MARKET MAKING OLIGOPOLY*

This paper analyzes price competition between market makers who set costly capacity constraints before they intermediate between producers and consumers. The unique equilibrium outcome with pure strategies at the capacity stage is the Cournot outcome. The paper thus provides a rationale for Cournot‐type competition between market makers. This contrasts with previous findings in the literature, where due to the absence of capacity constraints that are set ex ante the Bertrand result typically obtains.     

On the Optimality of Portfolio Insurance

This paper examines the optimality of an insurance strategy in which an investor buys a risky asset and a put on that asset. The put's striking price serves as the insurance level. In complete markets, it is highly unlikely that an investor would utilize such a strategy. However, in some types of less complete markets, an investor may wish to purchase a put on the risky asset. Given only a risky asset, a put, and noncontinuous trading, an investor would purchase a put as a way of introducing a risk-free asset into the portfolio. If, in addition, there is a risk-free asset and the investor's utility function displays constant proportional risk-aversion, then the investor would buy the risk-free asset directly and not buy a put. In sum, only under the most incomplete markets would an investor find an insurance strategy optimal.     

Expectations and the Treasury Bill-Federal Funds Rate Spread over Recent Monetary Policy Regimes

This paper shows that the spread between the 3–month Treasury bill and the federal funds rate has significant predictive power for the future change in the federal funds rate during the volatile nonborrowed reserves operating regime, but it has less and no predictive power during the borrowed reserves regime and the federal funds targeting regime, respectively. These findings suggest that Treasury bill rates forecast future federal funds rates most accurately when the Federal Reserve follows a well-defined rule that does not smooth the impact of shocks on the federal funds rate.     

A NOTE ON THE SUPERIORITY OF LEVERED SHARES UNDER THE POSITIVE NPV RULE

The purpose of this note is to demonstrate that under the market conditions upon which the validity of the positive NPV rule in capital budgeting depends, levered shares will on average out-perform unlevered shares to a degree which more than compensates for the additional risk.
Dans ce papier, on démontre que - dans les conditions du marché dont dépend la validité du principe de la valeur actuelle nette relative aubudget en capital - les titres sujets au leverage donneront en moyenne de meilleurs rendements que ceux qui ne le sont pas, couvrant ainsi largement le risque supplémentaire.
Der Zweck dieser Amerkung ist es zu zeigen, dass unter den Marktbedingungen, mvon die Gültigkeit der Kapitalwertmethode im Rahmen der Investitionsplanung abhägt, die Aktienrendite eines verschuldeten Unternehmens die Aktienrendite eines nicht-verschuldeten Unternehmens hinsichtlich des Verschuldungsrisikos überkompensiert.     

Re-Examining the Consumption–Wealth Relationship: The Role of Model Uncertainty

This paper discusses the consumption–wealth relationship. We use data on consumption, assets, and labor income and a vector error correction framework. This framework defines a set of models that differ in the number of co-integrating vectors, the form of deterministic components and lag length. Further models can be defined through parametric restrictions and, in particular, interest centers on a weak exogeneity restriction that says that the co-integrating residuals do not affect consumption and income directly. Key results in previous work relate to the roles of permanent and transitory shocks in driving wealth and how consumption responds to these shocks. We investigate the robustness of these results to model uncertainty and argue for the use of Bayesian model averaging. We find that there is a large degree of model uncertainty. Whether this uncertainty has important empirical implications depends on the researcher's attitude toward the theory used to motivate a co-integrating relationship between consumption, assets and income. If we work with models consistent with this theory and impose the weak exogeneity restriction, we find precisely estimated results that show that permanent shocks have only a small role in driving assets and that the predominant transitory shocks have little effect on consumption. These findings are consistent with the previous literature. However, if we work with a broader set of models and let the data speak, we find that the exact magnitude of the role of permanent shocks is hard to estimate precisely. Thus, although some support exists for the view that their role is small, we cannot rule out the possibility that they have a substantive role to play.     

THE IMPACT OF TRADE AND INVESTMENT AGREEMENTS ON AUSTRALIA'S INWARD FDI FLOWS

International trade and investment agreements are one of the primary instruments of global financial liberalisation. They are enacted to enhance the flows of foreign direct investment (FDI) between signatories by reducing regulatory barriers to investment; promoting stable host investment environments; and guaranteeing investors against non‐commercial risk. As a net capital importer, Australia has sought to attract FDI through participation in such accords since the early 1980s. This paper examines the determinants of Australia's inward FDI flows—focussing specifically on the effects of trade and investment agreements. Using panel data, we find that both bilateral trade and bilateral and multilateral investment agreements attract FDI flows into Australia, thereby indicating that the policy of enticing FDI through participation in these accords is quite possibly effective.     

Fiscal Sustainability in a New Keynesian Model

Recent work on optimal monetary and fiscal policy in New Keynesian models suggests that it is optimal to allow steady‐state debt to follow a random walk. In this paper we consider the nature of the time inconsistency involved in such a policy and its implication for discretionary policymaking. We show that governments are tempted, given inflationary expectations, to utilize their monetary and fiscal instruments in the initial period to change the ultimate debt burden they need to service. We demonstrate that this temptation is only eliminated if following shocks, the new steady‐state debt is equal to the original (efficient) debt level even though there is no explicit debt target in the government's objective function. Analytically and in a series of numerical simulations we show which instrument is used to stabilize the debt depends crucially on the degree of nominal inertia and the size of the debt stock. We also show that the welfare consequences of introducing debt are negligible for precommitment policies, but can be significant for discretionary policy. Finally, we assess the credibility of commitment policy by considering a quasi‐commitment policy, which allows for different probabilities of reneging on past promises.     

External Constraints on Monetary Policy and the Financial Accelerator

We develop a small open economy macroeconomic model where financial conditions influence aggregate behavior. Our goal is to explore the connection between the exchange rate regime and financial distress. We first show that a calibrated version of the model captures well the behavior of the Korean economy during its financial crisis period of 1997–98. In particular, the model accounts for the sharp increase in lending rates and the large drop in output, employment, investment, and measured productivity. The financial market frictions play an important role, further, explaining roughly half the decline in overall economic activity. We then perform some counterfactual exercises to illustrate how the fixed exchange rate regime likely exacerbated the crisis by tying the hands of monetary policy.     

Globalization of R&D and China: An Introduction

In this introduction, we discuss the recent changes in multinational corporations' (MNCs) research and development (R&D) strategies and China's rising role in this new development. Significant changes include: 1) More and more corporations have started overseas R & D operations; 2) the missions of many overseas R&D facilities have shifted from the traditional supplementing and supporting roles to become critical and strategic components of MNCs' global R&D networks; and 3) MNC overseas R&D operations have expanded their geographic reach to carefully selected developing countries. China has benefited from such changes and has become one major attraction for such R&D facilities due to its rich endowment of low-cost and well- trained scientists and engineers as well as its fast growing domestic market and burgeoning foreign investment in manufacturing. The explosion of foreign R&D investment has also been accompanied by the rapid growth of China's domestic investment in R&D. The growth in both domestic and foreign investment in R&D implies that China will improve its position in global economic and technological competition. However, it is unclear to the rest of the world about the implications of China's rising R&D and whether or not China can capture the value from the presence of foreign R&D centres. We conclude that issues related to China's science and technology development in general and foreign R&D in China in particular warrant more research in the future.     

An Empirical Examination of the Fisher Effect in Australia*

This paper analyzes the Fisher effect in Australia. Initial testing indicates that both interest rates and inflation contain unit roots. Furthermore, there are indications that the variables have non-standard error processes. To overcome problems associated with this and derive the correct small sample distributions of test statistics we make use of Monte Carlo simulations. These tests indicate that while a long-run Fisher effect seems to exist, there is no evidence of a short-run Fisher effect. This suggests that, while short-run changes in interest rates reflect changes in monetary policy, longer run levels indicate inflationary expectations. Thus, the longer run level of interest rates should not be used to characterize the stance of monetary policy.