Sovereign Risk, FDI Spillovers, and Growth

This paper studies the effect of sovereign risk on capital flows from rich to poor nations in the context of a two-country model, where Foreign Direct Investment (FDI) creates positive externalities in domestic production. We show that if externalities are large, a developing country never expropriates foreign assets, and behaves as under perfect enforcement of foreigners' property rights, jumping to the steady state in one period. If externalities are absent, a developing country always expropriates foreign assets and, then, there are no capital flows in equilibrium, as occurs in autarky. If externalities are of a medium size, our model can account for scarce capital flows from rich to poor nations, as well as other key features of the data, such as rising-over-time patterns of foreign capital and FDI in developing countries. In addition, the model offers an economic rationale for the FDI restrictions observed across nations.     

What Determined the Great Cap Rate Compression of 2000–2007, and the Dramatic Reversal During the 2008–2009 Financial Crisis?

In this paper we revisit the many studies that have attempted to explain the determinants of commercial real estate capitalization rates. We introduce two new innovations. First we are able to incorporate two macroeconomic factors that greatly impact cap rates besides treasury rates and local market fundamentals – the variables most commonly used in such research. These are the general corporate risk premium operating in the economy, and the growth rate of debt relative to GDP in the general economy (liquidity). The addition of these factors greatly adds to the ability of previous models to explain the secular fall of cap rates in the last decade and their recent rise – in terms of traditional measures of within-sample fit. Our second innovation is methodological; our analysis uses a large and robust quarterly panel data set of over 30 US metropolitan areas from 1980q1 through 2009q3. With this data we compare 3 models: a “base model” and then one that selectively adds each of our macro-economic variables. We test the ability of each of these models to fit the 2002–2009 period using “back test” dynamic forecasts. Our conclusion is that much of the secular decline in cap rates from 2000 through 2007 and their subsequent rise seem attributable to the macro-economic factors and less to movements in market fundamentals.     

Optimal consumption and investment for markets with random coefficients

We consider an optimal investment and consumption problem for a Black–Scholes financial market with stochastic coefficients driven by a diffusion process. We assume that an agent makes consumption and investment decisions based on CRRA utility functions. The dynamic programming approach leads to an investigation of the Hamilton–Jacobi–Bellman (HJB) equation which is a highly nonlinear partial differential equation (PDE) of the second order. By using the Feynman–Kac representation, we prove uniqueness and smoothness of the solution. Moreover, we study the optimal convergence rate of iterative numerical schemes for both the value function and the optimal portfolio. We show that in this case, the optimal convergence rate is super-geometric, i.e., more rapid than any geometric one. We apply our results to a stochastic volatility financial market.     

The short and long-run interdependencies between the Eurozone and the USA

We estimate quarterly cointegrating vector autoregressive models for the Eurozone and the USA based on long-run restrictions derived from a dynamic open economy model. Three long-run relations between the Eurozone and the USA emerge: relative purchasing power parity, international interest parity and a stationary output gap between the two economies. Generalized impulse response functions show differences in the dynamic adjustment of the two economies. Due to the I(1)-characteristic of both output series and the stability conditions imposed by the long-run equilibrium relationships, shocks to the model produce level effects only, while growth rates converge to their long-run averages.

The Impact of the Single Market Programme on EU Banking

The rise of the service economy has been the predominant pattern of structural change in the twentieth century. This article investigates the driving forces behind the recent stages of this development. Focusing on international input—output data from the early 1970s to the 1990s, a decomposition analysis separates the quantitative impacts of demand, technology and trade-driven determinants of output growth. Our findings confirm the rise of knowledge-based services as the most dynamic component, thus strengthening the case for ‘quaternarisation’ as a process which is distinctly characterised by the substantial contribution of technological and organisational change to structural development.     

Circuit Breakers and the Tail Index of Equity Returns

Using the tail index of returns on U.S. equities as a summarymeasure of extreme behavior, we examine changes in the equitymarkets surrounding the development of program trading for portfolioinsurance, the crash of 1987, and the subsequent introductionof circuit breakers and other changes in market architecture.Recently-developed tests for the null of constancy of the tailindex, versus the alternative of a change at an unknown date,permit inference on changes in extreme behavior over a longtime period while allowing for second-moment dependence in thereturn data. We find strong evidence of a decrease in the tailindex (increase in the probability of extreme events) aroundthe beginning of large-scale program trading, and weaker, butstill substantial, evidence of further significant change inthe tail index following the introduction of circuit breakers.Point estimates of the tail index suggest that the tail indexmay have roughly regained pre-program trading levels. More generally,the results tend to suggest that long samples of U.S. equityreturns should not be treated as samples from a single distributionfunction, particularly in examining extremes.     

Comparison of solutions to the multi-country Real Business Cycle model

We compare the performance of perturbation, projection, and stochastic simulation algorithms for solving the multi-country RBC model described in Den Haan et al. (this issue). The main challenge of solving this model comes from its large number of continuous-valued state variables, ranging between four and 20 in the specifications we consider. The algorithms differ substantially in terms of speed and accuracy, and a clear trade-off exists between the two. Perturbation methods are very fast but invoke large approximation errors except at points close to the steady state; the projection methods considered are accurate on a large area of the state space but are very slow for specifications with many state variables; stochastic simulation methods have lower accuracy than projection methods, but their computational cost increases only moderately with the state-space dimension. Simulated series generated by different methods can differ noticeably, but only small differences are found in unconditional moments of simulated variables. On the basis of our comparison, we identify the factors that account for differences in accuracy and speed across methods, and we suggest directions for further improvement of some approaches.     

Quasi-linear preferences in the macroeconomy: Indeterminacy,heterogeneity and the representative consumer

We use aggregation theory to investigate the link between one-consumer and multi-consumer economies under a quasi-linear class of preferences. Our study is carried out in the context of the neoclassical growth model. The quasi-linear preferences considered are additive in consumption and leisure and linear in leisure. We first show that in a homogeneous agents economy, the individual hours worked are not uniquely determined. We then demonstrate that the indeterminacy can be resolved by introducing heterogeneity. For example, idiosyncratic shocks to productivities or imperfect substitutability of labor restore the uniqueness of equilibrium. As a special case, our analysis includes the indivisible labor model by Hansen (1985).JEL Classification: C73, D90, E21We are grateful to Morten Ravn for his guidance. We have benefited from the comments of an anonymous referee, Jordi Caballé, Finn Kydland, Franck Portier, Michael Reiter, Xavier Sala-i-Martin, William Schworm and Andrew Scott. Any remaining errors are ours. This research was supported by the Instituto Valenciano de Investigaciones Económicas and the Ministerio de Ciencia y Tecnología de España, the Ramón y Cajal program, and BEC 2001-0535.     

Product differentiation and competitive selection

By studying the effect of different patterns of demand in an evolutionary selection model this paper shows how product differentiation reduces competitive selection pressure and thus increases the chances for the coexistence of firms. With the example of a duopoly it shows that: (1) a monopoly is the likely outcome of competition in homogeneous products, (2) although product differentiation does not preclude a monopoly it greatly improves the chances for the stable coexistence of firms in the long run, and (3) the more differentiated the products, the more stable the duopoly. JEL Classification: B52, L11 This study has benefited from insightful comments and suggestions of two anonymous referees as well as from discussions with Michael Peneder, Werner H?lzl, and Harry Bloch. I would also like to thank Dennis C. Mueller and Gustav Feichtinger for supervising my doctoral thesis preceding this paper.