The monetary policy dilemma: Will interest rates have to rise?

UK interest rates are now at their lowest level for more than two decades, and the government is hoping that interest rates can be kept at a low and sustainable level comparable to the 1960s. Indeed, some commentators are calling for still lower interest rates to offset the risk that the £12bn tax increases and cuts in government spending that will come into effect in the next financial year will lead to stagnant consumer spending and a stalled recovery. Against this must be weighed the risk that the recent very good run of inflation figures will prove temporary. Both headline and underlying inflation will be pushed up by indirect tax increases and there is the possibility that wages will follow too, as employees seek to maintain their living standards in a tightening labour market. That risk would point to a much more cautious monetary policy stance and the possibility that the government may need to raise rates from their present level if it is to achieve its inflation objective. The Chancellor faces a clear dilemma. In this Viewpoint, we assess the evidence available to guide him in his decisions and draw out the implications for the future path of interest rates.     

A Practical Framework for the Analysis of Social Security Reform

‘When I use a word’, Humpty Dumpty said in a rather scornful tone, ‘it means just what I choose it lo mean — neither more nor less’. (Through the Looking Glass, Ch. 6)     

THE DETERMINANTS OF ILLEGAL DRUG USE

An extensive set of self-reported survey data exists on illegal drug use. The survey data show that drug use is quite frequent among the younger adult population, relatively infrequent among those of high-school age, and rare among middle-aged and older adults. Drug use varies by occupational category in ways that are difficult to rationalize. This study utilizes a model in which an individual's time is allocated among labor, non-drug consumption, leisure, and drug use, where the individual is cognizant of the effect of drug use on his wages. The study analyzes comparative static results and then uses data from the National Longitudinal Survey of Youth to estimate a probit model of the individual decision to use drugs. The findings of the study are that non-economic factors dominate the decision for both harder drugs and drugs more broadly defined. One must consider this finding tentative, however, since usable drug price data were not available.     

Evidence on the Timing and Determinants of Overfunded Pension Plan Termination

This paper examines the factors associated with the timing of overfunded pension plan termination.     

Trading Volume: Implications of an Intertemporal Capital Asset Pricing Model

We derive an intertemporal asset pricing model and explore its implications for trading volume and asset returns. We show that investors trade in only two portfolios: the market portfolio, and a hedging portfolio that is used to hedge the risk of changing market conditions. We empirically identify the hedging portfolio using weekly volume and returns data for U.S. stocks, and then test two of its properties implied by the theory: Its return should be an additional risk factor in explaining the cross section of asset returns, and should also be the best predictor of future market returns.     

How to Discount Cashflows with Time-Varying Expected Returns

While many studies document that the market risk premium is predictable and that betas are not constant, the dividend discount model ignores time‐varying risk premiums and betas. We develop a model to consistently value cashflows with changing risk‐free rates, predictable risk premiums, and conditional betas in the context of a conditional CAPM. Practical valuation is accomplished with an analytic term structure of discount rates, with different discount rates applied to expected cashflows at different horizons. Using constant discount rates can produce large misvaluations, which, in portfolio data, are mostly driven at short horizons by market risk premiums and at long horizons by time variation in risk‐free rates and factor loadings.     

Who Do Heterodox Economists Think They Are?1

This paper attempts to engage with the established debate on the nature of heterodox economics. However, it starts from the position that previous attempts to classify and identify heterodox economics have been biased towards a priori definition. The paper aims to inform the discussion of the nature of heterodoxy with some empirical analysis. The paper examines survey data collected from a small/medium‐sized sample of AHE members on the core concepts in economics. The paper applies factor analysis to the data. It also applies principles of biological taxonomy, and thence cluster analysis to the problem. The paper finds that within the self‐identified community of self‐identified heterodox economists there is little agreement as to whether members are pluralist, or what their attitude is to the mainstream. Indeed, there is little agreement on any core concepts or principles. The paper argues that there is little structure to heterodox economics beyond that provided by pre‐existing (or constituent) schools of thought. Based on this study, heterodox economics appears a complex web of interacting individuals and as a group is a fuzzy set. These results would lead us to question further strict distinctions between heterodox, mainstream and pluralist economists.     

Public Information and Coordination: Evidence from a Credit Registry Expansion

This paper provides evidence that lenders to a firm close to distress have incentives to coordinate: lower financing by one lender reduces firm creditworthiness and causes other lenders to reduce financing. To isolate the coordination channel from lenders' joint reaction to new information, we exploit a natural experiment that forced lenders to share negative private assessments about their borrowers. We show that lenders, while learning nothing new about the firm, reduce credit in anticipation of other lenders' reaction to the negative news about the firm. The results show that public information exacerbates lender coordination and increases the incidence of firm financial distress.     

An Exploratory Study of the Complexities of Coping Behavior in Adirondack Wilderness

Recreation researchers have considered coping behaviors one possible explanation for wilderness recreationists' high overall satisfaction levels despite reports of visitor over-crowding and other social conditions exceeding acceptable levels. Studies of recreationists' use of behavioral coping and cognitive coping mechanisms have had mixed results. This study used field-based interviews and surveys to identify coping behavior by hikers in the wilderness areas of New York's Adirondack Park. Findings indicate that wilderness hikers develop complex and variable strategies of coping behavior to maintain multiple satisfactions.     

A Nonparametric Approach to Pricing and Hedging Derivative Securities Via Learning Networks

We propose a nonparametric method for estimating the pricing formula of a derivative asset using learning networks. Although not a substitute for the more traditional arbitrage-based pricing formulas, network-pricing formulas may be more accurate and computationally more efficient alternatives when the underlying asset's price dynamics are unknown, or when the pricing equation associated with the no-arbitrage condition cannot be solved analytically. To assess the potential value of network pricing formulas, we simulate Black-Scholes option prices and show that learning networks can recover the Black-Scholes formula from a two-year training set of daily options prices, and that the resulting network formula can be used successfully to both price and delta-hedge options out-of-sample. For comparison, we estimate models using four popular methods: ordinary least squares, radial basis function networks, multilayer perceptron networks, and projection pursuit. To illustrate the practical relevance of our network pricing approach, we apply it to the pricing and delta-hedging of S&P 500 futures options from 1987 to 1991.