International Investment Positions: A Cross-Sectional Analysis

We explore some empirical properties of gross international investment positions. In a cross-section of countries, we find that more open countries with larger domestic financial markets tend to hold greater quantities of foreign assets and liabilities.international investment positions, international investment income flows, asset trade.

Asymmetric Shocks and Monetary Policy in a Currency Union

We analyse the conduct of monetary policy in a currency union in the face of asymmetric shocks. In particular, we compare the stabilization properties of a currency union versus exchange rate arrangements and show how the relative performance of a currency union depends on the extent of economic integration in patterns of consumption and production and on the relative weights placed on price stability versus employment stability in the monetary authority's objective function.monetary union, stabilization.

Pegging To The Dollar And The Euro

The newly-launched euro is bound to attract some "trackers"- that is, countries that attempt to maintain exchange rate stability against the euro. In this paper, we ask whether the existence of trackers should be a matter of concern for the European Union. To gain some insight, we review the historical experience of the US with respect to dollar trackers. We identify and analyse the countries most likely to track the euro. Although the aggregate size of potential euro-trackers is small relative to the euro zone, we argue that this does not justify an attitude of benign neglect. Rather, we make recommendations for EU policy towards euro-trackers, arguing in favour of some limited and conditional support for stable bilateral exchange rates.

The National Pensions Reserve Fund: Pitfalls and Opportunities

This paper analyses some key issues concerning the new National Pensions Reserve Fund. We briefly review the basic demographic and economic trends that motivate the establishment of the Fund. We consider the pitfalls facing the operation of the Fund and argue that a complete ban on domestic investment would minimise the politicisation problem. At least initially, the Fund should adopt an aggressive investment strategy, with a large equity allocation. We further argue that asset allocation should take into account the co-variation of returns with domestic macroeconomic and fiscal variables. Finally, we discuss the organisational structure of the Fund and its implications for optimal performance.

Pricing Fixed-Income Securities in an Information-Based Framework

In this paper we introduce a class of information-based models for the pricing of fixed-income securities. We consider a set of continuous- time information processes that describe the flow of information about market factors in a monetary economy. The nominal pricing kernel is at any given time assumed to be given by a function of the values of information processes at that time. By use of a change-of-measure technique we derive explicit expressions for the price processes of nominal discount bonds, and deduce the associated dynamics of the short rate of interest and the market price of risk. The interest rate positivity condition is expressed as a differential inequality. We proceed to the modelling of the price-level, which at any given time is also taken to be a function of the values of the information processes at that time. A simple model for a stochastic monetary economy is introduced in which the prices of nominal discount bonds and inflation-linked notes can be expressed in terms of aggregate consumption and the liquidity benefit generated by the money supply

Information, Inflation, and Interest

We propose a class of discrete-time stochastic models for the pricing of inflation-linked assets. The paper begins with an axiomatic scheme for asset pricing and interest rate theory in a discrete-time setting. The first axiom introduces a "risk-free" asset, and the second axiom determines the intertemporal pricing relations that hold for dividend-paying assets. The nominal and real pricing kernels, in terms of which the price index can be expressed, are then modelled by introducing a Sidrauski-type utility function depending on (a) the aggregate rate of consumption, and (b) the aggregate rate of real liquidity benefit conferred by the money supply. Consumption and money supply policies are chosen such that the expected joint utility obtained over a specified time horizon is maximised subject to a budget constraint that takes into account the "value" of the liquidity benefit associated with the money supply. For any choice of the bivariate utility function, the resulting model determines a relation between the rate of consumption, the price level, and the money supply. The model also produces explicit expressions for the real and nominal pricing kernels, and hence establishes a basis for the valuation of inflation-linked securities

Discrete-Time Interest Rate Modelling

This paper presents an axiomatic scheme for interest rate models in discrete time. We take a pricing kernel approach, which builds in the arbitrage-free property and provides a link to equilibrium economics. We require that the pricing kernel be consistent with a pair of axioms, one giving the inter-temporal relations for dividend-paying assets, and the other ensuring the existence of a money-market asset. We show that the existence of a positive-return asset implies the existence of a previsible money-market account. A general expression for the price process of a limited-liability asset is derived. This expression includes two terms, one being the discounted risk-adjusted value of the dividend stream, the other characterising retained earnings. The vanishing of the latter is given by a transversality condition. We show (under the assumed axioms) that, in the case of a limited-liability asset with no permanently-retained earnings, the price process is given by the ratio of a pair of potentials. Explicit examples of discrete-time models are provided

On the Representation of General Interest Rate Models as Square Integrable Wiener Functionals

In the setting proposed by Hughston & Rafailidis (2005) we consider general interest rate models in the case of a Brownian market information filtration $(\mathcal{F}_t)_{t\geq0}$. Let $X$ be a square-integrable $\mathcal{F}_\infty$-measurable random variable, and assume the non-degeneracy condition that for all $t<\infty$ the random variable $X$ is not $\mathcal{F}_t$-measurable. Let ${\sigma_t}$ denote the integrand appearing in the representation of $X$ as a stochastic integral, write $\pi_t$ for the conditional variance of $X$ at time $t$, and set $r_t = \sigma^2_t / \pi_t$. Then $\pi_t$ is a potential, and as such can act as a model for a pricing kernel (or state price density), where $r_t$ is the associated interest rate. Under the stated assumptions, we prove the following: (a) that the money market account process defined by $B_t = \exp (\int_0^t r_s \,ds)$ is finite almost surely at all finite times; and (b) that the product of the money-market account and the pricing kernel is a local martingale, and is a martingale provided a certain integrability condition is satisfied. The fact that a martingale is thus obtained shows that from any non-degenerate element of Wiener space satisfying the integrability condition we can construct an associated interest-rate model. The model thereby constructed is valid over an infinite time horizon, with strictly positive interest, and satisfies the relevant intertemporal relations associated with the absence of arbitrage. The results thus stated pave the way for the use of Wiener chaos methods in interest rate modelling, since any such square-integrable Wiener functional admits a chaos expansion, the individual terms of which can be regarded as parametric degrees of freedom in the associated interest rate model to be fixed by calibration to appropriately liquid sectors of the interest rate derivatives markets.Comment: 17 page