Careful Price Level Targeting pdf version
Abstract: This paper examines a class of interest rate rules that respond to public expectations and to lagged variables. Varying levels of commitment correspond to varying degrees of response to lagged output and targeting of the price level. If the response rises (unintentionally) above the optimal level, the outcome deteriorates severely. Hence, the optimal level of commitment is sensitive to the method of expectations formation and partial commitment is the robust, optimal policy.
Quantity Rationing of Credit pdf version
Abstract: Quantity rationing of credit, when firms are denied loans, has greater potential to explain macroeconomics fluctuations than borrowing costs. This paper develops a DSGE model with both types of financial frictions. A deterioration in credit market confidence leads to a temporary change in the interest rate, but a persistent change in the fraction of firms receiving financing, which leads to a persistent fall in real activity. Empirical evidence confirms that credit market confidence, measured by the survey of loan officers, is a significant leading indicator for capacity utilization and output, while borrowing costs, measured by interest rate spreads, is not.
Quantity Rationing of Credit and the Phillip’s Curve pdf version
Abstract: Quantity rationing of credit, when some firms are denied loans, has macroeconomics effects not fully captured by measures of borrowing costs. This paper develops a monetary DSGE model with quantity rationing and derives a Phillips Curve relation where inflation dynamics depend on cyclical unemployment, a risk premium and the fraction of firms receiving financing. Unemployment arising from disruptions in credit flows is defined to be cyclical. GMM estimates using data from a survey of bank managers confirms the importance of these variables for inflation dynamics.
Learning, Commitment and Monetary Policy: the case for partial commitment pdf version, Macroeconomic Dynamics 13(4), 2009, 421-449
Abstract: This paper examines a class of interest rate rules, studied in Evans and Honkapohja (2003, 2006), that respond to public expectations and to lagged variables. Their work is extended by considering varying levels of commitment that correspond to varying degrees of response to lagged output. Under commitment the policymaker adjusts the nominal rate with lagged output to impact public expectations. Within this class of rules, I provide a condition for non-explosive and determinate solutions. Expecatational stability obtains for any non-negative response to lagged output. Simulation results show that modified commitment, as advocated by Blake (2001), is best under least squares learning. However, in the presence of parameter uncertainty and/or measurement error in the policymaker's data on public expectations, the best policy is one of partial commitment, where the response to lagged output is less than under modified commitment. The case for partial commitment is strengthened if the gain parameter in the learning mechanism is high, which can be interpreted as the use of few lags by public agents in the formation of expectations or as an indication of low credibility of the policymaker. The appointment of a conservative central banker ameliorates these concerns about modified commitment.
Dangers of Commitment under Rational Expectations pdf version, Journal of Economics and Finance, forthcoming
Abstract: Within a New Keynesian framework, interest rate rules that respond to public expectations lead to determinate and expectationally stable solutions for any level of commitment, as shown by Waters (2009). That paper also demonstrates gains to commitment, under least square learning, though over-commitment can lead to some very poor outcomes for some parameter values. This paper shows an identical outcome under rational expectations. The optimal level of commitment is unchanged if there are observation errors in the policymaker's knowledge of public expectations, which is not the case under learning. However, if there is sufficient policymaker uncertainty about the parameter values, partial commitment is best.
Regime Changes, Learning and Monetary Policy pdf version, Journal of Macroeconomics 29(2), 2007, 255-282
Abstract: Monetary policymakers should be concerned with potential changes in regime. In the model presented here, increasing returns in production creates the possibility of multiple expectationally stable steady states. The policymaker tries to achieve the two goals of smoothing fluctuations around the high output steady state, while trying to prevent the economy from slipping to the inferior, low output steady state. Agents use a learning rule to make forecasts and a key parameter in the rule provides an indication of the credibility of the policymaker. The greater the magnitude of the shocks and the lower the credibility of the policymaker, the more emphasis should be placed on stabilizing output.
Dangers of Commitment: Monetary Policy with Adaptive Learning pdf version, Journal of Economics and Finance 30(1), 2006, 93-104
Abstract: This paper studies a class of interest rate rules, introduced by Evans and Honkapohja (2001a, 2004), that respond to public expectations and to lagged variables. The policymaker commits to the extent that the interest rate responds to lagged output in an effort to influence public expectations. Simulation results show that full commitment, the commitment optimum under rational expectations, is not optimal under adaptive learning for any reasonable parameter values.
Endogenous Rational Bubbles pdf version
Abstract: Tests on simulated data from an asset pricing model with heterogeneous forecasts show excess variance in the price and ARCH effects in the returns, features not explained by the strong version of the efficient markets hypothesis. An evolutionary game theory dynamic describe how agents switch between a fundamental forecast, a rational bubble forecast and the reflective forecast, which is a weighted average of the former two. Conditions determining the frequency and duration of episodes where a significant fraction of agents adopt the rational bubble forecast leading to large deviations in the price-dividend ratio are discussed.
Chaos in the Cobweb Model with a New Learning Dynamic pdf version Journal of Economics Dynamics and Control 33(6), 2009, 1201-1216
Abstract: The new learning dynamic of Brown, von Neumann and Nash (1950) is introduced to macroeconomic dynamics via the cobweb model to describe switching between rational and naive forecasting strategies. This dynamic has appealing properties such as positive correlation and inventiveness. There is persistent heterogeneity in the forecasts and chaotic behavior for a range of parameter values, and there are bifurcations between periodic orbits and strange attractors as in previous studies. Unlike Brock and Hommes (1997), the steady state is never a saddle and attractors show cycling around an unstable steady state. When agents are sufficiently aggressive in switching to better performing strategies, there is minimal variation in the price.
Instability in the Cobweb Model under the BNN dynamic pdf versionJournal of Mathematical Economics 46(2), 2010, 230-237
Abstract: The cobweb model where firms choose between rational and naive forecasting strategies has a 2-cycle when the elasticity of supply is greater than for demand for a number is different dynamics describing the evolution of strategy choices. This paper proves that the 2-cycle is exponentially unstable under the learning dynamic of Brown, von Neuman and Nash (1950). Issues arising in the analysis of piecewise smooth discrete time maps are discussed.
An Evolutionary Game Theory Explanation of ARCH Effects with William R. Parke pdf version, Journal of Economic Dynamics and Control 31(7), 2007, 2234-2262
Abstract: ARCH/GARCH models have been widely used to examine financial markets data, but formal explanations for the sources of conditional volatility are lacking. This paper demonstrates the existence of GARCH effects similar to those found in asset returns, in a standard asset pricing model with heterogeneous agents. Evolutionary game theory describes how agents endogenously switch between different forecasting strategies based on past forecast errors. We show conditions under which agents agree on the fundamental forecast and those where agents adopt strategies that use extraneous information. Divergence from agreement on fundamentals could lead to periods of high volatility in prices and returns. Econometric tests of simulated data show the existence of GARCH effects, we examine the impact of changes in the model parameters.
On the Evolutionary Stability of Rational Expectations with William R. Parke pdf version
Abstract: Evolutionary game theory provides a fresh perspective on the prospects that agents with heterogeneous expectations might eventually come to agree on a single expectation. We establish conditions under which such convergence of beliefs does occur, but also show that sufficient curvature in payoff weighting functions agents use to value forecasting performance can lead to persistent heterogeneous expectations. We illustrate our results in the context of an asset pricing model where a martingale solution competes with the fundamental solution for agents' attention.
Modeling Heterogeneous Forecasting Strategies the Right Way pdf version
Abstract: The a-BNN dynamic retains the desirable features of the BNN dynamic without the lack of a continuous derivative that complicates the analysis of the cobweb model under the latter. Both dynamics satisfy positive correlation and inventiveness, and there is an intuitively appealing steady state where one strategy dominates, which is not possible with the multinomial logit dynamic. Stability of the 2-cycle is analyzed.
Equity Price Bubbles in the Middle Eastern and North African Financial Markets with Mohammad Jahan-Parvar, Emerging Markets Review, 11(1), 2010, 39-48
Abstract: We empirically investigate the existence of periodically collapsing bubbles in seven Middle East and North African (MENA) financial markets for the period ending in May of 2009. We use the <cite>TaylorPeel98EL</cite> residual augmented least square Dickey and Fuller test (RALS DF) to detect the bubbles. We find that the hypothesis of a bubble formation cannot be rejected for all seven markets investigated in our study, leading us to believe that in fact there has been a break down in the cointegration relationship between real equity prices and real dividends and also between real market capitalizations and real dividends.
Unit Root Testing for Bubbles: A Resurrection? pdf version Economics Letters 101(3), 2008, 279-281
Abstract: Evans (1991) and Charemza and Deadman (1995) present models of bubbles that are not empirically detectable by unit root tests. However, the stochastic elements of those models enter multiplicatively, while the Monte Carlo results in those papers use a linear unit root test. This paper presents results based on the more natural log specification of the simulated data and shows that bubbles generated by the stochastic explosive unit root model of Charemza and Deadman (1995) are detectable by properly specified unit root tests while those of Evans' (1991) model of periodically collapsing bubbles are not.
REIT Markets and Rational Speculative Bubbles: An Empirical Investigation with James E. Payne pdf version, Applied Financial Economics 17(9), 2007, 747-753
Abstract: This paper uses the momentum threshold autoregressive (MTAR) model and the residuals augmented Dickey-Fuller approach to test for the presence of Evans’ (1991) periodically collapsing bubbles in the domestic REIT markets. The RADF test shows evidence of bubbles, but the results of the MTAR test are mixed. The MTAR test shows asymmetric adjustment for each REIT market, but only mortgage REITs show evidence of bubbles, which turn out to be negative meaning the price falls substantially below the level warranted by fundamentals.
Have Equity REITs Experiences Periodically Collapsing Bubbles? with James E. Payne pdf version, Journal of Real Estate Finance and Economics 34(2), 2007, 207-224
Abstract: This paper uses the momentum threshold autoregressive (MTAR) model and the residuals-augmented Dickey-Fuller (RADF) test to examine the possibility of Evans’ (1991) periodically collapsing bubbles in the equity REIT market. The results are mixed. The MTAR model indicates that overall real equity REIT prices and dividends are cointegrated with asymmetric adjustment towards the long-run equilibrium. However, the estimated coefficients of the MTAR model do not indicate the presence of periodically collapsing bubbles. Adjustment in the standard cointegration tests of bubbles for skewness and excess kurtosis via the RADF test fails to reject the null hypothesis of no cointegration, leaving the possibility of periodically collapsing bubbles. The MTAR and RADF results with respect to equity REIT sub-sectors are mixed. Lodging is the only sub-sector in which both the MTAR and RADF results support periodically collapsing bubbles. Moreover, market fundamentals proxied by two alternative measures of capacity utilization do not explain either real equity REIT prices or dividends.
REITs Market: Periodically Collapsing Negative Bubbles? with James E. Payne, pdf version, Applied Financial Economics Letters 1(2), 2005, 65-69
Abstract: This paper uses the momentum threshold autoregressive (MTAR) model to test for the presence of negative bubbles in the REITs market over the period 1972:01 to 2004:05. The results indicate that the respective REIT prices and dividends are cointegrated; however, there is asymmetric adjustment towards the long-run equilibrium. The estimated coefficients of the MTAR model indicate the presence of negative bubbles in the mortgage and hybrid REIT markets.
Interest Rate Pass Through and Asymmetric Adjustment: Evidence from the Federal Funds Rate Operating Target Period with James E. Payne, Applied Economics 40(11), 2008, 1355-1362
Abstract: This study examines the long-run interest rate pass through of the federal funds rate to the prime rate and whether there is asymmetric adjustment in the prime rate using the Enders-Siklos (2001) momentum threshold autoregressive (MTAR) model over the period 1987:2 to 2005:10. Once allowance is made for the endogenously determined structural break in the cointegrating relationship in 1996:4, the adjustment of the prime rate to changes in the federal funds rate appears asymmetric with upward rigidity, a result contrary to previous studies which found that the prime rate exhibits downward rigidity. The finding of upward rigidity in the prime rate lends support for the customer reaction and adverse selection hypotheses. Moreover, the empirical evidence seems to support the observation of increased pass through as a result of heightened competition in the banking industry as well as the Federal Reserve’s enhanced transparency in monetary policy during the 1990s.
Persuasive Advertising with Network Effects pdf version
Abstract: If there's lots of advertising, you're paying too much. This paper studies a linear city model where status is a consumption externality that depends on the number of other people using the product. Advertising affects utility both directly and through the magnitude of the externality. A major finding is that when a firm's advertising positively affects the status of its own product then the optimal level of advertising under competition is decreasing with the strength of the status effect. However, if firms collude the opposite is true and advertising increases with the magnitude of the status effect.