Working papers results

Consumption is striking back. Some recent evidence indicates that
the well-known asset pricing puzzles generated by the difficulties of
matching fluctuations in asset prices with high frequency fluctuations
in consumption might be solved found by considering consumption in
the long-run. A first strand of the literature concentrates on multiperiod
differences in log consumption, a second concentrates on the
cointegrating relation for consumption. Interestingly, only the (multiperiod)
Euler Equation for the consumer optimization problem is
considered by the first strand of the literature, while the cointegrationbased
literature concentrates exclusively on the (linearized) intertemporal
budget constraint. In this paper, we show that using the first
order condition in the linearized budget constraint to derive an explicit
long-run consumption function delivers an even more striking
strike back.

This paper studies how a central bank's preference for robustness against
model misspecification affects the design of monetary policy in a New-Keynesian
model of a small open economy. Due to the simple model structure,
we are able to solve analytically for the optimal robust policy rule, and we
separately analyze the effects of robustness against misspecification concerning
the determination of inflation, output and the exchange rate. We show that
an increased central bank preference for robustness makes monetary policy
respond more aggressively or more cautiously to shocks, depending on the
type of shock and the source of misspecification.

This paper introduces underground activities and tax evasion into a one sector dynamic general equilibrium model with external effects. The model presents a novel mechanism driving the self-fulfilling prophecies, which is triggered by the reallocation of resources to the underground sector to avoid the excess tax burden. This mechanism differs from the customary one, and it is complementary to it. In addition, the explicit introduction of an (even tiny) underground sector allows to reduce aggregate degree of increasing returns required for indeterminacy, and for having well behaved input demand schedules (in the sense they slope down).

Journal of Economic Literature Classification Numbers: O40, E260

A central problem for the game theoretic analysis of voting is that voting games
have very many Nash equilibria. In this paper, we consider a new refinement
concept for voting games that combines two ideas that appear reasonable for voting
games: First, trembling hand perfection (voters sometimes make mistakes when
casting their vote) and second, coordination of voters with similar interests. We
apply this refinement to an analysis of multicandidate elections under plurality rule
and runoff rule.
For plurality rule, we show that our refinement implies Duverger's law: In all
equilibria, (at most) two candidates receive a positive number of votes. For the case
of 3 candidates, we can completely characterize the set of equilibria. Often, there
exists a unique equilibrium satisfying our refinement; surprisingly, this is even true,
if there is no Condorcet winner. We also consider the equilibria under a runoff rule
and analyze when plurality rule and runoff rule yield different outcomes.

Building on recent work on dynamic interactive epistemology, we
extend the analysis of extensive-form psychological games (Geneakoplos,
Pearce & Stacchetti, Games and Economic Behavior, 1989) to
include conditional higher-order beliefs and enlarged domains of pay-off
functions. The approach allows modeling dynamic psychological
effects (such as sequential reciprocity, psychological forward induction,
and regret) that are ruled out when epistemic types are identified with
hierarchies of initial beliefs. We define a notion of psycholigical sequential
equilibrium, which generalizes the sequential equilibrium notion for
traditional games, for which we prove existence under mild assumptions.
Our framework also allows us to directly formulate assumptions about
"dynamic" rationality and interactive beliefs in order to explore strategic
interaction without assuming that players' beliefs are coordinated on an
equilibrium. In particular, we provide an exploration of (extensive-form)
rationalizability in psychological games.

We provide a summary updated guide for the construction, use and evaluation of
leading indicators, and an assessment of the most relevant recent developments in this
field of economic forecasting. To begin with, we analyze the problem of selecting a
target coincident variable for the leading indicators, which requires coincident indicator
selection, construction of composite coincident indexes, choice of filtering methods,
and business cycle dating procedures to transform the continous target into a binary
expansion/recession indicator. Next, we deal with criteria for choosing good leading
indicators, and simple non-model based methods to combine them into composite indexes.
Then, we examine models and methods to transform the leading indicators into
forecasts of the target variable. Finally, we consider the evaluation of the resulting
leading indicator based forecasts, and review the recent literature on the forecasting
performance of leading indicators.

Abstract

Iterated multiperiod ahead time series forecasts are made using a one-period ahead model, iterated forward for the desired number of periods, whereas direct forecasts are made using a horizon-specific estimated model, where the dependent variable is the multi-period ahead value being forecasted. Which approach is better is an empirical matter: in theory, iterated forecasts are more efficient if correctly specified, but direct forecasts are more robust to model misspecification. This paper compares empirical iterated and direct forecasts from linear univariate and bivariate models by applying simulated out-of-sample methods to 171 U.S. monthly macroeconomic time series spanning 1959 - 2002. The iterated forecasts typically outperform the direct forecasts, particularly if the models can select long lag specifications. The relative performance of the iterated forecasts improves with the forecast horizon.

We analyse the panel of the Greenbook forecasts (sample 1970-1996) and a
large panel of monthly variables for the US (sample 1970-2003) and show that
the bulk of dynamics of both the variables and their forecasts is explained by two
shocks. Moreover, a two factor model which exploits, in real time, information
on many time series to extract a two dimensional signal, produces a degree of
forecasting accuracy of the federal funds rate similar to that of the markets, and,
for output and inflation, similar to that of the Greenbook forecasts. This leads us
to conclude that the stochastic dimension of the US economy is two. We also show
that dimension two is generated by a real and nominal shock, with output mainly
driven by the real shock and inflation by the nominal shock. The implication is
that, by tracking any forecastable measure of real activity and price dynamics, the
Central Bank can track all fundamental dynamics in the economy.

How does the relationship between an investor and entrepreneur depend on the legal
system? In a double moral hazard framework, we show how optimal contracts,
corporate governance, and investor actions depend on the legal system. With better
legal protection, investors give more non-contractible support, demand more downside
protection, and exercise more governance. Investors in better legal systems develop
stronger governance and support competencies. Therefore, when investing in a different
legal systems they behave differently than local investors. We test these predictions
using a hand-collected dataset of European venture capital deals. The empirical
results confirm the predictions of the model.

Abstract

We employ Markov-switching regression methods to estimate fiscal policy feedback rules
in the U.S. for the period 1960-2002. Our approach allows to capture policy regime changes
endogenously. We reach three main conclusions. First, fiscal policy may be characterized,
according to Leeper (1991) terminology, as active from the 1960s throughout the 1980s, switching
gradually to passive in the early 1990s and switching back to active in early 2001. Second,
regime-switching fiscal rules are capable of tracking the time-series behaviour of the U.S. primary
deficit better than rules based on a constant parameter specification. Third, regime-switches in
monetary and fiscal policy rules do not exhibit any degree of synchronization. Our results are
at odds with the view that the post-war U.S. fiscal policy regime may be classified as passive at
all times, and seem to pose a challenge for the specification of the correct monetary-fiscal mix
within recent optimizing macroeconomic models considered suitable for policy analysis.