Looking Behind the U. K.Term Structure: Were there Peso Problems in Inflation?

This paper develops and estimates a general equilibrium model for the term structures of nominal and real interest rates that incorporates regime-switching into the dynamics ofthe state variables. The model generates time-varying risk premia via changes in the covariance structure of the state variables and Peso problems through regime- switching. When the model is estimated using real and nominal yields from the U. K., I find that Peso problems emanating from instability in inflation have a significant impact on the nominal term structure. Peso problems affect (i) the sample predictability of excess returns, (ii) nominal term premia,and (iii) the inflation risk premia linking real and nominal yields with expected inflation.

FX trading and Exchange Rate Dynamics

This paper provides new perspective on the poor performance of exchange rate models by focusing on the information structure of FX trading. I present a new theoretical model of FX trading that emphasizes the role of incomplete and heterogeneous information. The model shows how an equilibrium distribution of FX transaction prices and orders can arise at each point in time from the optimal trading decisions of dealers. This result motivates empirical investigation of how the equilibrium distribution of FX prices behaves using a new data set that details trading activity in the FX market. This analysis produces two striking results: (i) Much of the observed short-term volatility in exchange rates comes from sampling the heterogeneous trading decisions of dealers in an equilibrium distribution that, under normal market conditions, changes comparatively slowly. (ii) In contrast to the assumptions of traditional macro models, public news is rarely the predominant source of exchange rate movements over any horizon.Foreign Exchange, Trading, Microstructure

Real Risk, Inflation Risk, and the Term Structure

I develop and estimate a general equilibrium model for the term structures of nominal and real interest rates in the UK that incorporates Markov-switching. The model allows for non-neutralities, nonlinear dynamics, and flexibility in the dynamics of the risk premia - features that are all present in the data. I use the model to assess how accurately the term structure reflects changing expectations of future yields and inflation. This analysis shows that the presence of time-varying risk premia make it very hard to accurately track changes in the expected path of real or nominal yields over horizons of less than five years. By contrast, variations in inflation expected over the next two to three years are very accurately reflected by changes in spread between real and nominal yields, or by changes in nominal yields alone. Over longer horizons, the term structures closely track changing expectations regarding future nominal and real yields but not future inflation.Term Structure, Risk Premia, Inflation Risk, Markov-Switching

Exploring poverty gaps among children in the UK

"The purpose of this paper is to use poverty gap analysis to explore the depth of poverty experienced by children of low-income families in the UK. Measures set out in the Child Poverty Act1 and in the National Child Poverty Strategy2 are based on poverty headcounts, i.e. you are either below or above a certain poverty threshold. The most commonly used measure is the 60 per cent relative poverty measure, defined as individuals living in households with incomes below 60 per cent of the median income. The National Strategy, published in April 2011, introduces a new measure on severe poverty, defined as individuals living in households experiencing material deprivation and with incomes below 50 per cent of the median income. The head count does not distinguish between those with incomes just below the poverty line and those deeper in poverty. Policies which improve incomes for those at the bottom of the income distribution will not lead to a fall in measured income poverty, unless incomes are raised sufficiently to cross the chosen poverty threshold, and yet reducing these families’ depth of poverty is highly likely to improve living standards. This paper supplements the headcount measures with analysis of the ‘poverty gap’ for UK children. The poverty gap measures ‘How poor are the poor’ i.e. the extent of poverty for those who are below the relative poverty threshold. With this measure, an improvement in incomes for those in poverty which is not sufficient for them to escape poverty, is nevertheless captured as a drop in measured poverty. In practice, for each poor individual we measure the poverty gap by calculating the shortfall in their income from the poverty line, and expressing this as a percentage of the poverty line. For example, if the poverty line was 100 and the income was 25 then the poverty gap would be 75 per cent (100 minus 25 equals 75; 75 divided by 100 is 75 per cent). A poverty gap of 75 per cent can be interpreted as an income that is 75 per cent below the poverty line" - page 1