Fine‐Tuning a Corporate Hedging Portfolio: The Case of an Airline

Industrial companies typically face a multitude of risks that could cause significant fluctuations in their cash flow. This is a case study of the hedging strategy adopted by an international air carrier to manage its jet‐fuel price exposure. The airline's hedging approach uses “strips” of monthly collars constructed with Asian options whose payoffs are based on average of “within‐prompt‐month” oil prices. Using the carrier's own implicit objective function based on an annual granularity, the authors show how the air carrier could fine‐tune its current hedge portfolio by adding tailored exotic options. The article describes annual average‐price options, provides an explicit valuation of them, and considers how such instruments may affect corporate liquidity. Consistent with its annual objective function, the airline made this exotic derivative the central tool to hedge across all potential realized values of annual jet‐fuel spot prices. The authors believe this modified portfolio is better suited to address the firm's hedging cost and its overall exposure to jet‐fuel price fluctuations.     

A Phillips Curve with Anchored Expectations and Short‐Term Unemployment

This paper examines the behavior of U.S. core inflation, as measured by the weighted median of industry price changes. We find that core inflation since 1985 is well‐explained by an expectations‐augmented Phillips curve in which expected inflation is measured with professional forecasts and labor‐market slack is captured by the short‐term unemployment rate. We also find that expected inflation was backward‐looking until the late 1990s, but then became strongly anchored at the Federal Reserve's target. This shift in expectations changed the relationship between inflation and unemployment from an accelerationist Phillips curve to a level‐level Phillips curve. Our specification explains why high unemployment during the Great Recession did not reduce inflation greatly: partly because inflation expectations were anchored, and partly because short‐term unemployment rose less sharply than total unemployment.     

Information‐Hedging Disclosures and Insider Trading

I model the effect of disclosure on the tradeoff between information risk, liquidity risk, and price risk for a well‐informed, risk‐averse insider. Revealing some information before trading decreases the variability of the insider's information advantage and thus reduces his information risk. Disclosure also lowers adverse selection costs for market makers, which reduces the insider's liquidity risk by increasing his trading flexibility. However, disclosure increases price risk for the insider because the price fully reflects the revealed information. The reduction in information and liquidity risks outweigh the rise in price risk when the insider is less risk averse because a less risk‐averse insider's information‐based motive for trading is stronger than his hedging motive. The opposite relation holds when the insider is more risk averse. Therefore, a less (more) risk‐averse insider experiences an increase (decrease) in welfare when he discloses some information before trading. Cost of capital and policy implications are identified.     

Nowcasting U.S. Headline and Core Inflation

Forecasting future inflation and nowcasting contemporaneous inflation are difficult. We propose a new and parsimonious model for nowcasting headline and core inflation in the U.S. consumer price index and price index for personal consumption expenditures that relies on relatively few variables. The model's nowcasting accuracy improves as information accumulates over a month or quarter, outperforming statistical benchmarks. In real‐time comparisons, the model's headline inflation nowcasts substantially outperform those from the Blue Chip consensus and the Survey of Professional Forecasters. Across all four inflation measures, the model's nowcasting accuracy is comparable to that of the Federal Reserve Board's Greenbook.     

Stock Liquidity Risk and the Cross‐sectional Earnings‐Returns Relationship

We argue that a higher sensitivity to aggregate market‐wide liquidity shocks (i.e., a higher liquidity risk) implies a tendency for a stock's price to converge to fundamentals. We test this intuition within the framework of the earnings‐returns relationship. We find a positive liquidity risk effect on the relationship between return and expected change in earnings. This effect on the earnings‐returns relationship is distinct from the negative effect observed for stock illiquidity level. Notably, the liquidity risk effect is evident (absent) during periods of neutral/low (high) aggregate market liquidity. We also show that the liquidity risk effect is dominant in firms that: (a) are of intermediate size; (b) are of intermediate book‐to‐market; and (c) are profit making.     

Effects of Monetary and Macroprudential Policies—Evidence from Four Inflation Targeting Economies

We examine the effects of monetary and macroprudential policies in the Asia‐Pacific region, where many inflation targeting economies have adopted macroprudential policies in order to safeguard financial stability. Using structural panel vector autoregressions that identify both monetary and macroprudential policy actions, we show that tighter macroprudential policies used to contain credit growth also have a significant negative impact on macroeconomic aggregates such as real GDP and the price level. The similar effects of monetary and macroprudential policies may suggest a complementary use of the two policies at normal times. However, they could also create challenges for policymakers, especially during times when low inflation coincides with buoyant credit growth.     

Time Inconsistency and Free‐Riding in a Monetary Union

In monetary unions, a time inconsistency problem in monetary policy leads to a novel type of free‐rider problem in the setting of non‐monetary policies. The free‐rider problem leads union members to pursue lax non‐monetary policies that induce the monetary authority to generate high inflation. Free‐riding can be mitigated by imposing constraints on non‐monetary policies. Without a time inconsistency problem, the union has no free‐rider problem; then constraints on non‐monetary policies are unnecessary and possibly harmful. This theory is here detailed and applied to several non‐monetary policies: labor market policy, fiscal policy, and bank regulation.     

The Beauty Contest and Short‐Term Trading

Short‐termism need not breed informational price inefficiency even when generating beauty contests. We demonstrate this claim in a two‐period market with persistent liquidity trading and risk‐averse, privately informed, short‐term investors and find that prices reflect average expectations about fundamentals and liquidity trading. Informed investors engage in “retrospective” learning to reassess inferences (about fundamentals) made during the trading game's early stages. This behavior introduces strategic complementarities in the use of information and can yield two stable equilibria that can be ranked in terms of liquidity, volatility, and informational efficiency. We derive implications that explain market anomalies as well as empirical regularities.     

Global liquidity trap

How should monetary policy respond to a “global liquidity trap,” where the two countries may fall into a liquidity trap simultaneously? Using a two-country New Open Economy Macroeconomics model, we first characterize optimal monetary policy, and show that the optimal rate of inflation in one country is affected by whether or not the other country is in a liquidity trap. We next examine how well the optimal monetary policy is approximated by relatively simple monetary policy rules. The interest-rate rule targeting the producer price index performs well in this respect.     

Interaction of Government Tiers and Central Banks in a Federation: An Empirical Test

Fiscal rules are necessary to protect monetary policy from the consequences of unsustainable or active fiscal policy for inflation. Monetary unions, such as the Economic and Monetary Union (EMU), require even stronger fiscal rules to avoid free riding by regional fiscal authorities on the common monetary policy. By contrast, in a fiscal federation, the federal government internalises the effect of active regional policies on the overall price level. Federal fiscal policy contributes to price stability either by enforcing fiscal rules or by adjusting its own stance. Following Canzoneri, Cumby and Diba (2001), we test whether federal and regional governments in Germany behave in an active or passive way. We find evidence of a spillover effect of unsustainable policies on other regions. The German federal government offsets the effect on the price level by running passive policies. The Bundesbank's prime objective of price stability is therefore endorsed by fiscal policy. The results have implications for the regulation of fiscal policies in the EMU.     

The Debt‐Payment‐to‐Income Ratio as an Indicator of Borrowing Constraints: Evidence from Two Household Surveys

Liquidity constraints have been proposed as an important explanation for deviations from the rational expectations/permanent income hypothesis. This paper introduces to the liquidity constraint literature the ratio of a household's debt payments to its disposable personal income, the debt service ratio (DSR). We find that a household with a high DSR is significantly more likely to be turned down for credit than other households. Also, the consumption growth of likely constrained households, identified using the DSR along with the liquid‐asset‐to‐income ratio, is significantly more sensitive to past income than that of other households, confirming the DSR's value in identifying constrained households.     

A Tale of Two Rigidities: Sticky Prices in a Sticky‐Information Environment

Macroeconomic models with microeconomic foundations allow for comparisons with macro and micro empirical evidence. This paper proposes a model wherein firms: (i) acquire information infrequently, generating sticky information ( Mankiw and Reis 2002 ) and (ii) face menu costs, producing state‐dependent sticky prices. I estimate parameters via indirect inference and show that under considerable real rigidity, sticky prices in a sticky‐information environment are consistent with micro and macro evidence. Sticky prices not only help match micro data on price changes’ size and durations between adjustments; they also improve the model's fit with the macro data, as embodied in an empirical Phillips curve.     

Monetary Policy and the Lost Decade: Lessons from Japan

I investigate how monetary policy can avoid a deflationary slump when policy rates are near zero by studying interest rate policy during Japan's “Lost Decade.” Estimation results suggest that the Bank of Japan's interest rate policy fits a conventional reaction function with an inflation target near 1%. The disapointing economic performance thus seems primarily due to adverse economic shocks rather than extraordinary policy errors. Also, counterfactual policy simulations suggest that simply raising the inflation target would not have substantially improved performance. However, price‐level targeting or combining a higher inflation target with an aggressive output response would have achieved superior stabilization results.     

Reconciling Bagehot and the Fed's Response to September 11

Bagehot (1873) states that to prevent bank panics a central bank should provide liquidity at a "very high rate of interest." In contrast, most of the theoretical literature on liquidity provision suggests that central banks should lend at an interest rate of zero. This is broadly consistent with the Federal Reserve's behavior in the days following September 11, 2001. This paper shows that both policies can be reconciled. With commodity money, as in Bagehot's time, liquidity is scarce and a high price allows banks to self-select. In contrast, the Fed has a virtually unlimited ability to temporarily expand the money supply so self-selection is unnecessary.     

Long‐Run Inflation and the Distorting Effects of Sticky Wages and Technical Change

We show that the Calvo price‐setting model is not necessarily inconsistent with evidence of a weak relation between positive trend inflation and price dispersion. We identify the interaction between sticky wages and technical change as factors disrupting the allocative role of the wage system under positive trend inflation. In turn, this interaction generates inefficient wage dispersion, as opposed to price dispersion, which fuels inflation costs. We conclude that it is too early to dismiss the New Keynesian model as a useful vehicle to assess the costs of inflation.     

On the Asymmetric U‐Shaped Relationship between Inflation,Inflation Uncertainty,and Relative Price Skewness in the UK

We investigate the asymmetric relationships between aggregate inflation and the second and third moments of the cross‐sectional distribution of relative prices using a modified Calvo pricing model with regime‐dependent price rigidities. Calibration experiments reveal that the inflation‐standard deviation and inflation‐skewness relationships exhibit U‐shaped asymmetries around the historical mean inflation rate. UK sectoral data support our results. We conclude that monetary policy should target an inflation rate proximate to the (common) minima of these nonlinear relationships and that core inflation measures should not be used for policy purposes as they exclude much of the information contained in the higher moments.     

Why Is Canada's Price Level So Predictable?

This paper draws attention to the fact that the price level in Canada—which is an inflation targeter—has strayed little from the path it would have taken had inflation never wandered off the 2% target since its introduction and has tended to revert to that path after temporary deviations. Econometric analysis using Bayesian estimation suggests that a low probability can be assigned to explaining this behavior by mutually offsetting shocks. More plausible is the assumption that inflation expectations and interest rates are determined in a way that is consistent with an element of price‐level‐path targeting.     

Notes on the Underground: Monetary Policy in Resource‐Rich Economies

The central bank of a commodity‐exporting small open economy faces the traditional trade‐off between domestic inflation and output gap. The commodity sector introduces a terms‐of‐trade inefficiency that gives rise to an endogenous cost‐push shock, changes the target level for output, reduces the slope of the Phillips curve, and increases the importance of stabilizing the output gap. Optimal monetary policy calls for a reduction of the interest rate following a drop in the oil price. In contrast, a central bank with a mandate to stabilize consumer price inflation raises interest rates to limit the inflationary impact of an exchange rate depreciation.     

Monetary Policy,Asset Prices,and Liquidity in Over‐the‐Counter Markets

We develop a model where agents can allocate their wealth between a liquid asset, which can be used to purchase consumption goods, and an illiquid asset, which represents a better store of value. Should a consumption opportunity arise, agents may visit a frictional “over‐the‐counter” secondary asset market where they can exchange illiquid for liquid assets. We characterize how monetary policy affects both the issue price and the secondary market price of the asset. We also show that, in contrast to conventional wisdom, search and bargaining frictions in the secondary asset market can improve welfare if inflation is low.     

Sell‐Side Analyst Research and Stock Comovement

We document that a stock's price around a recommendation or forecast covaries with prices of other stocks the issuing analyst covers. The effect of shared analyst coverage on stock price comovement extends beyond analyst activity days. A stock's daily returns covary with the returns of other stocks with which it shares analyst coverage. These links between stock price comovement and shared analyst coverage are consistent with the coverage‐specific information we find in earnings forecasts; analysts who cover both stocks in a pair expect future earnings of the stocks to be more highly correlated than do analysts who cover only one stock from the pair. Collectively, our evidence indicates that analyst research produces coverage‐specific spillovers that raise price comovement among stocks that share analyst coverage. The strength of these spillovers is comparable to spillovers from broad industry and market information in analyst research.