Creator: Alvarez, Fernando, 1964- and Jermann, Urban J. Series: Endogenous incompleteness Abstract:
We study the asset pricing implications of a multi-agent 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.
Keyword: Equilibrium, Default, Solvency constraints, Risk, Shocks, and Assets Subject (JEL): G12 - General financial markets - Asset pricing ; Trading volume ; Bond interest rates and D50 - General equilibrium and disequilibrium - General
Creator: Ligon, Ethan., Thomas, Jonathan P., and Worrall, Tim. Series: Endogenous incompleteness Abstract:
This paper studies efficient insurance arrangements in village economies when there is complete information but limited commitment. Commitment is limited because only limited penalties can be imposed on households which renege on their promises. Any efficient insurance arrangement must therefore take into account the fact that households will renege if the benefits from doing so outweigh the costs. We study a general model which admits aggregate and idiosyncratic risk as well as serial correlation of incomes. It is shown that in the case of two households and no storage the efficient insurance arrangement is characterized by a simple updating rule. An example illustrates the similarity of the efficient arrangement to a simple debt contract with occasional debt forgiveness. The model is then extended to multiple households and a simple storage technology. We use data from the ICRISAT survey of three villages in southern India to test the theory against three alternative models: autarky, full insurance, and a static model of limited commitment due to Coate and Ravallion (1993). Overall, the model we develop does a significantly better job of explaining the data than does any of these alternatives.
Keyword: Village economies, Insurance arrangements, Limited commitment, Risk, India, and Agrarian economies Subject (JEL): O15 - Economic development - Human resources ; Human development ; Income distribution ; Migration, O12 - Economic development - Microeconomic analyses of economic development, and D81 - Information, knowledge, and uncertainty - Criteria for decision-making under risk and uncertainty
Creator: Kocherlakota, Narayana Rao, 1963- Series: Lucas expectations anniversary conference Abstract:
There were three important changes in the United States economy during the 1980s. First, from 1982-90, the decade featured the longest consecutive stretch of positive quarterly output growth in United States history. Second, wage inequality expanded greatly as the wages of highly skilled workers grew markedly faster than the wages of less skilled workers (Katz and Murphy (1992)). Finally, consumption inequality also expanded as the consumption of highly skilled workers grew faster than that of less skilled workers (Attanasio and Davis (1994)). This paper argues that these three aspects of the United States economic experience can be interpreted as being part of an efficient response to a macroeconomic shock given the existence of a particular technological impediment to full insurance. I examine the properties of efficient allocations of risk in an economic environment in which the outside enforcement of risksharing arrangements is infinitely costly. In these allocations, relative productivity movements have effects on both the current and future distribution of consumption across individuals. If preferences over consumption and leisure are nonhomothetic, these changes in the allocation of consumption will generate persistent cycles in aggregate output that do not occur in efficient allocations when enforcement is costless.
Keyword: Business cycle, Skilled workers, Risk, and Consumption Subject (JEL): E32 - Prices, business fluctuations, and cycles - Business fluctuations ; Cycles and E21 - Macroeconomics : Consumption, saving, production, employment, and investment - Consumption ; Saving ; Wealth
Creator: Glosten, Lawrence R., Jagannathan, Ravi., and Runkle, David Edward. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Dept.) Number: 505 Abstract:
Earlier researchers have found either no relation or a positive relation between the conditional expected return and the conditional variance of the monthly excess return on stocks when they used the standard GARCH-M model. This is in contrast to the negative relation found when other approaches were used to model conditional variance. We show that the difference in the estimated relation arises because the standard GARCH-M model is misspecified. When the standard model is modified allow for (i) the presence for seasonal patterns in volatility, (ii) positive and negative innovations to returns to having different impacts on conditional volatility, and (iii) nominal interest rates to affect conditional variance, we once again find support for a negative relation. Using the modified GARCH-M model, we also show that there is little evidence to support the traditional view that conditional volatility is highly persistent. Also, positive unanticipated returns result in a downward revision of the conditional volatility whereas negative unanticipated returns result in an upward revision of conditional volatility of a similar magnitude. Hence the time series properties of the monthly excess return on stocks appear to be substantially different from that of the daily excess return on stocks.
Keyword: Asset valuation, Return rate, Risk, Rate of return, Stocks, and Stock market Subject (JEL): G11 - General financial markets - Portfolio choice ; Investment decisions and G12 - General financial markets - Asset pricing ; Trading volume ; Bond interest rates
Creator: Smith, Bruce D., d. 2002. and Stutzer, Michael J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Dept.) Number: 410 Keyword: Risk, Farm Credit System, Mutuals, Assets, Adverse selection, Dividends, and FCS Subject (JEL): Q14 - Agriculture - Agricultural finance and H81 - Miscellaneous issues - Governmental loans, loan guarantees, credits, and grants
Creator: Boyd, John H. and Graham, Stanley L. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Dept.) Number: 398 Abstract:
This study estimates the effects of allowing bank holding companies (BHCs) to enter several lines of financial business not now permitted. A simulation technique is used to estimate the risk and return of hypothetical financial corporations after merger between a BHC and a large firm in each of these industries: securities, real estate, life insurance, property and casualty insurance, and insurance agencies. The study concludes that a merger between a BHC and a life insurance company may decrease the probability of bankruptcy for the merged firm relative to the BHC alone. This result does not hold true, however, for BHC mergers with firms in the other industries. In particular, BHC mergers with securities or real estate firms are found to increase the probability of bankruptcy.
Keyword: Bank holding company, Securities, Insurance, Risk, Merger, Bank holding companies, Bankruptcy, and Real estate Subject (JEL): G28 - Financial institutions and services - Government policy and regulation, G21 - Financial institutions and services - Banks ; Other depository institutions ; Micro finance institutions ; Mortgages, and G32 - Corporate finance and governance - Financing policy ; Financial risk and risk management ; Capital and ownership structure
Creator: Atkeson, Andrew. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Dept.) Number: 381 Abstract:
This paper examines the optimal debt contract between lenders and a sovereign borrower when the borrower is free to repudiate the debt and when his decision to invest or consume borrowed funds is unobservable. We show that recurrent debt crises are a necessary part of the incentive structure which supports the optimal pattern of lending.
Keyword: Credit market, Foreign lending, International capital, International debt, International loans, Risk, Optimal debt contract, Debt crisis, and Moral hazard Subject (JEL): F34 - International finance - International lending and debt problems
Creator: Kehoe, Patrick J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Dept.) Number: 367 Keyword: Shocks, Dynamic economy, Risk, Equilibrium, Stochastic comparative statistics, and Stockman Subject (JEL): C19 - Econometric and statistical methods : General - Other and E13 - General aggregative models - Neoclassical