Browsing by Subject "Macroeconomics"

This dissertation addresses three key issues in international finance and economics: the uncovered interest rate parity puzzle in exchange rates, the home bias puzzle in portfolio allocations, and the surprising lack of correlation between terms of trade shocks and output in small open economies.

The first chapter shows that the much-studied Uncovered Interest Rate Parity (UIP) puzzle, the observation that exchange rates do not adjust sufficiently to offset interest rate differentials, is more complicated than commonly understood. I show that the puzzle changes nature with the horizon. I confirm existing short-run evidence that high interest rate currencies depreciate less than predicted by the interest rate differential. But, building on Engel (2012), at longer horizons (4 to 7 years) I find a reverse puzzle: high interest rate currencies depreciate too much. Interestingly, the long-horizon excess depreciation leads exchange rates to converge to the UIP benchmark over the long-run. To address the changing nature of the puzzle, I propose a novel model, based on the mechanism of bond convenience yields, that can explain both the short and the long horizon UIP violations. I also provide direct empirical evidence that supports the mechanism.

In chapter 2, I address the puzzling observation that portfolios are concentrated in asset classes which comove strongly with the non-financial income of investors. As an explanation, I propose a framework of endogenously generated information asymmetry, where rational agents optimally choose to focus their limited attention on risk factors that drive both their non-financial income and some of the risky asset payoffs. In turn, the agents concentrate their portfolios in assets driven by those endogenously familiar factors. I explore an uncertainty structure that implies decreasing returns to information, whereas the previous literature has focused on a setup with increasing returns. I show that the two frameworks have differing implications, which I test in the data and find support for decreasing returns to information.

In chapter 3, I address the puzzling lack of correlation between Terms of Trade (ToT) and the Small Open Economy (SOE) GDP. A SOE model typically relies on three sources of exogenous disturbances: world real interest rate, Terms of Trade (ToT) and technology. However, the empirical literature has failed to reach a consensus on the relative importance of the terms of trade as a driver of business cycles, with some papers claiming they are hugely important while others find no evidence of a relationship at all. Kehoe and Ruhl (2008) have recently shown that the weak empirical link between ToT and the GDP might be due to measurement limitations with the output series in an open economy framework. This paper merges data on national accounts with data on global trade flows for a panel of 31 countries and finds that Terms of Trade have a negligible effect on GDP but a strong effect on aggregate consumption. The evidence supports the hypothesis that ToT are important drivers of business cycles, but measurement issues with GDP obscure their relationship with real output. This further suggests that researchers should be careful when equating model output with measured GDP in an open economy setup.

This dissertation will address the dynamic interrelationship between multiple macro-economic fundamentals. The second chapter details a solution to the excess volatility puzzle described in the macro-economic labor literature in which properly calibrated search and matching models are unable to accurately match both the volatility of vacancies and productivity. The model described utilizes agents who abstract from rational expectations via knightian uncertainty in order to break the tight mechanism that links both productivity and vacancies together. The third chapter documents previously unknown long and short run dynamic interrelationships between the real exchange rate and various macro-economic fundamentals. It refutes the Backus-Smith model's assertion that relative consumption growth and the real exchange rate should be tightly correlated and documents a novel relationship between relative investment and output growth. More specifically, it notes that higher relative investment today should signal future appreciations of the exchange rate. The fourth chapter takes the novel result from the third chapter and proposes a model in order to define a mechanism which may explain the interesting interrelationship between investment and the real exchange rate at medium and long horizons. In particular, the model utilizes bonds as a form of collateral in the production of the investment good in order to more tightly link the two fundamentals.

This dissertation consists of three essays. In the first essay, ``The Structural Shift in the Cyclicality of the U.S. Labor Income Share: Empirical Evidence'', I document a structural shift in the cyclicality of the labor share from countercyclical to procyclical. I conclude that this structural shift is due to a decline in the usage of labor hoarding at the firm level and to an increase in the volatility of real wages. I also provide evidence suggesting this shift is widespread to the entire economy and is not due to structural changes in the industrial composition for the U.S. economy. In the second essay, ``The Cyclicality of the Labor Share: Labor Hoarding, Risk Aversion and Real Wage Rigidities'', I explore whether the decline in the usage of labor hoarding is able to jointly generate the vanishing procyclicality of labor productivity and the shift in the cyclicality of the labor share. I conclude that while these models are able to generate the vanishing procyclicality of labor productivity, they will generate counterfactually a more countercyclical labor share. This counterfactual result also occurs when I consider instead a decline in the workers' bargaining power in the wage bargaining power and an increase in the relative importance of aggregate demand shocks. In the third essay, ``The Public Sector Wage Premium: An Occupational Approach'', I characterize the strategy undertaken by the U.S. government to provide insurance to workers in occupations that are on the left-tail of the private wage distribution. I conclude that the government is effectively offering a high wage premium to non-routine manual workers and a wage penalty to non-routine cognitive workers.

This dissertation asks whether frequency misspecification of a New Keynesian model

results in temporal aggregation bias of the Calvo parameter. First, when a

New Keynesian model is estimated at a quarterly frequency while the true

data generating process is the same but at a monthly frequency, the Calvo

parameter is upward biased and hence implies longer average price duration.

This suggests estimating a New Keynesian model at a monthly frequency may

yield different results. However, due to mixed frequency datasets in macro

time series recorded at quarterly and monthly intervals, an estimation

methodology is not straightforward. To accommodate mixed frequency datasets,

this paper proposes a data augmentation method borrowed from Bayesian

estimation literature by extending MCMC algorithm with

"Rao-Blackwellization" of the posterior density. Compared to two alternative

estimation methods in context of Bayesian estimation of DSGE models, this

augmentation method delivers lower root mean squared errors for parameters

of interest in New Keynesian model. Lastly, a medium scale New Keynesian

model is brought to the actual data, and the benchmark estimation, i.e. the

data augmentation method, finds that the average price duration implied by

the monthly model is 5 months while that by the quarterly model is 20.7

months.

This dissertation presents two essays on Markov-Switching dynamic stochastic general equilibrium models.

The first essay is "Perturbation Methods for Markov-Switching Models," which is co-authored with Juan Rubio-Ramirez, Dan Waggoner, and Tao Zha. This essay develops an perturbation-based approach to solving dynamic stochastic general equilibrium models with Markov-Switching, which implies that parameters governing policies or the environment evolve over time in a discrete manner. Our approach has the advantages that it introduces regime switching from first principles, allows for higher-order approximations, shows non-certainty equivalence of first-order approximations, and allows checking the solution for determinacy. We explain the model setup, introduce an iterative procedure to solve the model, and illustrate it using a real business cycle example.

The second essay considers a model with financial frictions and studies the role of expectations and unconventional monetary policy during financial crises. During a financial crisis, the financial sector has

reduced ability to provide credit to productive firms, and the central bank may help lessen the magnitude of the downturn by using unconventional monetary policy to inject liquidity into credit markets. The model allows agents in the economy to expect policy changes by allowing parameters to change according to a Markov process, so agents have expectations about the probability of the central bank intervening during a crisis, and also have expectations about the central bank's exit strategy post-crisis.

Using this Markov Regime Switching specification, the paper addresses three issues. First, it considers the effects of different exit strategies, and shows that, after a crisis, if the central bank sells off its accumulated assets too quickly, the economy can experience a double-dip recession. Second, it analyzes the effects of expectations of intervention policy on pre-crisis behavior. In particular, if the central bank commits to always intervening during crises, there is a loss of output in pre-crisis times relative to if the central bank commits to never intervening. Finally, it considers the welfare implications of committing to intervening during crises, and shows that committing can raise or lower welfare depending upon the exit strategy used, and that committing before a crisis can be welfare decreasing but then welfare increasing once a crisis occurs.

My Ph.D. dissertation is composed of two chapters studying how monetary policy influences asset prices.

The first chapter empirically explores the effects of the Federal Reserve (Fed)'s large-scale asset purchasing (LSAP) program on the cross-section of equity returns through financial intermediaries' funding liquidity. Using the LSAP shock by Swanson (2017) as a policy measure and the Liquidity Mismatch Index by Bai et al. (2017) as a funding liquidity measure of intermediaries, I show that an expansionary policy shock increases the stock return of banks with low liquidity more than those with high liquidity. In addition, the liquidity of lenders also influences their borrowers' equity prices through their sticky loan contracts. Firms borrowing from low liquidity banks, and of high loan-to-asset ratio earn relatively higher returns under the same expansionary shock. The response of borrowers is weaker, more delayed, and more persistent than that of lenders. These findings collectively provide supportive evidence of the bank lending channel as a policy transmission mechanism in the quantitative easing period.

The second chapter theoretically analyzes how monetary policy feedback rule can influence the risk premium of financial assets in a New Keynesian general equilibrium model where a firm's default is endogenously determined from the limited liability of stockholders, and nominal price and wage rigidity exist. A productivity (monetary policy) shock shifts supply (demand) curve, causing output comove positively (negatively) with inflation. A policy rule to output and inflation determines the magnitude of output response to those shocks, determining the price of risk and the procyclicality of dividend. Higher (lower) inflation and lower (lower) output feedback lead to higher equity premium driven by a productivity (policy) risk. This trend is robust to the source of nominal rigidity. Under a baseline calibration, the model generates 1.76% (1.87%) of the annual levered (unlevered) equity risk premium, indicating an endogenous leverage does not amplify the equity return. The countercyclicality of the default rate in the model generates a credit risk premium, but does not amplify the overall credit spread. Producing reasonable asset pricing dynamics based on New Keynesian production-based models remains challenge.