrete-time models
This paper presents tractable and efficient numerical solutions to general equilibrium models of asset prices and consumption where the representative agent has recursive preferences. It provides a discrete-time presentation of the approach of Fisher and Gilles (1999), treating continuous-time representations as approximations to discrete-time "truth." First, exact discrete-time solutions are derived, illustrating the following ideas: (i) The price-dividend ratio (such as the wealth-consumption ratio) is a perpetuity (the canonical infinitely lived asset), the value of which is the sum of ...
Working Paper
Bayesian Inference and Prediction of a Multiple-Change-Point Panel Model with Nonparametric Priors
Change point models using hierarchical priors share in the information of each regime when estimating the parameter values of a regime. Because of this sharing, hierarchical priors have been very successful when estimating the parameter values of short-lived regimes and predicting the out-of-sample behavior of the regime parameters. However, the hierarchical priors have been parametric. Their parametric nature leads to global shrinkage that biases the estimates of the parameter coefficient of extraordinary regimes toward the value of the average regime. To overcome this shrinkage, we model ...