Discount curve construction with tension splines

Polynomial splines are popular in the estimation of discount bond term structures, but suffer from well-documented problems with spurious inflection points, excessive convexity, and lack of locality in the effects of input price perturbations. In this paper, we address these issues through the use of shape-preserving splines from the class of generalized tension splines. Our primary focus is on the classical hyperbolic tension spline which we derive non-parametrically from a penalized least squares criterion, but extensions to generalized tension splines—such as rational splines and exponential splines—are also covered. Our methodology allows both for best-fitting of noisy bonds and for the construction of an exact interpolatory term structure to a set of liquid instruments. We work with a local tension B-spline basis and support both fully non-parametric and user-imposed knot location strategies.     

Local Pollution in Federal Systems

It is widely accepted that decentralized control of local pollution is inefficient if the central and the local authorities are imperfectly informed. This paper shows how the central authority can introduce a flexible grant-in-aid system that induces the local authority to use a weighted combination of local and central information when the local authority suffers from confirmatory bias. If the central authority is highly uncertain about the environmental effects of a specific pollutant, the tax/subsidy scheme can be designed to allow local information to play an essential role in the environmental policy. If the central authority is certain that a pollutant must not exceed a specific limit, the tax/subsidy scheme can be designed to allow local information little influence on the environmental policy.     

International interdependencies in fiscal stabilization policies

Trade links imply that business cycle fluctuations are transmitted among trade partners. To the extent that fiscal policy can mitigate business cycle fluctuations international interdependencies in stabilization policies arise. We analyse in a two country general equilibrium model the role of fiscal policy in mitigating risk or providing implicit insurance in the presence of capital market imperfections and adjustment failures (rigid wages). It is shown that there is a welfare case for an active stabilization policy, and that it is larger in the presence of adjustment failures (rigid wages). Non-cooperative policy decisions imply inefficiencies in fiscal stabilization policies, which in the case of flexible wages may imply too much stabilization, whereas stabilization is always insufficient in the case of rigid wages.     

Gains from quota trade: theoretical models and an application to the Danish fishery

We provide a framework for evaluating potential effects of introducingtradable quotas to a sector. The effects depend on the economiesof scale and scope of the production technology, and on firms'ability and willingness to learn best practice methods (catchingup) and to change their input and output composition (mix).To illustrate our approach, data from the Danish fishery areused to calculate the potential gains from introducing individuallytransferable fishing quotas. Data envelopment analysis is usedto model the production technology. We find that pure reallocationis as important as pure learning, i.e. quota reallocation withoutcatching-up is as valuable as learning best practice with fixedallocations.     

Product Market Integration and Heterogeneity—Rent Sharing and Pricing to Market

International product market integration makes market penetration easier and therefore creates both export opportunities and import threats. This changes the competitive position of firms and is associated with changes in trade, production, and specialization structures. The gains and losses in this process are unlikely to be equally shared due to heterogeneity across firms/sectors. In a Ricardian trade model with heterogeneity across firms, we find “pricing to market”—effects not only for exports, but also for pricing in the domestic market even for nontradables. Rents to be shared in wage bargaining differ across tradables and nontradables. It is shown that lower trade frictions affect the scope for “pricing to market” and cause wages to become more closely driven by (relative) productivity. Labor market prospects tend not to improve for low wage jobs, and not to deteriorate for high wage jobs.     

Jump-Diffusion Processes: Volatility Smile Fitting and Numerical Methods for Option Pricing

This paper discusses extensions of the implied diffusion approach of Dupire (1994) to asset processes with Poisson jumps. We show that this extension yields important model improvements, particularly in the dynamics of the implied volatility surface. The paper derives a forward PIDE (PartialIntegro-Differential Equation) and demonstrates how this equationcan be used to fit the model to European option prices. For numerical pricing of general contingent claims, we develop an ADI finite difference method that is shown to be unconditionally stable and, if combined with Fast Fourier Transform methods, computationally efficient. The paper contains several detailed examples fromthe S&P500 market. This revised version was published online in November 2006 with corrections to the Cover Date.     

Interest-rate policy and rational expectations

The choice of monetary instrument under rational expectations is discussed in a general equilibrium model for the financial sector. It is shown that a supply rule leads to indeterminate asset prices, whereas the prices are determinate under an appropriately formulated interest-rate policy.     

Attitudes toward foreign assignments among Danish economists

This article addresses attitudinal issues toward foreign assignments and reports on data collected from a distinct sample of respondents—Danish economists. One of the much‐debated questions is whether foreign assignments are becoming less attractive, in particular among the younger employees, who tend to follow more narrow self‐interests and stay home. This is supposed to be reinforced by deteriorating corporate policies (i.e., offers being less attractive). The present study provides the basis for rather significant findings. The economists tend to look quite positively on expatriation (across age, gender, seniority, former foreign assignment, and unemployment), and this finding is supported by the fact that about 25% of the respondents already had experiences with foreign assignment. © 2004 Wiley Periodicals, Inc.