Precautionary Savings with Risky Assets: When Cash Is Not Cash

U.S. industrial firms invest heavily in noncash, risky financial assets such as corporate debt, equity, and mortgage‐backed securities. Risky assets represent 40% of firms’ financial portfolios, or 6% of total book assets. We present a formal model to assess the optimality of this behavior. Consistent with the model, risky assets are concentrated in financially unconstrained firms holding large financial portfolios, are held by poorly governed firms, and are discounted by 13% to 22% compared to safe assets. We conclude that this activity represents an unregulated asset management industry of more than $1.5 trillion, questioning the traditional boundaries of nonfinancial firms.     

Fundamental Economic Variables,Expected Returns,and Bond Fund Performance

In this article, we develop relative pricing (APT) models that are successful in explaining expected returns in the bond market. We utilize indexes as well as unanticipated changes in economic variables as factors driving security returns. An innovation in this article is the measurement of the economic factors as changes in forecasts. The return indexes are the most important variables in explaining the time series of returns. However, the addition of the economic variables leads to a large improvement in the explanation of the cross-section of expected returns. We utilize our relative pricing models to examine the performance of bond funds.     

A Mechanism for Inducing Cooperation in Noncooperative Environments: Theory and Applications

We construct a market‐based mechanism that induces players in a noncooperative game to make the same choices as characterize cooperation. We then argue that this mechanism is applicable to a wide range of economic questions and illustrate this claim using the problem of “The Tragedy of the Commons.”     

Dynamic Optimal Taxation with Private Information

We study dynamic optimal taxation in a class of economies with private information. Optimal allocations in these environments are complicated and history-dependent. Yet, we show that they can be implemented as competitive equilibria in market economies supplemented with simple tax systems. The market structure in these economies is similar to that in Bewley (1986) ; agents supply labour and trade risk-free claims to future consumption, subject to a budget constraint and a debt limit. Optimal taxes are conditioned only on two observable characteristics—an agent's accumulated stock of claims, or wealth, and her current labour income. We show that optimal taxes are generally non-linear and non-separable in these variables and relate the structure of marginal wealth and income taxation to the properties of agent preferences.     

CAPITAL FLOWS AND JAPANESE ASSET VOLATILITY

Characterizing asset price volatility is an important goal for financial economists. The literature has shown that variables that proxy for the information arrival process can help explain and/or forecast volatility. Unfortunately, however, obtaining good measures of volume and/or order flow is expensive or difficult in decentralized markets such as foreign exchange. We investigate the extent that Japanese capital flows, which are released weekly, reflect information arrival that improves foreign exchange and equity volatility forecasts. We find that capital flows can help explain transitory shocks to generalized autoregressive conditionally heteroskedastic volatility.     

Monetary News Shocks

We pursue an empirical strategy to identify a monetary news shock in the U.S. economy. We use a monetary policy residual, along with other variables in a vector autoregression (VAR), and identify a monetary news shock as the linear combination of reduced-form innovations that is orthogonal to the current residual and that maximizes the sum of contributions to its forecast error variance over a finite horizon. Real GDP declines in a persistent manner after a positive monetary news shock. This contraction in economic activity is accompanied by a fall in inflation and a rapid increase in the nominal interest rate.     

The Price Is (Almost) Right

Most previous research tests market efficiency using average abnormal trading profits on dynamic trading strategies, and typically rejects the joint hypothesis of market efficiency and an asset pricing model. In contrast, we adopt the perspective of a buy‐and‐hold investor and examine stock price levels. For such an investor, the price level is more relevant than the short‐horizon expected return, and betas of cash flow fundamentals are more important than high‐frequency stock return betas. Our cross‐sectional tests suggest that there exist specifications in which differences in relative price levels of individual stocks can be largely explained by their fundamental betas.     

The Impact of Inflation and Taxation on Tenure Choice and the Redistributive Effects of Home-Mortgage Interest Rate ReguIation*

Judy Yates (1981) notes the regressive redistributive impact of home-mortgage interest rate regulation and offers some explanations. This paper provides an alternative explanation of Yates' observations in terms of the interaction of inflation with the current tax system in Australia. A model of tenure choice in the context of inflation and taxation is developed. In explaining this phenomenon, the model also establishes the regressive nature of the tax subsidy to owner-occupation. Home-mortgage interest rate regulation is then introduced. This reinforces the redistributive bias in the housing finance market. The model is used finally to predict the impact of deregulation. It is concluded that deregulation by itself can only remove redistributive bias resulting from regulated mortgage interest rates. Reform of the tax system is required to eliminate the regressive redistributive effects of the tax subsidy to owner-occupation .