Search Results
Journal Article
A quantitative study of the role of wealth inequality on asset prices
This article studies the equilibrium properties of asset prices in a Lucas tree model when agents display a concave coefficient of absolute risk tolerance. This preference specification introduces a role for wealth inequality even under the presence of complete markets. The article finds evidence suggesting that the role of wealth inequality on asset prices may be non-negligible. The equity premium in the unequal economy is between 24 and 47 basis points larger than the equity premium displayed in an egalitarian economy.
Journal Article
On the benefits of GDP-indexed government debt: lessons from a model of sovereign defaults
Whether governments should issue GDP-indexed sovereign debt continues to be the subject of policy debates. This article contributes to this debate by studying the effects of issuing GDP-indexed sovereign debt contracts using the equilibrium default model studied by Aguiar and Gopinath (2006) and Arellano (2008). We consider an extension with perfect indexation, i.e., the government issues Arrow-Debreu securities with payoffs that depend on the next-period aggregate income realization. The ex-ante welfare gain from the introduction of income-indexed bonds is equivalent to a permanent increase ...
Working Paper
Debt dilution and sovereign default risk
We measure the effects of debt dilution on sovereign default risk and show how these effects can be mitigated with debt contracts promising borrowing-contingent payments. First, we calibrate a baseline model la Eaton and Gersovitz (1981) to match features of the data. In this model, bonds' values can be diluted. Second, we present a model in which sovereign bonds contain a covenant promising that after each time the government borrows it pays to the holder of each bond issued in previous periods the difference between the bond market price that would have been observed absent current-period ...
Working Paper
On the cyclicality of the interest rate in emerging economy models: solution methods matter
We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space ...
Working Paper
Sudden stops, time inconsistency, and the duration of sovereign debt
We study the sovereign debt duration chosen by the government in the context of a standard model of sovereign default. The government balances increasing the duration of its debt to mitigate rollover risk and lowering duration to mitigate the debt dilution problem. We present two main results. First, when the government decides the debt duration on a sequential basis, sudden stop risk increases the average duration by 1 year. Second, we illustrate the time inconsistency problem in the choice of sovereign debt duration: Governments would like to commit to a duration that is 1.7 years shorter ...
Journal Article
Europe may provide lessons on preventing mortgage defaults
During the last global recession, house prices fell in some European countries almost as much as in some U.S. states. However, mortgage defaults occurred at a much lower rate in Europe. The authors say the difference might be explained by two regulations that apply in Europe but are used on a limited or much less restrictive basis in the U.S.
Working Paper
Mortgage defaults
We incorporate house price risk and mortgages into a standard incomplete market (SIM) model. We calibrate the model to match U.S. data, and we show that the model also accounts for non-targeted features of the data such as the distribution of down payments, the life-cycle prole of homeownership, and the mortgage default rate. In addition, we show that the average coefficients that measure the agents' ability to self-insure against income shocks are similar to those of a SIM model without housing (as presented by Kaplan and Violante, 2010). However, incorporating housing increases the values ...
Briefing
Recoveries from recessions associated with banking crises : how does this one compare?
Recessions associated with banking crises tend to differ from other recessions in that the weakness of the financial sector, particularly the limited supply of credit, encumbers the subsequent recovery. The recovery from the 2007-09 recession, compared to past recoveries from recessions associated with banking crises, is within the historical range in terms of its level of GDP growth. In terms of unemployment, however, the recovery from the 2007-09 recession is markedly weaker than the historical norm.>
Working Paper
Asymmetric information and the lack of international portfolio diversification
There is pervasive evidence that individuals invest primarily in domestic assets and thus hold poorly diversified portfolios. Empirical studies suggest that informational asymmetries may play a role in explaining the bias towards domestic assets. In contrast, theoretical studies based on asymmetric information fail to produce significant quantitative effects. The present paper develops a theoretical model in which the presence of informational asymmetries explains a significant fraction of the home equity bias observed in the data. The main departure from previous theoretical work is the ...