The Quantitative Importance of News Shocks in Estimated DSGE Models

We estimate a dynamic stochastic general equilibrium (DSGE) model with several frictions and both unanticipated and news shocks, using quarterly U.S. data from 1954 to 2004 and Bayesian methods. We find that unanticipated shocks dominate news shocks in accounting for the unconditional variance of output, consumption, and investment growth, interest rate, and the relative price of investment. The unanticipated shock to the marginal efficiency of investment is the dominant shock, accounting for over 45% of the variance in output growth. News shocks account for less than 15% of the variance in output growth. Within the set of news shocks, nontechnology sources of news dominate technology news, with wage markup news shocks accounting for about 60% of the variance share of both hours and inflation. We find that in the estimated DSGE model (i) the presence of endogenous countercyclical price and wage markups due to nominal frictions substantially diminishes the importance of news shocks relative to a model without these frictions, and (ii) while there is little change in the estimated contributions of technology news when we restrict wealth effects on labor supply, the contributions of nontechnology news shocks are relatively more sensitive.     

The Rationality and Efficiency of Stock Price Relative to Money Announcement Information

Recent studies find that stock price reacts only to unanticipated changes in the money supply. These studies assume a joint hypothesis of rationality and efficiency in their tests. This paper formulates a model in which stock price depends both upon anticipated and unanticipated money supply forecasts. From this model, an econometric model that separates the hypotheses of rationality and efficiency is estimated. The results show that investors rationally incorporate forecasts of the weekly current money announcement into stock price during the pre-October 6, 1979, sample period. However, efficiency with respect to money information cannot be corroborated in this period. Cross-equation restrictions implied by rationality are rejected during the post-October 6, 1979, period. In this period, efficiency again cannot be corroborated. Alternative money prediction specifications indicate the robustness of these results.     

The Effects of Inflation and Money Supply Announcements on Interest Rates

This paper examines the impact of the money supply and inflation rate announcements on interest rates. Survey data on expectations of the money supply and consumer and producer price indexes are used to distinguish anticipated and unanticipated components of the announcements. This distinction is used to test for the efficiency of the financial market response to the announcements of new information. The results indicate that the unanticipated components of the announced changes in the Producers Price Index and in the money supply have an immediate positive effect on short-term interest rates. The Consumer Price Index announcement has no apparent effect. There is no evidence of a delayed announcement effect. However, there is some indication of a liquidity effect of the money supply change on interest rates. This takes place when reserves are changing and several weeks prior to the information announcement.     

Relative Price Variability,Real Shocks,and the Stock Market

In this paper, we investigate the effects of relative price variability on output and the stock market and gauge the extent to which inflation proxies for relative price variability in stock return-inflation regressions. The evidence shows that the negative stock return-inflation relations proxy for the adverse effects of relative price variability on economic activity, particularly during the seventies, when the U.S. experienced oil supply shocks. Hence, it appears that inflation spuriously affects the stock market in two ways: the aggregate output link of Fama (1981) and the supply shocks reflected in relative price variability.     

A quarterly model of unanticipated monetary growth,output and the price level in the U.K. 1963–1978

This paper develops and estimates using quarterly data from 1963 to 1978 a three-equation model of the U.K. economy, in which output is affected only by unanticipated monetary growth whereas the price level is influenced by both anticipated and unanticipated changes in the money supply. Expectations of monetary growth are assumed to be Muth-rational. The model was estimated using efficient procedures and tests of the over-identifying restrictions were favourable to the model specification. In particular, anticipated monetary growth was found to have no significant effect on output.     

Determinants of bid and ask quotes and implications for the cost of trading

Financial transaction costs are time varying. This paper proposes a model that relates transaction cost to characteristics of order flow. We obtain qualitatively consistent model results for different stocks and across different time periods. We find that an unusual excess of buyers (sellers) relative to sellers (buyers) tends to increase the ask (bid) price. Hence, the ask and bid components of spread change asymmetrically about the efficient price. For a fixed order imbalance surprise these effects are muted when unanticipated total volume is high. Unexpected high volatility in the transaction price process tends to widen the spread symmetrically about the efficient price. Our findings are consistent with predications from market microstructure theory that the cost of market making should depend on both the risk of trading with better-informed traders and inventory risk. We also find that order flow surprises have a significant impact on the efficient price and can also explain a substantial amount of persistence in the volatility of the efficient price. This dependence does not violate the efficient market hypothesis since the surprises, by definition, are not predictable.     

Market reaction to anticipated announcements

In this paper we analyze how anticipating a forthcoming public announcement affects the market reaction to the announcement by altering investors' incentives to acquire private information. Specifically, we study price change, volume, and information asymmetry at the time of the announcement. We also investigate how information acquisition, information asymmetry, price, and volume are influenced by the quality of prior knowledge, the marginal cost of gathering information, the degree of risk tolerance, and noise. Finally, we compare market reactions to anticipated announcements of known precision with the response to announcements that are either unanticipated or of uncertain quality.     

The Transmission of International Shocks: A Factor-Augmented VAR Approach

The empirical literature on the transmission of international shocks is based on small -scale VARs. In this paper, we use a large panel of data for 17 industrialized countries to investigate the international transmission mechanism, and revisit the anomalies that arise in the empirical literature. We propose a factor augmented VAR (FAVAR) that extends the model in Bernanke, Boivin, and Eliasz (2005) to the open economy. The main results can be summarized as follows. First, the dynamic effects on the UK economy of an unanticipated fall of short-term interest rates in the rest of the world are: real house price inflation, investment, GDP and consumption growth peak after 1 year, wages peak after 2 years, and CPI and GDP deflator inflation peak during the third year. Second, a positive international supply shock makes the distribution of the components of the UK consumption deflator negatively skewed. Third, in response to a domestic monetary shock, we find little evidence of the exchange rate and liquidity puzzles and little evidence of the forward discount and price anomalies.     

Partial anticipation, the flow of information and the economic impact of corporate debt sales

Corporate debt sales have been regarded as 'no news' eventsbecause there is no significant price reaction on average totheir announcement. We explore the hypothesis that this lackof average price reaction to debt sale announcements is explainedby the partial anticipation of debt offers. Theory suggeststhat the demand for debt capital is fundamentally related tochanges in the sources and uses of funds, and we find evidencethat earnings are significantly lower, investment growth issignificantly bigger, and, for some issuers, debt refundingrequirements are significantly greater in the period immediatelyprior to issue than in periods well before and after the issue.We find that this preissue information conditions investors'expectations of issue, thereby affecting the cross-sectionalannouncement date price reaction to debt sales in two ways.First, announcement date price reactions are negative, on average,for unanticipated offers or for those offers where prior informationsuggests that an issue is unlikely. Second, holding the probabilityof issue constant, announcement date price reactions are significantlymore negative for offers that raise more capital than investorsexpected. These results are consistent with cash flow signalingand asymmetric information models of corporate financings.     

Price,output, and exchange rate movements in the open economy

Since the advent of managed floating it has come to be accepted as a stylized fact that short-run deviations from purchasing power parity are both substantial and persistent. Two explanations of these deviations have been advanced in the literature. One emphasizes the role of changes in non-traded goods prices while the other views deviations from purchasing power parity as being due to sticky goods prices and slow adjustment of goods markets. This paper presents yet a third possible explanation of deviations from purchasing power parity — they may be necessary in order to facilitate the relative price changes that are required to maintain equilibrium in the face of unanticipated shocks. In addition, the issue of exchange rate overshooting is addressed. Whereas the sticky price models view exchange rate overshooting and exchange rate volatility as symptoms of some fundamental disequilibrium, the perspective taken here is that these events are, in principle, compatible with a world in which all markets clear continuously.     

A note on economic news and intraday exchange rates

Measured with intraday data in a 1987–1991 sample period, the mark/dollar exchange rate was affected by unanticipated information about the trade deficit and the consumer price index. The exchange rate showed no significant response to news about money supply, industrial production, the producer price index, or unemployment. Trade deficit surprises were negatively correlated with the value of the dollar as expected. CPI surprises showed a positive correlation, as would be predicted by sticky price models of exchange rates.The market's reaction to the 8:30am trade deficit announcement was complete by 9am, but the market's response to the CPI announcement was not as immediate. No significant reaction had occurred by 9am, and the spot price did not fully digest the information until 1pm. Significant responses were present in the 9am, 11am, and noon hours. Alternate measures of currency returns failed to explain this delayed response.     

Dating,discounting, and the robustness of the Lucas-Sargent proposition

From recent work by Thomas Sargent and others, it has become well known that, if expectations are formed rationally, monetary stabilization policy will be entirely ineffective in an economy in which the aggregate supply function relates output (relative to capacity) to the difference between the current price level and the value expected one period earlier. This paper considers whether this neutrality proposition holds when the expectation of some future price is compared with the current actual price in the supply equation. It is shown that the proposition remains valid if the future price is appropriately discounted.     

Market Response to the Weekly Money Supply Announcements in the 1970s

The hypothesis that the weekly announcement of the money supply affects interest rates is examined. The announcement effect is interpreted as a policy anticipation effect. That is, an unanticipated increase in the money supply leads to an increase in interest rates in anticipation of future tightening by the Federal Reserve. Estimates of this effect with proxies for the unanticipated change constructed from a survey of money supply forecasts and an ARIMA model indicate that: (a) financial markets respond very quickly to the announcement; and (b) the response was largest when policymakers emphasized the importance of the monetary aggregates.     

What is going on in the oil market?

Conclusion In this article, we propose a consistent view on the recent oil-price history based on fundamental data and economic theory. We sum up: After the turn of the century three major stylized shocks have hit market. First, the demand curve has shifted fight outwards, mainly driven, as extensively reported in the media, by sustained growth in China and other Asian Countries. Second, supply disruptions in countries with low extraction costs (Iraq and Venezuela) have shifted the supply curve to the left. Third, we show that speculators adjust their inventories in order to take advantage of predictable price fluctuations and play themselves a major role in the price formation. Optimal storage theory implies that aggregate inventories are negatively related to the oil price and positively to the volatility of supply and demand shocks. We provide evidence that the political events in the last years have increased volatility and induced the inventory curve to shift right outwards. We analyze in a graphical framework the interaction of all these shocks and conclude that speculators have caused the oil price to overshoot in the short run its long-run fundamental value. However, this is not at all attributable to market failure or the harmfulness of speculators. In fact, the opposite is true. Speculators have in general a dampening effect on the oil price. The record oil price in the very recent history is partly a consequence of speculators maintaining or building-up inventories to cope with the supply and demand shocks to come. Hence, high prices represent a short-term toll for future price stability. It follows from our analysis that the oil price is expected to fall towards its long-term mean, provided that no further shocks hit the economy and, critically, the oil supply. As we saw, this prediction is consistent with the observed prices in the futures markets. Also in terms of future price volatility, the outlook is rather upbeat. The increased inventory levels held by speculators will cushion the spot market against fluctuations in natural supply and demand and limit the degree to which the currently high underlying volatility will translate into higher price volatility. We would like to thank Manuel Ammann, Bernd Brommundt, Stephan Kessler, Ralf Seiz, Michael Verhofen, Hemrich von Wyss, and two anonymous referees for helpful comments We are particularly indebted to Sergej Peisotchenko at United Energy System (UES) of Russia and Jan Gjerde at Shell for clearing us up on technical aspects of oil production     

Money stock revisions and unanticipated money growth

An important ‘empirical regularity’ is the strong positive effect of money shocks on output and employment. One strand of business cycle theory relates this finding to temporary confusions between absolute and relative price changes. These models predict positive output effects of unperceived monetary movements, but the quantitative importance of unperceived shifts in nominal aggregates is subject to question. Another strand of theory, based on long-term nominal contracts and analogous price-setting institutions, generates output effects from unanticipated, but not necessarily contemporaneously unperceived, money shocks. However, the real effects of unpredicted, but contemporaneously understood, monetary changes are not obviously consistent with efficient institutional arrangements. The present paper provides some empirical evidence on the two types of theories by analyzing the output effects associated with revisions in the money stock data, where the revisions are interpreted as components of unperceived monetary movements. The revisions turn out to have no significant explanatory power for output. Previous findings that innovations from an estimated money growth equation have a significant output effect remain intact when the revisions are included as separate explanatory variables. Overall, the study provides a small amount of evidence against the special role of unperceived, as opposed to unanticipated, money movements as a determinant of business fluctuations.     

The Impact of Terrorist Attacks on International Stock Markets

We examine the effects of terrorist attacks on stock markets, using a dataset that covers all significant events and that directly relate to the major economies of the world. Our event study suggests that terrorist attacks produce mildly negative price effects. We compare these price reactions to those from an alternative type of unanticipated disaster, earthquakes, and find that price declines following terror attacks are more pronounced. However, in both cases prices rebound within the first week of the aftermath. We also compare price responses internationally and for separate industries, and find that reactions are strongest for local markets and for industries that are directly affected by the attack. Our results suggest that financial markets react strongly to terror events but then recover swiftly and soon return to business as usual. The September 11th attacks turn out to be the only event that caused long‐term effects on financial markets, especially in terms of industries' systematic risk.     

What do technology shocks tell us about the New Keynesian paradigm?

Researchers have used unanticipated changes to monetary policy to identify preference and technology parameters of macroeconomic models. This paper uses changes in technology to identify the same set of parameters. Estimates based on technology shocks differ substantially from those based on monetary policy shocks. In the post-World War II United States, a positive technology shock reduces inflation and increases hours worked, significantly and rapidly in both cases. Relative to policy shock identification, technology shock identification implies: (i) long duration durability in preferences instead of short duration habit, (ii) built-in inflation inertia disappears and price flexibility increases. In response to technological improvement, consumption durability increases hours worked because households temporarily increase labor supply to accumulate durables towards a new, higher steady state level. Limited nominal rigidities allow inflation to fall because firms are able to immediately cut prices when households’ labor supply increases. Finally, we consider alternative data constructions and econometric specifications; we find that (i) and/or (ii) hold in nearly every case.     

The effect of sequential information releases on trading volume and price behaviour

This paper examines a two-period setting in which each trader receives a private signal, possibly different, in each period before he trades. The principal objectives are threefold. First, we describe the risky asset demands and price reactions in a noisy rational expectations equilibrium where the time 1 average private signal is not revealed by the price sequence but the time 2 average private signal is. Secondly, we analyse how informed trading volume is affected by the revealed information and supply shocks when pure noise trading volume is uncorrected with observable market variables. Our result indicates that no trade occurs for informed traders when net supply remains fixed across rounds of trade. And, when supply shocks are random, trading volume is induced by the informed and the noise traders, but noise trading is not predictable. Finally, we investigate these properties in the case when pure noise trading volume is correlated with observable market variables. It is shown that no informed trading takes place when there is no supply shock. However, when net supply contains random shocks, trading volume consists of noise and informed trading, both of which can be estimated.     

Exchange rate variability and monetary policy under rational expectations: Some Euro-American experience 1973–1979

We analyze the sources of changes in nominal and real rates of exchange between six European currencies and the U.S. dollar. We conclude that over the period 1973–1979 unexpected changes in the price of oil, together with unanticipated monetary shocks at home or in the U.S. were the most important causes of changes in exchange rates. A multi-state Kalman filter technique is used to compute empirical proxies for unanticipated changes in the exogenous variables. Since both oil price shocks and changes in U.S. monetary trends effect the European currencies in different degrees, it follows that differential domestic rates of inflation are not the only reason why arrangements to restrict exchange rate fluctuations, such as the European Monetary System, may run into trouble.     

Order book approach to price impact

Buying and selling stocks causes price changes, which are described by the price impact function. To explain the shape of this function, we study the Island ECN orderbook. In addition to transaction data, the orderbook contains information about potential supply and demand for a stock. The virtual price impact calculated from this information is four times stronger than the actual one and explains it only partially. However, we find a strong anticorrelation between price changes and order flow, which strongly reduces the virtual price impact and provides for an explanation of the empirical price impact function.