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Creator: Alvarez, Fernando, 1964 and Jermann, Urban J. Series: Endogenous incompleteness Abstract: We study the asset pricing implications of a multiagent endowment economy where agents can default on debt. We build on the environment studied by Kocherlakota (1995) and Kehoe and Levine (1993). We present an equilibrium concept for an economy with complete markets and with endogenous solvency constraints. These solvency constraints prevent default, but at the cost of reduced risk sharing. We show that versions of the classical welfare theorems hold for this equilibrium definition. We characterize the pricing kernel, and compare it to the one for economies without participation constraints: interest rates are lower and risk premia depend on the covariance of the idiosyncratic and aggregate shocks.
Palabra clave: Equilibrium, Default, Solvency constraints, Risk, Shocks, and Assets Tema: G12  General financial markets  Asset pricing ; Trading volume ; Bond interest rates and D50  General equilibrium and disequilibrium  General 
Creator: Alvarez, Fernando, 1964, Atkeson, Andrew, and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 650 Abstract: The key question asked by standard monetary models used for policy analysis is, How do changes in shortterm interest rates affect the economy? All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: the observation that exchange rates are approximately random walks implies that fluctuations in interest rates are associated with nearly oneforone changes in conditional variances and nearly no changes in conditional means. In this sense, standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong.

Creator: Alvarez, Fernando, 1964, Atkeson, Andrew, and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 627 Abstract: Timevarying risk is the primary force driving nominal interest rate differentials on currencydenominated bonds. This finding is an immediate implication of the fact that exchange rates are roughly random walks. We show that a general equilibrium monetary model with an endogenous source of risk variation—a variable degree of asset market segmentation—can produce key features of actual interest rates and exchange rates. The endogenous segmentation arises from a fixed cost for agents to exchange money for assets. As inflation varies, the benefit of asset market participation varies, and that changes the fraction of agents participating. These effects lead the risk premium to vary systematically with the level of inflation. Our model produces variation in the risk premium even though the fundamental shocks have constant conditional variances.
Palabra clave: Timevarying conditional variances, Pricing kernel, Fama puzzle, Segmented markets, Forward premium anomaly, and Asset pricingpuzzle Tema: F31  Foreign Exchange, F41  Open Economy Macroeconomics, G15  International Financial Markets, G12  Asset Pricing; Trading Volume; Bond Interest Rates, F30  International Finance: General, and E43  Interest Rates: Determination, Term Structure, and Effects 
Creator: Alvarez, Fernando, 1964, Kehoe, Patrick J., and Neumeyer, Pablo Andrés Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 616 Abstract: Are optimal monetary and fiscal policies time consistent in a monetary economy? Yes, but if and only if under commitment the Friedman rule of setting nominal interest rates to zero is optimal. This result is of applied interest because the Friedman rule is optimal for the standard preferences used in applied work, those consistent with the growth facts.
Palabra clave: Sustainable plans, Maturity structure, Friedman rule, and Time inconsistency 
Creator: Alvarez, Fernando, 1964, Atkeson, Andrew, and Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 605 Abstract: This paper analyzes the effects of money injections on interest rates and exchange rates in a model in which agents must pay a BaumolTobin style fixed cost to exchange bonds and money. Asset markets are endogenously segmented because this fixed cost leads agents to trade bonds and money only infrequently. When the government injects money through an open market operation, only those agents that are currently trading absorb these injections. Through their impact on these agents’ consumption, these money injections affect real interest rates and real exchange rates. We show that the model generates the observed negative relation between expected inflation and real interest rates. With moderate amounts of segmentation, the model also generates other observed features of the data: persistent liquidity effects in interest rates and volatile and persistent exchange rates. A standard model with no fixed costs can produce none of these features.

Creator: Alvarez, Fernando, 1964, Atkeson, Andrew, and Edmond, Chris Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 417 Abstract: We examine the responses of prices and inflation to monetary shocks in an inventorytheoretic model of money demand. We show that the price level responds sluggishly to an exogenous increase in the money stock because the dynamics of households' money inventories leads to a partially offsetting endogenous reduction in velocity. We also show that inflation responds sluggishly to an exogenous increase in the nominal interest rate because changes in monetary policy affect the real interest rate. In a quantitative example, we show that this nominal sluggishness is substantial and persistent if inventories in the model are calibrated to match U.S. households' holdings of M2.

Creator: Alvarez, Fernando, 1964 and Atkeson, Andrew Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 577 Abstract: We develop a new general equilibrium model of asset pricing and asset trading volume in which agents’ motivations to trade arise due to uninsurable idiosyncratic shocks to agents’ risk tolerance. In response to these shocks, agents trade to rebalance their portfolios between risky and riskless assets. We study a positive question — When does trade volume become a pricing factor? — and a normative question — What is the impact of Tobin taxes on asset trading on welfare? In our model, economies in which marketwide risk tolerance is negatively correlated with trade volume have a higher risk premium for aggregate risk. Likewise, for a given economy, we ﬁnd that assets whose cash ﬂows are concentrated on states with high trading volume have higher prices and lower risk premia. We then show that Tobin taxes on asset trade have a ﬁrstorder negative impact on exante welfare, i.e., a small subsidy to trade leads to an improvement in exante welfare. Finally, we develop an alternative version of our model in which asset trade arises from uninsurable idiosyncratic shocks to agents’ hedging needs rather than shocks to their risk tolerance. We show that our positive results regarding the relationship between trade volume and asset prices carry through. In contrast, the normative implications of this speciﬁcation of our model for Tobin taxes or subsidies depend on the speciﬁcation of agents’ preferences and nontraded endowments.
Palabra clave: Liquidity, Tobin taxes, Asset pricing, and Trade volume Tema: G12  Asset Pricing; Trading Volume; Bond Interest Rates 
Creator: Alvarez, Fernando, 1964, Atkeson, Andrew, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 388 Abstract: The key question asked by standard monetary models used for policy analysis, How do changes in shortterm interest rates affect the economy? All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: the observation that exchange rates are approximately random walks implies that fluctuations in interest rates are associated with nearly oneforone changes in conditional variances and nearly no changes in conditional means. In this sense standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong.

Creator: Alvarez, Fernando, 1964, Atkeson, Andrew, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 371 Abstract: Under mild assumptions, the data indicate that fluctuations in nominal interest rate differentials across currencies are primarily fluctuations in timevarying risk. This finding is an immediate implication of the fact that exchange rates are roughly random walks. If most fluctuations in interest differentials are thought to be driven by monetary policy, then the data call for a theory which explains how changes in monetary policy change risk. Here we propose such a theory based on a general equilibrium monetary model with an endogenous source of risk variation—a variable degree of asset market segmentation.
Palabra clave: TimeVarying Conditional Variances, Forward Premium Anomaly, Pricing Kernel, Segmented Markets, Asset PricingPuzzle, and Fama Puzzle Tema: F41  Open Economy Macroeconomics, F30  International Finance: General, G15  International Financial Markets, E43  Interest Rates: Determination, Term Structure, and Effects, F31  Foreign Exchange, and G12  Asset Pricing; Trading Volume; Bond Interest Rates