Optimal Monetary Policy in an Operational Medium‐Sized DSGE Model

We show how to construct optimal policy projections in Ramses, the Riksbank’s open‐economy medium‐sized dynamic stochastic general equilibrium model for forecasting and policy analysis. Bayesian estimation of the parameters of the model indicates that they are relatively invariant to alternative policy assumptions and supports our view that the model parameters may be regarded as unaffected by the monetary policy specification. We discuss how monetary policy, and in particular the choice of output gap measure, affects the transmission of shocks. Finally, we use the model to assess the recent Great Recession in the world economy and how its impact on the economic development in Sweden depends on the conduct of monetary policy. This provides an illustration on how Rames incoporates large international spillover effects.     

Estimation and Evaluation of Conditional Asset Pricing Models

We find that several recently proposed consumption‐based models of stock returns, when evaluated using an optimal set of managed portfolios and the associated model‐implied conditional moment restrictions, fail to capture key features of risk premiums in equity markets. To arrive at these conclusions, we construct an optimal Generalized Method of Moments (GMM) estimator for models in which the stochastic discount factor (SDF) is a conditionally affine function of a set of priced risk factors, and we show that there is an optimal choice of managed portfolios to use in testing a null model against a proposed alternative generalized SDF.     

PARALLEL TRADE,INTERNATIONAL EXHAUSTION AND INTELLECTUAL PROPERTY RIGHTS: A WELFARE ANALYSIS*

This paper analyses the issue of parallel trade (arbitrage) for products protected by intellectual property rights. We discuss a basic trade‐off that arises between the ex post better allocation that typically occurs under parallel trade when demand dispersion is not too high, and the ex ante reduced product quality because of lower investment. We show that the size of the welfare effects is significantly affected by the presence of a ‘generic’ product, which represents a form of competition for the monopolist. The monopolist will introduce a ‘fighting brand’ to compete with the generic, which dilutes but does not eliminate the result on the adverse effects of parallel trade on investments.     

Interpreting Factor Models

We argue that tests of reduced‐form factor models and horse races between “characteristics” and “covariances” cannot discriminate between alternative models of investor beliefs. Since asset returns have substantial commonality, absence of near‐arbitrage opportunities implies that the stochastic discount factor can be represented as a function of a few dominant sources of return variation. As long as some arbitrageurs are present, this conclusion applies even in an economy in which all cross‐sectional variation in expected returns is caused by sentiment. Sentiment‐investor demand results in substantial mispricing only if arbitrageurs are exposed to factor risk when taking the other side of these trades.     

Depreciation Rules and the Relation between Marginal and Historical Cost

The reported cost of a product frequently contains historical cost components that reflect past investments in productive capacity. We examine a setting wherein a firm makes a sequence of overlapping capacity investments. Earlier research has identified particular accrual accounting (depreciation) rules with the property that, on a per unit basis, the historical cost of a product captures precisely its marginal cost. Relative to this benchmark, we investigate and characterize the direction and magnitude of the bias in reported historical cost that results from alternative depreciation rules, including in particular straight‐line depreciation in conjunction with partial direct expensing. In addition, we demonstrate that for a reasonable range of parameter specifications the resulting bias is rather small. Finally, we apply our framework to two specific settings. First, in a regulatory context, we establish the extent to which the accounting profit margin is indicative of a firm's pricing power in the product market. Second, we model an internal control scenario in which a manager's performance is evaluated using residual income, and identify the distortions in investment levels that result from the use of alternative depreciation rules.     

Identity Theft Legislation: The Fair and Accurate Credit Transactions Act of 2003 and the Road Not Taken

This article provides a review of the Fair and Accurate Credit Transactions Act of 2003 (FACTA) as it relates to the growing problem of identity theft. The article also examines other identity theft‐related proposed legislation from the 108th Congress and analyzes the effectiveness of the proposed measures. The authors conclude that FACTA represents an important step toward reducing the incidence of identity theft as well as ameliorating the damage that it causes. However, unless and until Congress addresses the extensive use and distribution of Social Security numbers and the safeguarding of data, identity theft is likely to continue to wreak financial and social havoc.     

The Emergence of Biometrics and Its Effect on Consumers

Biometric authentication systems are becoming increasingly common. Though their use offers important advantages to governmental agencies, business, and consumers, the widespread use of biometric technology has the potential for serious negative consequences. In this paper, the authors explore the effects on consumers of the incorporation of biometric authentication into mainstream commerce, specifically focusing on privacy concerns of consumers in the context of the fair information practice principles of notice/awareness, choice/consent, access/participation, integrity/security, and enforcement/redress.