Contagion of self-fulfilling financial crises due to diversification of investment portfolios

We look at two countries that have independent fundamentals, but share the same group of investors. Each country might face a self-fulfilling crisis: Agents withdrawing their investments fearing that others will. A crisis in one country reduces agents’ wealth. This makes them more averse to the strategic risk associated with the unknown behavior of other agents in the second country, increasing their incentive to withdraw their investments. Consequently, the probability of a crisis there increases. This generates a positive correlation between the returns in the two countries. Since diversification affects returns in our model, its welfare implications are non-trivial.     

Some international evidence on the Lucas Supply Function

We provide empirical evidence on the Lucas Supply Function based on actual inflation surprises for 19 industrial economies. Our results show that the inflation surprise positively correlates with the output gap and that this relationship is negatively related to inflation variability.     

When sunspots don't matter

Summary We show that a finite, competitive economy isimmune to sunspots if (i) preferences are strictly convex, (ii) the set of feasible allocations is convex, and (iii) the contingent-claims market is perfect. The conditions (i)–(ii) cover some, but not all, economies with nonconvex technologies. Based on an indivisible-good example, we show that even economies with strictly convex preferences and full insurance arenot in general immune from sunspots. We also show that (1) the sufficient conditions (i)–(iii) are not necessary for sunspot immunity and (2)ex-ante efficiency is not necessary for immunity from sunspots.This paper is based on an earlier paper, Indivisibilities in Production, and Sunspot Equilibrium, presented at the 1990 S.E.D.C. Meetings, Minneapolis-St. Paul, June 1990. The research support of NSF Grant SES-9012780, the Center for Analytic Economics, and the Thorne Fund is gratefully acknowledged.     

Existence of adaptively stable sunspot equilibria near an indeterminate steady state

We examine the nonlinear model x_t=E_tF(x_t+1). Markov stationary sunspot equilibria (SSEs) exist near an indeterminate steady state, , provided . Despite the importance of indeterminacy in macroeconomics, earlier results have not provided conditions for the existence of adaptively stable SSEs near an indeterminate steady state. We show that there exist Markov SSEs near x? that are E-stable, and therefore locally stable under adaptive learning, if .     

Sunspot fluctuations in dynamics with predetermined variables

Summary. In this paper, I study the existence of Sunspot Equilibria in a general framework whose dynamics allow for the presence of predetermined variables in the system. The main motivation for this research comes from the fact that previous studies did not allow for such predetermined variables which, nevertheless, appear quite naturally in economic models. I show, for a non-negligible subset of dynamics with predetermined variables verifying usual assumptions, the existence of Stationary Sunspot Equilibria fluctuating between an arbitrary finite number of states arbitrarily close to a steady state. Received: March 1, 1995; revised version September 18, 1996     

Expectations and optimal monetary policy: A stability problem revisited

A landmark result in the optimal monetary policy design literature is that fundamental-based interest rate rules invariably lead to rational expectations equilibria (REE) that are not stable under adaptive learning. In this paper, we make a novel information assumption that private agents cannot observe aggregate fundamental shocks, and use simple linear forecasting rules for learning. We find that with fundamental-based rules, there exist limited information equilibria that are stable under learning. Moreover, there are multiple equilibria. Learning can be used as a selection tool to identify a unique equilibrium.     

CAPITAL–LABOUR SUBSTITUTION AND ENDOGENOUS FLUCTUATIONS: A MONOPOLISTIC COMPETITION APPROACH WITH VARIABLE MARKUP*

This paper analyses an overlapping generations model with endogenous product diversity where strategic interactions between producers are introduced; it examines how they affect the stability properties of the steady state. Because of free entry, strategic interactions between producers imply a new dynamic feature, markup variability, promoting indeterminacy and endogenous cycles. Indeed, in contrast to the model without strategic interaction, endogenous fluctuations can occur when the substitution between the production factors, capital and labour, is not too weak, but in accordance with empirical estimates.     

Countercyclical pricing: A consumer heterogeneity explanation

We show that a seasonal good could be priced countercyclically due to the heterogeneous seasonal shifts in consumer valuations. We provide empirical support for our explanation based on two product categories (canned soup and tuna) studied in the literature.     

Robust estimation and control under commitment

In a Markov decision problem with hidden state variables, a decision maker expresses fear that his model is misspecified by surrounding it with a set of alternatives that are nearby as measured by their expected log likelihood ratios (entropies). Sets of martingales represent alternative models. Within a two-player zero-sum game under commitment, a minimizing player chooses a martingale at time 0. Probability distributions that solve distorted filtering problems serve as state variables, much like the posterior in problems without concerns about misspecification. We state conditions under which an equilibrium of the zero-sum game with commitment has a recursive representation that can be cast in terms of two risk-sensitivity operators. We apply our results to a linear quadratic example that makes contact with findings of T. Ba?ar and P. Bernhard [H^∞-Optimal Control and Related Minimax Design Problems, second ed., Birkhauser, Basel, 1995] and P. Whittle [Risk-sensitive Optimal Control, Wiley, New York, 1990].     

“Ex-ante” Taylor rules and expectation forming in emerging markets

The success of monetary policy in stabilizing inflation depends substantially on its influence on expectation formation of private agents. This paper provides a novel perspective on the expectation forming process of financial markets. Using forecasts for the short-term interest rate, the inflation rate, and output growth for 10 emerging markets in Latin-America, central and eastern Europe, we estimate expected (“ex-ante”) Taylor-type rules. We find evidence for significant differences in the expectation formation process in the sense that the well-known Taylor principle fairly holds for only some countries, while for the other countries it does not. The adaption of an explicit inflation targeting regime seems to explain this cross-country differences.     

Sunspots and predictable asset returns

This paper uses a stylised asset-pricing model to show that sunspots may cause asset returns to be predictable, a widely documented feature of many speculative markets. This result parallels and extends previous works showing that sunspots render asset prices excessively volatile.     

Business cycle and corruption

In studying the Great Depression, Galbraith asserts that the higher the transitory income the higher the corruption. For a panel of 39 countries over 13 years, 1995-2007, Galbraith's claim holds. Regression analyses also confirm that the higher the permanent income, the lower the corruption.     

A risk-driven approach to exchange rate modelling

The paper presents a new approach to exchange rate modelling that augments the CHEER model with a sovereign credit default risk as perceived by financial investors making their decisions. In the cointegrated VAR system with nine variables comprised of the short- and long-term interest rates in Poland and the euro area, inflation rates, CDS indices and the zloty/euro exchange rate, four long-run relationships were found. Two of them link term spreads with inflation rates, the third one describes the exchange rate and the fourth one explains the inflation rate in Poland. Transmission of shocks was analysed by common stochastic trends. The estimation results were used to calculate the zloty/euro equilibrium exchange rate.