WP Series Archive

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Working Paper Series



10. LeBaron, Blake, "Heterogeneous Gain Learning and Long Swings in Asset Prices" (2010).

Abstract: This paper considers the impact of heterogeneous gain learning in an asset pricing model. A relatively stylized model is shown to generate persistent swings of asset prices from their fundamental values which replicates long range samples of U.S financial data.  The detailed mechanisms of the learning models are then explored.  Evidence suggests that agents' perceptions of risk and its dynamics and persistence are important in generating appropriate price/fundamental dynamics.  Agents putting large amounts of weight on the recent past in their volatility models control a large fraction of wealth, and are important in perpetuating the volatility magnifying dynamics of the market.

9. Jaffe, Adam, & Werfel, Seth (Federal Reserve Bank of NY), "Induction and Evolution in the Origin of Inventions: Evidence from Smoking Cessation Products" (2010).

Abstract: Neoclassical economic theory predicts that policies that discourage the consumption of a particular good will induce innovation in a socially desirable substitute. Evolutionary theory emphasizes the possibility of innovation waves associated with the identification of new dominant designs. We incorporate both of these possibilities in a model of the invention of new smoking cessation products, based on a new dataset of patents on such products from 1951-2004. We find that an increase in cigarette tax levels and smoking bans had no discernable impact on the industry-wide rate of invention in smoking cessation products. It does appear, however, that dominant designs did have substantial positive innovation effects. More specifically, the introduction of the nicotine gum and patch are estimated to have increased the rate of patenting activity in smoking cessation products by 60 and 79 percent, respectively, subject to a 10 percent rate of decay. Finally, these products had larger innovation effects at the firm level than among individual inventors.

8. McCulloch, Rachel, "The International Trading System and Its Future" (2010).

Abstract: This chapter describes the evolution and structure of the international trading system, focusing on the tension between the fundamental GATT/WTO principle of most-favored-nation (MFN) treatment and the proliferation of discriminatory trading arrangements, including regional agreements as well as new versions of special and differential treatment of low-income countries. It also discusses the increasing pressure to use the enforcement power of the GATT/WTO system to achieve member compliance with social norms in the areas of labor and environment. The chapter concludes by considering some significant challenges that currently face the international trading system and possible directions of the system’s evolution in response to these challenges.

7. Tortorice, Daniel, "Endogenous Separation, Wage Rigidity and the Dynamics of Unemployment" (2010).

Abstract: This paper shows that the Mortensen-Pissarides (MP) model requires endogenous separation to explain the volatility of unemployment. I estimate a version of the MP model with wage rigidity and permanent shocks to match productivity. The model generates sufficient volatility in unemployment, vacancies, job-finding and job-separation despite relatively low worker outside options. I then re-estimate the model while restricting the separation rate to be constant and show that, even though the estimation procedure finds the best fitting model, the model predicts too little variance in unemployment and too much variance in the job-finding rate. Based on this result I conclude that models of unemployment fluctuations need endogenous separation rates to explain unemployment fluctuations.

6. Tortorice, Daniel, "Credit Constraints, Learning and Aggregate Consumption Volatility" (2011).

Abstract: This paper documents three empirical facts. First, the volatility of consumption growth relative to income growth rose from 1947-1960 and then fell dramatically by 50 percent from the 1960s to the 1990s. Second, the correlation between consumption growth and personal income growth fell by about 50 percent over the same time period. Finally, the absolute deviation of consumption growth from its mean exhibits one break in U.S. data, and the mean of the absolute deviations has fallen by about 30 percent. First, I find that a standard dynamic, stochastic general equilibrium model is unable to explain these facts. Then, I examine the ability of two hypotheses: a fall in credit constraints and changing beliefs about the permanence of income shocks to account for these facts. I find evidence for both explanations and the beliefs explanation is more consistent with the data. Importantly, I find that estimated changes in beliefs about the permanence of income shocks have significant explanatory power for consumption changes.

5. Tortorice, Daniel, "Unemployment Expectations and the Business Cycle" (2010).

Abstract: I compare unemployment expectations from the Michigan Survey of Consumers to VAR forecastable movements in unemployment. I document three key facts. First, one-half to one-third of the population expects unemployment to rise when it is falling at the end of a recession even though the VAR predicts the fall in unemployment. Second, more people expect unemployment to rise when it is falling at the end of a recession than expect it to rise when it is rising at the beginning of a recession even though the VAR predicts these changes. Finally, the lag change in unemployment is almost as important as the VAR forecast in predicting the fraction of the population that expects unemployment to rise. Professional forecasters do not make these mistakes. Least squares learning or real time expectations do little
to help explain these facts. However, delayed updating of expectations can explain some of these facts and extrapolative expectations explains these facts best. Individuals with higher income or education are only slightly less likely to make these expectational errors and
those who makes these errors are 8-10 percent less likely to believe it is a good time to make a major purchase.

4. Osler, Carol, & Savaser, Tanseli (Williams), "Extreme Returns: The Case of Currencies" (2010).

Abstract: This paper investigates how active price-contingent trading contributes to extreme returns even in the absence of news. Price-contingent trading, which is common across financial markets, includes algorithmic trading, technical trading, and dynamic option hedging. The paper highlights four properties of such trading that increase the frequency of extreme returns, and then estimates the relative of these properties using data from the foreign exchange market. The four key properties we consider are: (1) high kurtosis in the distribution of order sizes; (2) clustering of trades within the day; (3) clustering of trades at certain prices; and (4) positive and negative feedback between trading and returns. Calibrated simulations indicate that interactions among these properties are at least as important as any single one. Among individual properties, the orders’ size distribution and feedback effects have the strongest influence. Price-contingent trading could account for over half of realized excess kurtosis in currency returns.

3. Osler, Carol, Mende, Alexander (Leibniz Universität), & Menkhoff, Lukas (Leibniz Universität), "Price Discovery in Currency Markets" (2010).

Abstract: This paper examines the price discovery process in currency markets, basing its analysis on the pivotal distinction between the customer (end-user) market and the interdealer market. It first provides evidence that the price discovery process cannot be based on adverse selection between dealers and end users, as postulated in standard equity-market models, because the spreads dealers quote to their customers are not positively related to a trade’s likely information content. The paper then highlights three hypotheses from the literature – fixed operating costs, market power, and strategic dealing –that may explain the cross-sectional variation in customers spreads. The paper finishes by proposing a price discovery process relevant to liquid two-tier markets and providing preliminary evidence that this process applies to currencies.

2. Oberlechner, Thomas, (Webster University Vienna) & Osler, Carol, "Overconfidence in Currency Markets" (2009).

Abstract: This paper tests the influential hypothesis, typically attributed to Friedman (1953), that irrational traders will be driven out of financial markets by trading losses. The paper’s main finding is that overconfident currency dealers are not driven out of the market. Traders with extensive experience are neither more nor less overconfident than their inexperienced colleagues. We first provide evidence that currency dealers are indeed overconfident, which is notable since they get daily trading practice and face intense financial incentives to accuracy.

1. Hall, George, & Sargent, Thomas (NYU), "Interest rate risk and other determinants of post WWII U.S. government debt/GDP dynamics" (2010).

Abstract: This paper uses a sequence of government budget constraints to motivate estimates of returns on the U.S. Federal government debt. Our estimates differ conceptually and quantitatively from the interest payments reported by the U.S. government. We use our estimates to account for contributions to the evolution of the debt-GDP ratio made by inflation, growth, and nominal returns paid on debts of different maturities.