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on Dynamic General Equilibrium |
| By: | David Amdur (Department of Economics, Georgetown University) |
| Abstract: | Why are aggregate equity payouts and debt issued positively correlated over the business cycle in U.S. data? Standard real business cycle (RBC) models have few predictions about capital structure, because they assume that nancial markets are frictionless. On the other hand, the tradeo theory of capital structure argues that nancial frictions determine rms' optimal mix of debt and equity nancing. We develop an RBC model with nancial frictions and use it to explain some stylized facts about aggregate U.S. debt and equity ows. We document that debt issued and equity payouts are (i) positively correlated with output, (ii) positively correlated with investment, and (iii) positively correlated with each other. Our model can account for these stylized facts. We also calibrate the model to the periods 1952 { 1983 and 1984 { 2007 in order to explain the nding that real variables have become less volatile in the later subperiod, while nancial variables have become more volatile. By varying both the scale of technology shocks and the degree of nancial frictions, we are able to account for both results. Classification-JEL Codes: E32, G32, G35 |
| Keywords: | Debt-equity nance, RBC models, business cycle moderation, corporate nance, capital structure, tradeo theory, payout policy |
| Date: | 2008–08–03 |
| URL: | http://d.repec.org/n?u=RePEc:geo:guwopa:gueconwpa~08-08-03&r=dge |
| By: | Kevin J. Lansing |
| Abstract: | This paper develops a stochastic endogenous growth model that exhibits “excess volatility” of equity prices because speculative agents overreact to observed technology shocks. When making forecasts about the future, speculative agents behave like rational agents with very low risk aversion. The speculative forecast rule alters the dynamics of the model in a way that tends to confirm the stronger technology response. For moderate levels of risk aversion, the forecast errors observed by the speculative agent are close to white noise, making it difficult for the agent to detect a misspecification of the forecast rule. In model simulations, I show that this type of behavior gives rise to intermittent asset price bubbles that coincide with improvements in technology, investment and consumption booms, and faster trend growth, reminiscent of the U.S. economy during the late 1920s and late 1990s. The model can also generate prolonged periods where the price-dividend ratio remains in the vicinity of the fundamental value. The welfare cost of speculation (relative to rational behavior) depends crucially on parameter values. Speculation can improve welfare if actual risk aversion is low and agents underinvest relative to the socially-optimal level. But for higher levels of risk aversion, the welfare cost of speculation is large, typically exceeding one percent of per-period consumption. |
| Keywords: | Asset pricing ; Technology |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2008-08&r=dge |
| By: | Morris A. Davis; Robert F. Martin |
| Abstract: | We test if a standard representative agent model with a home-production sector can resolve the equity premium or value premium puzzles. In this model, agents value market consumption and a home consumption good that is produced as an aggregate of the stock of housing, home labor, and a labor-augmenting technology shock. We construct the unobserved quantity of the home consumption good by combining observed data with restrictions of the model. We test the first-order conditions of the model using GMM. The model is rejected by the data; it cannot explain either the historical equity premium or the value premium. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:931&r=dge |
| By: | Strid, Ingvar (Stockholm School of Economics); Walentin, Karl (Research Department, Central Bank of Sweden) |
| Abstract: | In this paper block Kalman filters for Dynamic Stochastic General Equilibrium models are presented and evaluated. Our approach is based on the simple idea of writing down the Kalman filter recursions on block form and appropriately sequencing the operations of the prediction step of the algorithm. It is argued that block filtering is the only viable serial algorithmic approach to significantly reduce Kalman filtering time in the context of large DSGE models. For the largest model we evaluate the block filter reduces the computation time by roughly a factor 2. Block filtering compares favourably with the more general method for faster Kalman filtering outlined by Koopman and Durbin (2000) and, furthermore, the two approaches are largely complementary |
| Keywords: | Kalman filter; DSGE model; Bayesian estimation; Computational speed; Algorithm; Fortran; Matlab |
| JEL: | C10 C60 |
| Date: | 2008–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0224&r=dge |
| By: | Giulio Fella (Queen Mary, University of London); Giovanni Gallipoli (University of British Columbia) |
| Abstract: | In this paper we ask whether policies targeting a reduction in crime rates through changes in education outcomes can be considered an effective and cost-viable alternative to interventions based on harsher punishment alone. In particular we study the effect of subsidizing high school completion. Most econometric studies of the impact of crime policies ignore equilibrium effects and are often reduced-form. This paper provides a framework within which to study the equilibrium impact of alternative policies. We develop an overlapping generation, life-cycle model with endogenous education and crime choices. Education and crime depend on different dimensions of heterogeneity, which takes the form of differences in innate ability and wealth at birth as well as employment shocks. PSID, NIPA and CPS data are used to estimate the parameters of a production function with different types of human capital and to approximate a distribution of permanent heterogeneity. These estimates are used to pin down some of the model's parameters. The model is calibrated to match education enrolments, aggregate (property) crime rate and some features of the wealth distribution. In our numerical experiments we find that policies targeting crime reduction through increases in high school graduation rates are more cost-effective than simple incapacitation policies. Furthermore, the cost-effectiveness of high school subsidies increases significantly if they are targeted at the wealth poor. We also find that financial incentives to high school graduation have radically different implications in general and partial equilibrium (i.e. the scale of the programmes can substantially change its outcomes). |
| Keywords: | Crime, Education, Subsidies |
| JEL: | H52 |
| Date: | 2008–07 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp630&r=dge |
| By: | Vindigni, Andrea (Princeton University) |
| Abstract: | This paper investigates the role that idiosyncratic uncertainty plays in shaping social preferences over the degree of labor market flexibility, in a general equilibrium model of dynamic labor demand where the productivity of firms evolves over time as a Geometric Brownian motion. A key result demonstrated is that how the economy responds to shocks, i.e. unexpected changes in the drift and standard deviation of the stochastic process describing the dynamics of productivity, depends on the power of labor to extract rents and on the status quo level of firing costs. In particular, we show that when firing costs are relatively low to begin with, a transition to a rigid labor market is favored by all and only the employed workers with idiosyncratic productivity below some threshold value. A more volatile environment, and a lower rate of productivity growth, i.e. “bad times,” increase the political support for more labor market rigidity only where labor appropriates of relatively large rents. Moreover, we demonstrate that when the status quo level of firing costs is relatively high, the preservation of a rigid labor market is favored by the employed with intermediate productivity, whereas all other workers favor more flexibility. The coming of better economic conditions need not favor the demise of high firing costs in rigid high-rents economies, because “good times” cut down the support for flexibility among the least productive employed workers. The model described provides some new insights on the comparative dynamics of labor market institutions in the U.S. and in Europe over the last few decades, shedding some new light both on the reasons for the original build-up of “Eurosclerosis,” and for its the persistence up to the present day. |
| Keywords: | employment protection, firing costs, productivity, political economy, rents, volatility, growth, institutional divergence |
| JEL: | D71 D72 E24 J41 J63 J65 |
| Date: | 2008–05 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp3509&r=dge |
| By: | Díaz-Giménez, Javier (Universidad Carlos III, Madrid); Giolito, Eugenio P. (Universidad Carlos III, Madrid) |
| Abstract: | We study the steady state of an overlapping generations economy where singles search for spouses. In our model economy men and women live for many years and they differ in their fecundity, in their earnings, and in their survival probabilities. These three features are age-dependent and deterministic. Singles meet at random. They propose when the expected value of their current match exceeds that of remaining single. If both partners propose, the meeting ends up in a marriage. Marriages last until death does them apart, widows and widowers never remarry, and people make no other economic decisions whatsoever. In our model economy people marry because they value companionship, bearing children, and sharing their income with their spouses. The matching function depends on the single sex-ratios which are endogenous. Our model economy has only two free parameters: the search friction and the utility share of bearing children. We choose their values to match the median ages of first-time brides and grooms. We show that modeling the marriage decision in this simple way is sufficient to account for the age distributions of ever and never married men and women, for the probabilities of marrying a younger bride and a younger groom, and for the age distributions of first births observed in the United States in the year 2000. The previous literature on this topic claims that marriage is a waiting game in which women are choosier than men, and old and rich pretenders outbid the young and poor ones in their competition for fecund women. In this article we tell a different story. We show that their shorter biological clocks make women uniformly less choosy than men of the same age. This turns marriage into a rushing game in which women are willing to marry older men because delaying marriage is too costly for women. Our theory predicts that most of the gender age difference at first marriage will persist even if the gender wage-gap disappears. It also predicts that the advances in the reproductive technologies will play a large role in reducing the age difference at first marriage. |
| Keywords: | marriage, search, sex ratio |
| JEL: | J12 D83 |
| Date: | 2008–06 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp3539&r=dge |
| By: | Pere Gomis-Porqueras; Adrian Peralta-Alva |
| Abstract: | This paper tries to understand the underlying causes of the rapid increase in obesity rates over recent decades. In particular, we propose a dynamic general equilibrium model to derive the quantitative implications of a decline in the relative (monetary and time) cost of food prepared away from home on the caloric intake of the average American adult over the last forty years. Two channels that lower this relative cost are considered. First, productivity improvements in the production of food prepared away from home. We and that this channel is qualitatively consistent with expenditure trends in food items, but falls short of accounting for the magnitude of the observed changes. We then consider actual declines in income taxes and in the gender wage gap, which increase the cost of preparing food at home from scratch. Our model accounts for three quarters of the observed changes in calorie consumption, and is consistent with trends in aggregate food expenditures, time use, and key macroeconomic variables. Our results indicate that changes in the relative cost of food prepared away from home play an important role in our understanding of the increased weight of the American population during the last 40 years. |
| Keywords: | Obesity |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2008-017&r=dge |
| By: | Pere Gomis-Porqueras; Adrian Peralta-Alva |
| Abstract: | In this paper we study optimal monetary and fiscal policies, and the welfare costs of inflation, within the Lagos and Wright (2005) framework. Monetary equilibria may be inefficient without fiscal policy tools due to bargaining frictions. We show that subsidies in decentralized markets can be implemented to alleviate underproduction, while money is still essential. Deviations from the Friedman rule may be large, and having fiscal and monetary policies in place results in considerable welfare gains. When fiscal policies are held constant, the welfare costs of increasing inflation may be as high as 8% of lifetime consumption. When lump sum monetary transfers are not available, a positive production subsidy may be inflationary and welfare reducing. However, sales taxes in the decentralized market and production taxes in the centralized market may increase welfare. The optimality of the Friedman rule in this case depends crucially on the bargaining power of the buyer, and equilibria are not first best. |
| Keywords: | Monetary policy ; Fiscal policy |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2008-015&r=dge |
| By: | Juan Carlos Hatchondo; Leonardo Martinez |
| Abstract: | This paper extends the baseline framework used in recent quantitative studies of sovereign default by assuming that governments can borrow using long-duration bonds. Previous studies have assumed that governments can borrow using bonds that mature after one quarter. Once we assume that the government issues bonds with a duration that is close to the average duration observed in emerging economies, the model is able to generate a substantially higher and more volatile interest rate. This narrows the gap between the predictions of the model and the data, which indicates that the introduction of long-duration bonds may be a useful tool for future research about emerging economies. Our analysis is also relevant for the study of other credit markets. |
| Keywords: | Bonds |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedrwp:08-02&r=dge |
| By: | Theodoros Diasakos |
| Abstract: | This is a study on the comparative statics of general equilibrium asset prices in a representative-agent model where securities are specified by their dividend processes - vector geometric Brownian motions with fixed factor loadings. As usual, equilibrium asset prices are conditional expectations of future dividends valued at the marginal utility of equilibrium consumption. I examine the comparative statics of the equilibrium prices of securities relative to the equilibrium price of a zero-coupon bond. I show that the inner product of the vector of factor loadings of the dividend of a security with the gradient vector (with respect to the current realization of the Brownian motion) of its equilibrium relative price is always non-negative. More precisely, it is positive unless all of the factor loadings are zero. Based on this result, I provide expressions for the comparative statics. They attest to the richness of the corresponding dynamics. In general, since changes in the components of the Brownian motion induce wealth effects, the equilibrium relative price of a security may vary with the current realization of a component of the Brownian vector, even when its dividend is independent of that component. My analysis uncovers a mechanism that has hitherto been ignored by the literature: the wealth effects do not operate only through changes in risk aversion but also via altering the "riskiness" of a security. Market-clearing leads to endogenously generated correlation across asset prices and asset returns, over and above that induced by correlation between asset payoffs, giving the appearance of "contagion". I demonstrate that this obtains even under constant absolute risk aversion (in which case, the risk aversion channel of wealth effects leaves equilibrium relative prices unchanged). |
| Keywords: | comparative statics, general equilibrium, asset prices, contagion, dynamically complete markets |
| JEL: | G10 G12 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:72&r=dge |