http://www.federalreserve.gov/pubs/feds/feeds.xml Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors. References in publications to the Finance and Economics Discussion Series (other than acknowledgment) should be cleared with the author(s) to protect the tentative character of these papers. 2011-12-08T11:27:38-05:00 en Board of Governors of the Federal Reserve System http://www.federalreserve.gov/pubs/feds/2012/201204/201204abs.html Dario Caldara, Jesus Fernandez-Villaverde, Juan Rubio-Ramirez, and Yao Wen. This paper compares different solution methods for computing the equilibrium of dynamic stochastic general equilibrium (DSGE) models with recursive preferences such as those in Epstein and Zin (1989 and 1991) and stochastic volatility. Models with these two features have recently become popular, but we know little about the best ways to implement them numerically. To fill this gap, we solve the stochastic neoclassical growth model with recursive preferences and stochastic volatility using four different approaches: second- and third-order perturbation, Chebyshev polynomials, and value function iteration. We document the performance of the methods in terms of computing time, implementation complexity, and accuracy. Our main finding is that perturbations are competitive in terms of accuracy with Chebyshev polynomials and value function iteration while being several orders of magnitude faster to run. Therefore, we conclude that perturbation methods are an attractive approach for computing this class of problems. 2012-01-26T14:34:51-05:00 en Computing DSGE Models with Recursive Preferences and Stochastic Volatility 2012-01-26T14:34:51-05:00 DSGE models recursive preferences perturbation 2012-04: Computing DSGE Models with Recursive Preferences and Stochastic Volatility http://www.federalreserve.gov/pubs/feds/2012/201204/201204pap.pdf PDF version Dario Caldara Dario Caldara Board of Governors of the Federal Reserve System Jesus Fernandez-Villaverde Jesus Fernandez-Villaverde University of Pennsylvania, NBER, CEPR, and FEDEA Juan Rubio-Ramirez Juan Rubio-Ramirez Duke University, Federal Reserve Bank of Atlanta, and FEDEA Yao Wen Yao Wen University of Pennsylvania Dario Caldara, Jesus Fernandez-Villaverde, Juan Rubio-Ramirez, and Yao Wen 2012-01-26T14:34:51-05:00 2012-04 C63 C68 E32 http://www.federalreserve.gov/pubs/feds/2012/201203/201203abs.html William B. Peterman. This paper considers the impact of endogenous human capital accumulation on optimal tax policy in a life cycle model. Including endogenous human capital accumulation, either through learning-by-doing or learning-or-doing, is analytically shown to create a motive for the government to use age-dependent labor income taxes. If the government cannot condition taxes on age, then it is optimal to use a tax on capital in order to mimic such taxes. Quantitatively, introducing learning-by-doing or learning-or-doing increases the optimal tax on capital by forty or four percent, respectively. Overall, the optimal tax on capital is thirty five percent higher in the model with learning-by-doing compared to the model with learning-or-doing implying that how human capital accumulates is of significant importance when determining the optimal tax policy. 2012-01-19T13:45:33-05:00 en The Effect of Endogenous Human Capital Accumulation on Optimal Taxation 2012-01-19T13:45:33-05:00 Optimal taxation capital taxation human capital 2012-03: The Effect of Endogenous Human Capital Accumulation on Optimal Taxation http://www.federalreserve.gov/pubs/feds/2012/201203/201203pap.pdf PDF version William Peterman William Peterman Board of Governors of the Federal Reserve System William B. Peterman 2012-01-19T13:45:33-05:00 2012-03 E24 E62 H21 http://www.federalreserve.gov/pubs/feds/2012/201202/201202abs.html Mark A. Carlson, Kurt F. Lewis, and William R. Nelson. This paper describes the construction of a financial stress index. This stress index differs from other indexes in that it incorporates the co-movement and volatility of financial series as well as the levels of the series. Our index also uses past experience more than others to guide the assessment about which characteristics of the data suggest financial stress exists. In addition to describing the construction of our financial stress index, we spend some time discussing issues relevant to the general construction of stress indexes. 2012-01-16T09:51:01-05:00 en Using Policy Intervention to Identify Financial Stress 2012-01-16T09:51:01-05:00 Financial stress financial markets financial institutions 2012-02: Using Policy Intervention to Identify Financial Stress http://www.federalreserve.gov/pubs/feds/2012/201202/201202pap.pdf PDF version Mark Carlson Mark Carlson Board of Governors of the Federal Reserve System Kurt Lewis Kurt Lewis Board of Governors of the Federal Reserve System William Nelson William Nelson Board of Governors of the Federal Reserve System Mark A. Carlson, Kurt F. Lewis, and William R. Nelson 2012-01-16T09:51:01-05:00 2012-02 E59 G01 http://www.federalreserve.gov/pubs/feds/2012/201201/201201abs.html Andrew D. Paciorek. Although the volatility of house prices is often ascribed to demand-side factors, constraints on housing supply have important and little-studied implications for housing dynamics. I illustrate the strong relationship in city-level data between the volatility of house prices and the regulation of new housing supply. I then employ a dynamic structural model of housing investment to estimate the effect of supply constraints on both the level of new construction and the responsiveness of investment to house prices. I find that supply constraints increase volatility through two channels: First, regulation lowers the elasticity of new housing supply by increasing lags in the permit process and adding to the cost of supplying new houses on the margin. Second, geographic limitations on the area available for building houses, such as steep slopes and water bodies, lead to less investment on average relative to the size of the existing housing stock, leaving less scope for the supply response to attenuate the effects of a demand shock. My estimates and simulations confirm that regulation and geographic constraints play critical and complementary roles in decreasing the responsiveness of investment to demand shocks, which in turn amplifies house price volatility. 2012-01-09T14:34:26-05:00 en Supply Constraints and Housing Market Dynamics 2012-01-09T14:34:26-05:00 house prices volatility housing supply regulation 2012-01: Supply Constraints and Housing Market Dynamics http://www.federalreserve.gov/pubs/feds/2012/201201/201201pap.pdf PDF version Andrew Paciorek Andrew Paciorek Board of Governors of the Federal Reserve System Andrew D. Paciorek 2012-01-09T14:34:26-05:00 2012-01 http://www.federalreserve.gov/pubs/feds/2011/201160/201160abs.html Jason DeBacker, Bradley Heim, Vasia Panousi, and Ivan Vidangos. We use a new and large panel dataset of household income to shed light on the permanent versus transitory nature of rising inequality in individual male labor earnings and in total household income, both before and after taxes, in the United States over the period 1987-2006. Due to the quality and the significant size of our dataset, we are able to conduct our analysis using rich and precisely estimated error-components models of income dynamics. Our main specification finds evidence for a quadratic heterogeneous income profiles component and a random walk component in permanent earnings, and for a moving-average component in autoregressive transitory earnings. We find that the increase in inequality over our sample period was entirely permanent for male earnings, and predominantly permanent for household income. We also show that the tax system, though reducing inequality, nonetheless did not materially affect its increasing trend. Furthermore, we compare our model-based findings against those of simpler, non-model based inequality decomposition methods. We show that the results for the trends in the evolution of the permanent and transitory variances are remarkably similar across methods, whereas the results for the shares of those variances in cross-sectional inequality differ widely. Further investigation into the sources of these differences suggests that simpler methods produce erroneous decompositions because they cannot flexibly capture the relative degree of persistence of the transitory component of income. 2011-12-23T12:41:43-05:00 en Rising Inequality: Transitory or Permanent? New Evidence from a U.S. Panel of Household Income 1987-2006 2011-12-23T12:41:43-05:00 Income inequality variance decomposition error-components models transitory vs. permanent 2011-60: Rising Inequality: Transitory or Permanent? New Evidence from a U.S. Panel of Household Income 1987-2006 http://www.federalreserve.gov/pubs/feds/2011/201160/201160pap.pdf PDF version Jason DeBacker Jason DeBacker Treasury Department Bradley Heim Bradley Heim Indiana University Vasia Panousi Vasia Panousi Federal Reserve Board Ivan Vidangos Ivan Vidangos Federal Reserve Board Jason DeBacker, Bradley Heim, Vasia Panousi, and Ivan Vidangos 2011-12-23T12:41:43-05:00 2011-60 C33 D31 J31 http://www.federalreserve.gov/pubs/feds/2011/201159/201159abs.html Edward Nelson. This paper reviews Allan H. Meltzer's "A History of the Federal Reserve, Volume 2." This two-book volume covers Federal Reserve policies from 1951 to 1986. The book represents an enormous achievement in synthesizing a great amount of archival information into a historical account grounded on economic analysis. At the same time, Meltzer's interpretation of specific eras is open to question. He does not appear to acknowledge adequately the degree to which 1950s monetary policy decisions had a solid analytical foundation. Furthermore, Meltzer's account of the shift from the 1970s inflation to the 1980s disinflation implausibly stresses a shift in policymakers' objective function. The crucial change over this period, both in the United States and other countries, is more likely to have been policymakers' improved grasp of the connections between monetary policy and inflation. The review also takes issue with Meltzer's account, in his book's epilogue, of the financial crisis from 2007 to 2009. In this epilogue, Meltzer understates the degree to which the Federal Reserve's reaction to the financial crisis was in line with the historical practice of the Federal Reserve and other central banks. 2012-01-03T14:22:23-05:00 en A Review of Allan Meltzer's "A History of the Federal Reserve, Volume 2" 2012-01-03T14:22:23-05:00 Federal Reserve history financial crisis Allan Meltzer Great Inflation 2011-59: A Review of Allan Meltzer's "A History of the Federal Reserve, Volume 2" http://www.federalreserve.gov/pubs/feds/2011/201159/201159pap.pdf PDF version Edward Nelson Edward Nelson Board of Governors of the Federal Reserve System Edward Nelson 2012-01-03T14:22:23-05:00 2011-59 E52 E58 http://www.federalreserve.gov/pubs/feds/2011/201158/201158abs.html Olesya V. Grishchenko, Joel M. Vanden, and Jianing Zhang. In this paper we estimate the value of the embedded option in U.S. Treasury Inflation Protected Securities (TIPS). The option value exhibits significant time variation that is correlated with periods of deflationary expectations. We use our estimated option values to construct an embedded option price index and an embedded option return index. We then use our embedded option indices as independent variables and examine their statistical and economic significance for explaining the future inflation rate. In most of our regressions, our embedded option return index is significant even in the presence of traditional inflation variables, such as the yield spread between nominal Treasuries and TIPS, the return on gold bullion, the VIX index return, and the lagged inflation rate. We conduct several robustness tests, including alternative weighting schemes, alternative variable specifications, and alternative data samples. We conclude that the embedded option in TIPS contains useful information for future inflation, both in-sample and out-of-sample. Our results should be valuable to practitioners, monetary authorities, and policymakers alike. 2012-01-04T09:45:49-05:00 en The Information Content of the Embedded Deflation Option in TIPS 2012-01-04T09:45:49-05:00 TIPS embedded option inflation deflation term structure 2011-58: The Information Content of the Embedded Deflation Option in TIPS http://www.federalreserve.gov/pubs/feds/2011/201158/201158pap.pdf PDF version Olesya Grishchenko Olesya Grishchenko Board of Governors of the Federal Reserve System Joel Vanden Joel Vanden Smeal College of Business, Penn State University Jianing Zhang Jianing Zhang Smeal College of Business, Penn State University Olesya V. Grishchenko, Joel M. Vanden, and Jianing Zhang 2012-01-04T09:45:49-05:00 2011-58 E31 G12 E43 E44 http://www.federalreserve.gov/pubs/feds/2011/201157/201157abs.html Celso Brunetti and David Reiffen. Trading by commodity index traders (CITs) has become an important aspect of financial markets over the past 10 years. We develop an equilibrium model of trader behavior that relates uninformed CIT trading to futures prices. The model predicts that CIT trading reduces the cost of hedging. We test the model using a unique non-public dataset which precisely identifies trader positions. We find evidence, consistent with the model, that index traders have become an important supply of price risk insurance. 2012-01-24T09:01:40-05:00 en Commodity Index Trading and Hedging Costs 2012-01-24T09:01:40-05:00 Commodity index traders hedging costs volatility 2011-57: Commodity Index Trading and Hedging Costs http://www.federalreserve.gov/pubs/feds/2011/201157/201157pap.pdf PDF version Celso Brunetti Celso Brunetti Board of Governors of the Federal Reserve System David Reiffen David Reiffen CFTC Celso Brunetti and David Reiffen 2012-01-24T09:01:40-05:00 2011-57 G13 C32 http://www.federalreserve.gov/pubs/feds/2011/201156/201156abs.html Alan K. Detmeister. This paper examines a number of alternative PCE price inflation measures including overall PCE inflation, PCE inflation excluding food and energy, trimmed mean PCE inflation, component-smoothed inflation, variance-weighted inflation, inflation with weights based on disaggregated regressions, and survey measures of inflation expectations. When averaging across a handful of specifications based on the primary uses of a core inflation measure three conclusions arise: 1. Inflation rates for nearly all the measures best track ex-post trend inflation or predict future overall inflation when they are averaged over a considerable number of months. Overall PCE price inflation should be averaged over 18 months or longer. A shorter averaging period is appropriate for core measures, often on the order of 12 months. 2. Even after appropriately averaging each index, core inflation indexes generally perform better than overall inflation. 3. Exclusion indexes, such as PCE excluding food and energy, perform slightly worse than many other possible core inflation measures; trimmed mean PCE, or a variance-weighted index, may be better choice for a summary inflation measure. 2012-01-24T08:32:04-05:00 en The Usefulness of Core PCE Inflation Measures 2012-01-24T08:32:04-05:00 Inflation core prices 2011-56: The Usefulness of Core PCE Inflation Measures http://www.federalreserve.gov/pubs/feds/2011/201156/201156pap.pdf PDF version Alan Detmeister Alan Detmeister Board of Governors of the Federal Reserve System Alan K. Detmeister 2012-01-24T08:32:04-05:00 2011-56 E31 E37 http://www.federalreserve.gov/pubs/feds/2011/201155/201155abs.html William B. Peterman. Previous literature demonstrates that in a computational life cycle model the optimal tax on capital is positive and large. Given the computational complexities of these overlapping generations models it is helpful to determine the relative importance of the economic factors driving this result. I highlight the impact of changing two common assumptions in a benchmark model that generates a large optimal tax on capital similar to the model in Conesa et al. (2009). First, the utility function is altered such that it implies an agent's Frisch labor supply elasticity is constant, as opposed to increasing, over his lifetime. Second, the government is allowed to tax accidental bequests at a separate rate from ordinary capital income. The main finding of this paper is that these two changes cause the optimal tax on capital to drop by almost half. Furthermore, I find that the welfare costs of adopting the high optimal tax on capital from the benchmark model in the model with the altered assumptions, which calls for a lower tax on capital, are equivalent to 0.35 percent of total lifetime consumption. Quantifying the impact of these assumptions in the benchmark model is important because the first has limited empirical evidence and the second, although included for tractability, confounds a motive for taxing capital with a motive for taxing accidental bequests. 2012-01-20T15:54:06-05:00 en Determining the Motives for a Positive Optimal Tax on Capital 2012-01-20T15:54:06-05:00 Opitmal taxation capital taxation 2011-55: Determining the Motives for a Positive Optimal Tax on Capital http://www.federalreserve.gov/pubs/feds/2011/201155/201155pap.pdf PDF version William Peterman William Peterman Board of Governors of the Federal Reserve System William B. Peterman 2012-01-20T15:54:06-05:00 2011-55 E62 H21 http://www.federalreserve.gov/pubs/feds/2011/201154/201154abs.html Vasia Panousi and Dimitris Papanikolaou. High-powered incentives may induce higher managerial effort, but they also expose managers to idiosyncratic risk. If managers are risk averse, they might underinvest when firm-specific uncertainty increases, leading to suboptimal investment decisions from the perspective of well-diversified shareholders. We empirically document that when idiosyncratic risk rises, firm investment falls, and more so when managers own a larger fraction of the firm. This negative effect of managerial risk aversion on investment is mitigated if executives are compensated with options rather than with shares or if institutional investors form a large part of the shareholder base. 2012-01-11T10:32:07-05:00 en Investment, Idiosyncratic Risk, and Ownership 2012-01-11T10:32:07-05:00 Investment idiosyncratic risk managerial onwership risk aversion 2011-54: Investment, Idiosyncratic Risk, and Ownership http://www.federalreserve.gov/pubs/feds/2011/201154/201154pap.pdf PDF version Vasia Panousi Vasia Panousi Federal Reserve Board Dimitris Papanikolaou Dimitris Papanikolaou Kellogg School of Management Vasia Panousi and Dimitris Papanikolaou 2012-01-11T10:32:07-05:00 2011-54 G01 G11 G32 http://www.federalreserve.gov/pubs/feds/2011/201153/201153abs.html Joanne W. Hsu. American women tend to be less financially literate than men, which is consistent with a household division of labor in which men manage finances. However, women also tend to outlive their husbands, so they will eventually need to take over this task. Using a new survey of older couples, I find that women acquire financial literacy as they approach widowhood. At an estimated increase of 0.04 standard deviations per year approaching widowhood, 80 percent of women in the sample would catch up with their husbands prior to the expected onset of widowhood. These findings reflect actual increases by women and are not merely an artifact of cognitive decline among older men. The results are consistent with a model in which the household division of labor breaks down when a spouse dies: women have incentives both to delay acquiring financial knowledge and also to begin learning before widowhood. This paper represents the first empirical examination of the financial literacy of both members of couples and provides a life-cycle interpretation of the gender gap in financial literacy. 2012-01-18T13:08:32-05:00 en Aging and Strategic Learning: The Impact of Spousal Incentives on Financial Literacy 2012-01-18T13:08:32-05:00 Financial literacy cognitive abilities human capital surveys aging 2011-53: Aging and Strategic Learning: The Impact of Spousal Incentives on Financial Literacy http://www.federalreserve.gov/pubs/feds/2011/201153/201153pap.pdf PDF version Joanne Hsu Joanne Hsu Board of Governors of the Federal Reserve System Joanne W. Hsu 2012-01-18T13:08:32-05:00 2011-53 D14 J24 C81 http://www.federalreserve.gov/pubs/feds/2011/201152/201152abs.html Tim Bollerslev, James Marrone, Lai Xu, and Hao Zhou. Recent empirical evidence suggests that the variance risk premium, or the difference between risk-neutral and statistical expectations of the future return variation, predicts aggregate stock market returns, with the predictability especially strong at the 2-4 month horizons. We provide extensive Monte Carlo simulation evidence that statistical finite sample biases in the overlapping return regressions underlying these findings can not ``explain" this apparent predictability. Further corroborating the existing empirical evidence, we show that the patterns in the predictability across different return horizons estimated from country specific regressions for France, Germany, Japan, Switzerland and the U.K. are remarkably similar to the pattern previously documented for the U.S. Defining a ``global" variance risk premium, we uncover even stronger predictability and almost identical cross-country patterns through the use of panel regressions that effectively restrict the compensation for world-wide variance risk to be the same across countries. Our findings are broadly consistent with the implications from a stylized two-country general equilibrium model explicitly incorporating the effects of world-wide time-varying economic uncertainty. 2012-01-10T18:15:34-05:00 en Stock Return Predictability and Variance Risk Premia: Statistical Inference and International Evidence 2012-01-10T18:15:34-05:00 Variance risk premium return predictability over-lapping return regressions international stock market returns global variance risk 2011-52: Stock Return Predictability and Variance Risk Premia: Statistical Inference and International Evidence http://www.federalreserve.gov/pubs/feds/2011/201152/201152pap.pdf PDF version Tim Bollerslev Tim Bollerslev Duke University James Marrone James Marrone University of Chicago Lai Xu Lai Xu Duke University Hao Zhou Hao Zhou Federal Reserve Board Tim Bollerslev, James Marrone, Lai Xu, and Hao Zhou 2012-01-10T18:15:34-05:00 2011-52 C12 C22 G12 G13 http://www.federalreserve.gov/pubs/feds/2011/201151/201151abs.html Arthur B. Kennickell. For many years, the cross-sectional Survey of Consumer Finances (SCF) has shown relatively weak or inconsistent changes in the shape of the distribution of net worth, despite many shifts in income and other economic factors. In 2009, households that had taken part in the 2007 SCF were re-interviewed to obtain information on the changes in their financial condition over the period of the intervening financial crisis. Looked at as a second cross section, the 2009 data show a pattern of wealth distribution very similar in shape to what had been seen in the earlier cross sections. Between the two years, however, there was considerable variation in the relative positions of households within the wealth distribution. This paper presents data on the changed situation of households and it decomposes the observed wealth changes in terms of underlying portfolio shifts. It is generally recognized that changes in the value of residential real estate, corporate equities and private businesses were important sources of wealth losses. Although the data presented here confirm that picture, they also show a great deal of heterogeneity below the aggregate level. The observed stability of the pseudo-cross-sectional wealth shares in the panel despite the underlying turmoil is largely a consequence of changes in values of businesses and equities among comparatively wealthy households offsetting changes in the value of housing assets among other households. 2011-12-13T17:10:56-05:00 en Tossed and Turned: Wealth Dynamics of U.S. Households 2007-2009 2011-12-13T17:10:56-05:00 Wealth mobility financial crisis Survey of Consumer Finances portfolio choice 2011-51: Tossed and Turned: Wealth Dynamics of U.S. Households 2007-2009 http://www.federalreserve.gov/pubs/feds/2011/201151/201151pap.pdf PDF version Arthur Kennickell Arthur Kennickell Board of Governors of the Federal Reserve System Arthur B. Kennickell 2011-12-13T17:10:56-05:00 2011-51 D31 G11 C81 http://www.federalreserve.gov/pubs/feds/2011/201150/201150abs.html James Costain and Anton Nakov. Starting from the assumption that firms are more likely to adjust their prices when doing so is more valuable, this paper analyzes monetary policy shocks in a DSGE model with firm-level heterogeneity. The model is calibrated to retail price microdata, and inflation responses are decomposed into "intensive", "extensive", and "selection" margins. Money growth and Taylor rule shocks both have nontrivial real effects, because the low state dependence implied by the data rules out the strong selection effect associated with fixed menu costs. The response to sector-specific shocks is gradual, but inappropriate econometrics might make it appear immediate. 2011-12-08T11:27:38-05:00 en Distributional dynamics under smoothly state-dependent pricing 2011-12-08T11:27:38-05:00 Nominal rigidity state-dependent pricing menu costs heterogeneity Taylor rule 2011-50: Distributional dynamics under smoothly state-dependent pricing http://www.federalreserve.gov/pubs/feds/2011/201150/201150pap.pdf PDF version James Costain James Costain Bank of Spain Anton Nakov Anton Nakov Board of Governors of the Federal Reserve System James Costain and Anton Nakov 2011-12-08T11:27:38-05:00 2011-50 E31 E52 D81