Efficient Calibration of Trinomial Trees for One-Factor Short Rate Models

In this paper we propose a computationally efficient implementation of general one factor short rate models with a trinomial tree. We improve the Hull–Whites procedure to calibrate the tree to bond prices by circumventing the forward rate induction and numerical root search algorithms. Our calibration procedure is based on forward measure changes and is as general as the Hull–White procedure, but it offers a more efficient and flexible method of constructing a trinomial term structure model. It can be easily implemented and calibrated to both prices and volatilities. JEL classification G13, C6     

Liquidation triggers and the valuation of equity and debt

Many bankruptcy codes implicitly or explicitly contain net-worth covenants, which provide the firm’s bondholders with the right to force reorganization or liquidation if the value of the firm falls below a certain threshold. In practice, however, default does not necessarily lead to immediate change of control or to liquidation of the firm’s assets by its debtholders. To consider the impact of this on the valuation of corporate securities, we develop a model in which liquidation is driven by a state variable that accumulates with time and severity of distress. We model a dynamic grace period for the liquidation event. Recent or severe distress events may have greater impact on the liquidation trigger. Our model can be applied to a wide array of bankruptcy codes and jurisdictions.     

Restructuring of traditional farms and new land relations in Ukraine

This paper reports the results of a 1993/1994 survey of 2500 farm managers, farm employees, and private farmers in Ukraine, highlighting changes at the farm level in response to programs of land reform and farm restructuring. As of early 1994, Ukrainian reform had moved to the first stage, which involves privatization of much of the agricultural land and creation of shareholding farms. Over 60% of agricultural land in Ukraine has been transferred from state to collective ownership; among the collective and state farms surveyed, nearly 75% have reorganized and most of them have allocated land and asset shares to members. The number of independent private farmers in Ukraine exceeds 30 000, but with an average farm size of 20 ha they cultivate less than 2% of farmland. Reform at the farm level in Ukraine has thus begun, but at present is at a very early stage.     

Empirical labor search: A survey

This paper surveys the existing empirical research that uses search theory to empirically analyze labor supply questions in a structural framework, using data on individual labor market transitions and durations, wages, and individual characteristics. The starting points of the literature are the Mincerian earnings function, Heckman's classic selection model, and dynamic optimization theory. We develop a general framework for the labor market where the search for a job involves dynamic decision making under uncertainty. It can be specialized to be in agreement with most published research using labor search models. We discuss estimation, policy evaluation with the estimated model, equilibrium model versions, and the decomposition of wage variation into factors due to heterogeneity of various model determinants as well as search frictions themselves. We summarize the main empirical conclusions.     

What the Pension Benefit Guaranty Corporation can learn from the Federal Savings and Loan Insurance Corporation

This article attempts to draw attention to some important lessons that the Pension Benefit Guaranty Corporation (PBGC) can learn from the experience of the Federal Savings and Loan Insurance Corporation (FSLIC). FSLIC was the government agency that insured deposits at savings and loan associations until it was replaced in 1989, leaving a massive deficit to be financed by taxpayers. Like FSLIC, the PBGC is a government agency that guarantees a form of private corporate debt. As guarantor of the pension benefits promised by private plan sponsors, the PBGC bears the risk of a shortfall between the value of insured benefits and the assets securing those benefits. There has been a significant change in the attitude and behavior of senior public officials and legislators as a result of the S&L debacle. Directors of the PBGC and the Secretaries of Labor to whom they report have pointed out the weaknesses of some of the pension funds that the PBGC insures and have pursued an active legislative agenda designed to reduce the PBGC's vulnerability to those weaknesses. Those efforts have resulted in a series of laws and amendments to laws that have significantly improved the U.S. pension guarantee system. But the magnitude of the PBGC's exposure to shortfall risk depends on three factors: (1) the financial strength of plan sponsors, (2) the degree of underfunding of insured benefits, and (3) the mismatch between the market-risk exposure of insured benefits (a form of long-term corporate debt) and the market-risk exposure of the assets securing that debt. Only the first two of these have been addressed by past legislative reforms. The third factor appears not to be well understood. It is apparently a widespread belief among policymakers that a well-diversified pension portfolio of equity securities provides an effective long-run hedge against liabilities of defined-benefit pension plans, so that there is no mismatch problem. This belief is mistaken. Equities are not a hedge against fixed-income liabilities even in the long run. Thus, even if the PBGC achieves the goal of full funding at one point in time, the mismatch between the market-risk exposure of the pension benefits that it insures and the pension assets backing them creates the potential for large shortfall losses in the future as the economy and capital market rates change in unpredictable ways. Therein lies an uncomfortable parallel with the S&L debacle.     

Money stock revisions and unanticipated money growth

An important ‘empirical regularity’ is the strong positive effect of money shocks on output and employment. One strand of business cycle theory relates this finding to temporary confusions between absolute and relative price changes. These models predict positive output effects of unperceived monetary movements, but the quantitative importance of unperceived shifts in nominal aggregates is subject to question. Another strand of theory, based on long-term nominal contracts and analogous price-setting institutions, generates output effects from unanticipated, but not necessarily contemporaneously unperceived, money shocks. However, the real effects of unpredicted, but contemporaneously understood, monetary changes are not obviously consistent with efficient institutional arrangements. The present paper provides some empirical evidence on the two types of theories by analyzing the output effects associated with revisions in the money stock data, where the revisions are interpreted as components of unperceived monetary movements. The revisions turn out to have no significant explanatory power for output. Previous findings that innovations from an estimated money growth equation have a significant output effect remain intact when the revisions are included as separate explanatory variables. Overall, the study provides a small amount of evidence against the special role of unperceived, as opposed to unanticipated, money movements as a determinant of business fluctuations.     

Delayed agreements and nonexpected utility

The unexplained occurrence of inefficient delays in reaching agreement is known in the economics literature as the “Hicks paradox.” This paper describes a strategic situation in which players may play a simultaneous move game either before or after a move of Nature. The structure is such that if the players were expected utility maximizers, they would be indifferent over the order of play. However, if at least one of the players is a nonexpected utility maximizer, for example, if player one has preferences over lotteries which exhibit betweenness and fanning out, such a player may strictly prefer to wait before playing the game. If both players exhibit fanning out and betweenness, then there exist games in which both prefer to delay agreement.