Demography as a forecasting tool

The European population is rapidly ageing. This implies changing economic and social relations between the generations. In turn this precipitates economic change. In particular the welfare bill in the future needs to be paid for more dependants by a smaller working population. This fundamental shift also changes the conditions for productivity growth, trade and even monetary policy. Using demographic projections to forecast these changes and integrate them into futures scenarios contributes to realism in the futures envisioned. Demographic processes can be influenced by policy, but the feedback is slow. This ensures the usefulness of demographic forecasting but it also implies that policy decisions need to be taken well in advance of the problems that ageing will cause. At horizons beyond 10–20 years there are ample opportunity to adapt the society to avoid unacceptable scenarios. Before that the scope for action is much less and much more constrained. The inertia of the demographic structure is such that it is hard and probably costly to turn unwanted trends caused by unbalanced age structures. For example, a likely consequence of the developing scarcity of labour in Europe is that the demand for education goes down in spite of the desirability for society to expand higher education.     

Macroeconomic effects of IMF-sponsored programs in Latin America: output costs, program recidivism and the vicious cycle of failed stabilizations

We investigate the effects of IMF stabilization programs, and the reasons behind the unusually high IMF activity and relatively low program completion rates in Latin America. We base our tests on a panel, and distinguish between IMF program approvals and completion. We find that Latin America has higher output costs of IMF programs (especially when completed), no improvement in the current account, and a much higher likelihood of program failure and recidivism than other regions. The common finding that entering into an IMF-supported program incurs real short-run costs on the economy is entirely driven by the experiences in Latin America.     

Equity Risk, Conversion Risk, and the Demand for Insurance

Existing insurance theory fails when applied to real property because it does not account for variations in the economic environment. The article studies optimal property insurance in the presence of two sources of variation: equity risk and conversion risk. Equity risk is randomness of the value of a property. It tends to raise demand for conventional insurance. In contrast, conversion risk is randomness in the value the property would have if, after severe damage, it were converted to the highest‐valued use. It is distinct from equity risk because the highest‐valued use is typically not the current one. Under independent conversion risk, the optimum upper limit is a compromise among underlying conversion thresholds. Absent independence, the optimum can be quite different. Conversion risk can raise or lower the demand for property insurance. Insurance contracts that fail to address conversion tend to undermine the orderly disposition of obligations and reduce the gains from reallocation of risks through insurance.     

On the Distribution of CBOE Option Trade Prices Occurring Between Consecutive Stock Trades

This paper examines the volume distribution of option trade prices that occurs when the underlying stock price remains constant. The width of these option trade price bands provides direct evidence on the law of one price and the redundancy of options assumed in many option models. We find that index option bands are narrower than equity option bands. Furthermore, for both equity and index options, puts have narrower bandwidths than calls. In general, option price bandwidth is narrow and can be explained by the minimum price movement allowed by the Chicago Board Options Exchanges (CBOE). This supports the single price law and the redundancy assumption. The existence of bid/ask quotes on the option does not materially affect the above results although it does alter the frequency of multiple option trade prices for a given underlying stock price. We note that over 53% of option trading volume occurs without bid/ask quotes on the CBOE compared to less than 15% a decade ago. Our results suggest that the effective bid/ask spread on options is probably no larger than the minimum price movements allowed by the CBOE. Furthermore, the need for the liquidity services of market makers may be declining if the decline in quoting activity stems from cross trading (i.e. trades not involving market makers).     

Tax Competition and Redistribution in a Two-Country Endogenous-Growth Model

This paper examines the effects of policy coordinationin a two-country world with endogenous growth and imperfect capitalmobility. Redistribution is financed by a source-based capital-incometax. Comparing the cases in which countries do and do not coordinatetheir fiscal policies, it is shown that redistribution can beinefficiently high if fiscal policies are not coordinated. Thisis because the negative effects of fiscal policy on home savingsaffect economic growth abroad by inducing a decline in foreigninvestment. This externality can dominate the well-known tax-baseexternality.     

Litigation, School Finance Reform, and Aggregate Educational Spending

In the past two decades, litigation in many U.S. stateshas triggered educational reform movements designed to reducethe inequalities in educational expenditures across school districts.This paper uses a panel data set across all the states from 1970–1990to examine the role of litigation and educational finance reformin determining the level of education funding in a flexible,dynamic setting. An important finding of our work is that litigationand reform have differential effects across the states, in somecases leading to increases while in other cases decreases inpredicted spending.     

Debt in industry equilibrium

This article shows (1) how entry and exit of firms in a competitiveindustry affect the valuation of securities and optimal capitalstructure, and (2) how, given a trade-off between tax advantagesand agency costs, a firm will optimally adjust its leveragelevel after it is set up. We derive simple pricing expressionsfor corporate debt in which the price elasticity of demand forindustry output plays a crucial role. When a firm optimallyadjusts its leverage over time, we show that total firm valuecomprises the value of discounted cash flows assuming fixedcapital structure, plus a continuum of options for marginalincreases in debt.     

Pricing mortgage-backed securities in a multifactor interest rate environment: a multivariate density estimation approach

Multivariate density estimation (MDE) suggests that mortgage-backedsecurity (MBS) prices can be well described as a function ofthe level and slope of the term structure. We analyze how thisfunction varies across MBSs with different coupons. An importantfinding is that the interest rate level proxies for the moneynessof the option, the expected level of prepayments, and the averagelife of the cash flows, while the term structure slope controlsfor the average rate at which these cash flows should be discounted.     

Why do security prices change? A transaction-level analysis of NYSE stocks

This article develops and tests a structural model of intradayprice formation that embodies public information shocks andmicrostructure effects. We use the model to analyze intradaypatterns in bid-ask spreads, price volatility, transaction costs,and return and quote auto-correlations, and to construct metricsfor price discovery and effective trading costs. Informationasymmetry and uncertainty over fundamentals decrease over theday, although transaction costs increase. The results help explainthe U-shaped pattern in intraday bid-ask spreads and volatility,and are also consistent with the intra-day decline in the varianceof ask price changes.