Piketty’s Elasticity of Substitution: A Critique

This article examines Thomas Piketty’s explanation of a falling wage share. Piketty explains rising income inequality between labor and capital as a result of one parameter of a production function: an elasticity of substitution, σ, between labor and capital greater than one. This article reviews Piketty’s elasticity argument, which relies on a non-standard definition of capital. In light of the theory of land rent, it discusses why the non-standard capital definition is a measure of wealth, not capital and is problematic for estimating elasticities. It then presents simple long-run estimates of σ in constant elasticity of substitution functions for Piketty’s data as well as for a subset of his capital measure that comes closer to the standard definition of productive capital. The estimation results cast doubt on Piketty’s hypothesis that σ is greater than one.     

Early evidence on balloon performance

Balloon loans have become increasingly popular in recent years. For this reason, it is important to understand their features, assess their potential risks, and monitor their early performance. This article focuses on these topics. The first section discusses balloon characteristics and mortgage choice. The second section discusses expected balloon performance. The third section provides an econometric model for monitoring current performance. The fourth and fifth sections describe the data and results, respectively. The final section summarizes the article and offers some concluding remarks. The fundamental conclusions are that (1) early balloon performance is slightly worse than expected (i.e., balloons are not matching fixed-rate performance prior to balloon reset dates); (2) balloon performance is, however, within the range expected over the full term of the loans (i.e., performance worse than fixed-rate performance, but better than ARM performance); and (3) balloons have important characteristics that help mitigate systematic risk.     

Speculative attacks with unpredictable or unknown foreign exchange reserves

During a currency crisis, speculators usually do not know the value of a central bank's foreign exchange reserves. In this paper I show that modelling speculators as having imperfect knowledge of reserves enriches the predictions of the classical model of speculative attacks. With realistic lags in reserve reporting and costs to unsuccessful speculation, successful speculative attacks will involve a jump depreciation, unsuccessful attacks may occur, attacks may occur when fundamentals are improving, attacks may not be preceded by large increases in interest rates, and fixed exchange rates may be abandoned with no attack and no decline in the money supply. JEL Classification: F31     

Persistent deficits and the market value of government debt

This paper investigates whether postwar Canadian public financial policy satisfies a borrowing constraint. Direct tests of the present-value relation suggested by this constraint shed light on the sustainability of current policy. We examine monthly data on Canadian federal government finances using tests for cointegration. The finding is that the joint behaviour of real debt and real surpluses is inconsistent with intertemporal budget balance for the government. One interpretation of this finding is that the government is systematically paying real returns to bondholders by issuing further debt. Alternatively, bondholders may expect the government to finance future interest payments from a source other than primary surpluses, e.g. the sale of physical assets.     

Pricing options with Green's functions when volatility,interest rate and barriers depend on time

We derive the Green's function for the Black–Scholes partial differential equation with time-varying coefficients and time-dependent boundary conditions. We provide a thorough discussion of its implementation within a pricing algorithm that also accommodates American style options. Greeks can be computed as derivatives of the Green's function. Generic handling of arbitrary time-dependent boundary conditions suggests our approach to be used with the pricing of (American) barrier options, although options without barriers can be priced equally well. Numerical results indicate that knowledge of the structure of the Green's function together with the well-developed tools of numerical integration make our approach fast and numerically stable.