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11. Institutional Herding in the Corporate Bond Market

Author:
Fang Cai, Song Han, and Dan Li
Publication Date:
12-2012
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We find substantial herding in U.S. corporate bonds among bond fund managers, much higher than that previously documented for the equity market. Herding is generally stronger among illiquid bonds, and buy herding and sell herding are driven by different factors. In particular, sell herding increases on negative news about bond ratings and corporate earnings. Interestingly, increases in ex-post transparency in corporate bond trading through Trade Reporting and Compliance Engine (TRACE) led to higher buy herding but not to higher sell herding. Finally, we find significant return reversals in the post-herding quarters, especially for sell herding and for junk bonds. Price reversal is most prominent when funds herd to sell illiquid bonds, which suggests that temporary price pressure is the reason behind price reversal.
Topic:
Markets, Business, Investment, Corporations, and Liquidity
Political Geography:
Global Focus

12. Limited Market Participation and Asset Prices in the Presence of Earnings Management

Author:
Bo Sun
Publication Date:
06-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We examine the role of earnings management in explaining the properties of asset prices and stock market participation. We demonstrate that investors' uncertainty about the extent of manipulation can cause excess movements in stock price relative to fluctuations in output. When faced with information asymmetry about fundamentals in the presence of earnings management, investors demand a higher equity premium for bearing the additional risk associated with their payoffs. In addition, when investors have heterogeneous beliefs about managerial manipulation, the dispersion in belief endogenously gives rise to limited stock market participation. Our model suggests that the increasing stringency of corporate governance and varying composition of investors may have played a role in the contemporaneous run-up of market participation rates in the recent years.
Topic:
Markets, Finance, Investment, and Stock Markets
Political Geography:
Global Focus

13. Evaluating the Forecasting Performance of Commodity Futures Prices

Author:
Trevor A. Reeve and Robert J. Vigfusson
Publication Date:
08-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Commodity futures prices are frequently criticized as being uninformative for forecasting purposes because (1) they seem to do no better than a random walk or an extrapolation of recent trends and (2) futures prices for commodities often trace out a relatively flat trajectory even though global demand is steadily increasing. In this paper, we attempt to shed light on these concerns by discussing the theoretical relationship between spot and futures prices for commodities and by evaluating the empirical forecasting performance of futures prices relative to some alternative benchmarks. The key results of our analysis are that futures prices have generally outperformed a random walk forecast, but not by a large margin, while both futures and a random walk noticeably outperform a simple extrapolation of recent trends (a random walk with drift). Importantly, however, futures prices, on average, outperform a random walk by a considerable margin when there is a sizeable difference between spot and futures prices.
Topic:
International Trade and Finance, Markets, Investment, and Commodities
Political Geography:
Global Focus

14. Housing Wealth and Consumption

Author:
Matteo Iacoviello
Publication Date:
08-2011
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Housing wealth is about one half of household net worth, and consumption is a considerable fraction (about two thirds) of Gross Domestic Product in the United States. Empirically, movements in housing wealth are associated with movements in consumption in the same direction. This observation has led many economists, commentators and policy makers to study how housing wealth and consumption are linked together. A sizeable portion of the comovement between housing wealth and consumption reflects common factors driving both variables, rather than the "wealth effect" of the former on the latter; however, a growing body of evidence suggests that the comovement is larger in developed financial markets and in the presence of liquidity constraints.
Topic:
Economics, Markets, Infrastructure, and Housing
Political Geography:
North America and United States of America

15. Interest on Excess Reserves as a Monetary Policy Instrument: The Experience of Foreign Central Banks

Author:
David Bowman, Etienne Gagnon, and Mike Leahy
Publication Date:
03-2010
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper reviews the experience of eight major foreign central banks with policy interest rates comparable to the interest rate on excess reserves paid by the Federal Reserve. We pursue two main lines of inquiry: 1) To what extent have these policy interest rates been lower bounds for short-term market rates, and 2) to what extent has tightening that included increasing these policy rates been achieved without reliance on reductions in reserves or other deposits held at the central bank? The foreign experience suggests that policy rate floors can be effective lower bounds for market rates, although incomplete access to central bank accounts and interest on them weakens this result. In addition, the foreign experience suggests that tightening by increasing the interest rate paid on central bank balances can help reduce or eliminate the need to drain balances. These results are consistent with theoretical results that show that tightening without draining is possible, irrespective of whether excess reserves are large or small.
Topic:
Markets, Interest Rates, Central Bank, and Fiscal Policy
Political Geography:
Global Focus

16. Tax Smoothing in Frictional Labor Markets

Author:
David M. Arseneau and Sanjay K. Chugh
Publication Date:
01-2009
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We re-examine the optimality of tax smoothing from the point of view of frictional labor markets. Our central result is that whether or not this cornerstone optimal fiscal policy pre- scription carries over to an environment with labor market frictions depends crucially on the cyclical nature of labor force participation. If the participation rate is exogenous at business- cycle frequencies — as is typically assumed in the literature — we show it is not optimal to smooth tax rates on labor income in the face of business-cycle shocks. However, if households do optimize at the participation margin, then tax-smoothing is optimal despite the presence of matching frictions. To understand these results, we develop a concept of general-equilibrium efficiency in search-based environments, which builds on existing (partial-equilibrium) search- efficiency conditions. Using this concept, we develop a notion of search-based labor-market wedges that allows us to trace the source of the sharply-contrasting fiscal policy prescriptions to the value of adjusting participation rates. Our results demonstrate that policy prescriptions can be very sensitive to the cyclical nature of labor-force participation in search-based environments.
Topic:
Markets, Labor Issues, and Tax Systems
Political Geography:
Global Focus

17. Political Disagreement, Lack of Commitment and the Level of Debt

Author:
Davide Debortoli and Ricardo Nunes
Publication Date:
07-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We analyze how public debt evolves when successive policymakers have different policy goals and cannot make credible commitments about their future policies. We consider several cases to be able to disentangle and quantify the respective effects of imperfect commitment and political disagreement. Absent political turnover, imperfect commitment drives the long-run level of debt to zero. With political disagreement, debt is a sizeable fraction of GDP and increasing in the degree of polarization among parties, no matter the degree of commitment. The frequency of political turnover does not produce quantitatively relevant effects. These results are consistent with much of the existing empirical evidence. Finally, we find that in the presence of political disagreement the welfare gains of building commitment are lower.
Topic:
Economics, Markets, and Political Economy
Political Geography:
United States

18. Optimal Fiscal and Monetary Policy in Customer Markets

Author:
David M. Arseneau and Sanjay K. Chugh
Publication Date:
01-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
A growing body of evidence suggests that ongoing relationships between consumers and firms may be important for understanding price dynamics. We investigate whether the existence of such customer relationships has important consequences for the conduct of both long-run and short-run policy. Our central result is that when consumers and firms are engaged in long-term relationships, the optimal rate of price inflation volatility is very low even though all prices are completely flexible. This finding is in contrast to those obtained in first-generation Ramsey models of optimal fiscal and monetary policy, which are based on Walrasian markets. Echoing the basic intuition of models based on sticky prices, unanticipated inflation in our environment causes a type of relative price distortion across markets. Such distortions stem from fundamental trading frictions that give rise to long-lived customer relationships and makes pursuing inflation stability optimal.
Topic:
Economics and Markets
Political Geography:
United States

19. On the Application of Automatic Differentiation to the Likelihood Function for Dynamic General Equilibrium Models

Author:
Houtan Bastani and Luca Guerrieri
Publication Date:
02-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
A key application of automatic differentiation (AD) is to facilitate numerical optimization problems. Such problems are at the core of many estimation techniques, including maximum likelihood. As one of the first applications of AD in the field of economics, we used Tapenade to construct derivatives for the likelihood function of any linear or linearized general equilibrium model solved under the assumption of rational expectations. We view our main contribution as providing an important check on finite-difference (FD) numerical derivatives. We also construct Monte Carlo experiments to compare maximum-likelihood estimates obtained with and without the aid of automatic derivatives. We find that the convergence rate of our optimization algorithm can increase substantially when we use AD derivatives.
Topic:
Economics and Markets
Political Geography:
United States

20. Cross-border Bank Acquisitions: Is there a Performance Effect?

Author:
Ricardo Correa
Publication Date:
03-2008
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper uses a unique database that includes deal and bank balance sheet information for 220 cross-border acquisitions between 1994 and 2003 to analyze the characteristics and performance effects of international takeovers on target banks. A discrete choice estimation shows that banks are more likely to get acquired in a cross-border deal if they are large, bad performers, in a small country, and when the banking sector is concentrated. Post-acquisition performance for target banks does not improve in the first two years relative to domestically-owned financial institutions. This result is explained by a decrease in the banks' net interest margin in developed countries and an increase in overhead costs in emerging economies.
Topic:
Economics, International Trade and Finance, and Markets