Taylor Rules, McCallum Rules and the Term Structure of Interest Rates

term structure, monetary policy, Taylor rule

Financial leverage and the leverage effect: A market and firm analysis

We quantify the effect of financial leverage on stock return volatility in a dynamic general equilibrium economy with debt and equity claims. The effect of financial leverage is studied both at a market and a firm level where the firm is exposed to both idiosyncratic and market risk. In a benchmark economy with both a constant interest rate and constant price of risk, financial leverage generates little variation in stock return volatility at the market level but significant variation at the individual firm level. In an economy that generates time-variation in interest rates and the price of risk, there is significant variation in stock return volatility at the market and firm level. In such an economy, financial leverage has little effect on the dynamics of stock return volatility at the market level. Financial leverage contributes more to the dynamics of stock return volatility for a small firm.

Taylor Rules, McCallum Rules and the Term Structure of Interest Rates

Recent empirical research shows that a reasonable characterization of federal-funds-rate targeting behavior is that the change in the target rate depends on the maturity structure of interest rates and exhibits little dependence on lagged target rates. See, for example, Cochrane and Piazzesi (2002). The result echoes the policy rule used by McCallum (1994) to rationalize the empirical failure of the `expectations hypothesis' applied to the term- structure of interest rates. That is, rather than forward rates acting as unbiased predictors of future short rates, the historical evidence suggests that the correlation between forward rates and future short rates is surprisingly low. McCallum showed that a desire by the monetary authority to adjust short rates in response to exogenous shocks to the term premiums imbedded in long rates (i.e. "yield-curve smoothing"), along with a desire for smoothing interest rates across time, can generate term structures that account for the puzzling regression results of Fama and Bliss (1987). McCallum also clearly pointed out that this reduced-form approach to the policy rule, although naturally forward looking, needed to be studied further in the context of other response functions such as the now standard Taylor (1993) rule. We explore both the robustness of McCallum's result to endogenous models of the term premium and also its connections to the Taylor Rule. We model the term premium endogenously using two different models in the class of affine term structure models studied in Duffie and Kan (1996): a stochastic volatility model and a stochastic price-of- risk model. We then solve for equilibrium term structures in environments in which interest rate targeting follows a rule such as the one suggested by McCallum (i.e., the "McCallum Rule"). We demonstrate that McCallum's original result generalizes in a natural way to this broader class of models. To understand the connection to the Taylor Rule, we then consider two structural macroeconomic models which have reduced forms that correspond to the two affine models and provide a macroeconomic interpretation of abstract state variables (as in Ang and Piazzesi (2003)). Moreover, such structural models allow us to interpret the parameters of the term-structure model in terms of the parameters governing preferences, technologies, and policy rules. We show how a monetary policy rule will manifest itself in the equilibrium asset-pricing kernel and, hence, the equilibrium term structure. We then show how this policy can be implemented with an interest-rate targeting rule. This provides us with a set of restrictions under which the Taylor and McCallum Rules are equivalent in the sense if implementing the same monetary policy. We conclude with some numerical examples that explore the quantitative link between these two models of monetary policy.

Arbitrage-Free Bond Pricing with Dynamic Macroeconomic Models

We examine the relationship between monetary-policy-induced changes in short interest rates and yields on long-maturity default-free bonds. The volatility of the long end of the term structure and its relationship with monetary policy are puzzling from the perspective of simple structural macroeconomic models. We explore whether richer models of risk premiums, specifically stochastic volatility models combined with Epstein-Zin recursive utility, can account for such patterns. We study the properties of the yield curve when inflation is an exogenous process and compare this to the yield curve when inflation is endogenous and determined through an interest-rate/Taylor rule. When inflation is exogenous, it is difficult to match the shape of the historical average yield curve. Capturing its upward slope is especially difficult as the nominal pricing kernel with exogenous inflation does not exhibit any negative autocorrelation - a necessary condition for an upward sloping yield curve as shown in Backus and Zin (1994). Endogenizing inflation provides a substantially better fit of the historical yield curve as the Taylor rule provides additional flexibility in introducing negative autocorrelation into the nominal pricing kernel. Additionally, endogenous inflation provides for a flatter term structure of yield volatilities which better fits historical bond data.

Arbitrage-free bond pricing with dynamic macroeconomic models

The authors examine the relationship between changes in short-term interest rates induced by monetary policy and the yields on long-maturity default-free bonds. The volatility of the long end of the term structure and its relationship with monetary policy are puzzling from the perspective of simple structural macroeconomic models. The authors explore whether richer models of risk premiums, specifically stochastic volatility models combined with Epstein-Zin recursive utility, can account for such patterns. They study the properties of the yield curve when inflation is an exogenous process and compare this with the yield curve when inflation is endogenous and determined through an interest rate (Taylor) rule. When inflation is exogenous, it is difficult to match the shape of the historical average yield curve. Capturing its upward slope is especially difficult because the nominal pricing kernel with exogenous inflation does not exhibit any negative autocorrelation-a necessary condition for an upward-sloping yield curve, as shown in Backus and Zin. Endogenizing inflation provides a substantially better fit of the historical yield curve because the Taylor rule provides additional flexibility in introducing negative autocorrelation into the nominal pricing kernel. Additionally, endogenous inflation provides for a flatter term structure of yield volatilities, which better fits historical bond data.Bonds - Prices ; Macroeconomics

Developing and Deploying Security Applications for In-Vehicle Networks

Radiological material transportation is primarily facilitated by heavy-duty on-road vehicles. Modern vehicles have dozens of electronic control units or ECUs, which are small, embedded computers that communicate with sensors and each other for vehicle functionality. ECUs use a standardized network architecture--Controller Area Network or CAN--which presents grave security concerns that have been exploited by researchers and hackers alike. For instance, ECUs can be impersonated by adversaries who have infiltrated an automotive CAN and disable or invoke unintended vehicle functions such as brakes, acceleration, or safety mechanisms. Further, the quality of security approaches varies wildly between manufacturers. Thus, research and development of after-market security solutions have grown remarkably in recent years. Many researchers are exploring deployable intrusion detection and prevention mechanisms using machine learning and data science techniques. However, there is a gap between developing security system algorithms and deploying prototype security appliances in-vehicle. In this paper, we, a research team at Oak Ridge National Laboratory working in this space, highlight challenges in the development pipeline, and provide techniques to standardize methodology and overcome technological hurdles.Comment: 10 pages, PATRAM 2

B Lymphocytes Are Required during the Early Priming of CD4\u3csup\u3e+\u3c/sup\u3e T Cells for Clearance of \u3cem\u3ePneumocystis\u3c/em\u3e Infection in Mice

B cells play a critical role in the clearance of Pneumocystis. In addition to production of Pneumocystis-specific Abs, B cells are required during the priming phase for CD4+ T cells to expand normally and generate memory. Clearance of Pneumocystis was found to be dependent on Ag specific B cells and on the ability of B cells to secrete Pneumocystis-specific Ab, as mice with B cells defective in these functions or with a restricted BCR were unable to control Pneumocystis infection. Because Pneumocystis-specific antiserum was only able to partially protect B cell–deficient mice from infection, we hypothesized that optimal T cell priming requires fully functional B cells. Using adoptive transfer and B cell depletion strategies, we determined that optimal priming of CD4+ T cells requires B cells during the first 2–3 d of infection and that this was independent of the production of Ab. T cells that were removed from Pneumocystis-infected mice during the priming phase were fully functional and able to clear Pneumocystis infection upon adoptive transfer into Rag1−/− hosts, but this effect was ablated in mice that lacked fully functional B cells. Our results indicate that T cell priming requires a complete environment of Ag presentation and activation signals to become fully functional in this model of Pneumocystis infection