Equilibrium Yield Curves

This paper considers how the role of inflation as a leading business-cycle indicator affects the pricing of nominal bonds. We examine a representative agent asset pricing model with recursive utility preferences and exogenous consumption growth and inflation. We solve for yields under various assumptions on the evolution of investor beliefs. If inflation is bad news for consumption growth, the nominal yield curve slopes up. Moreover, the level of nominal interest rates and term spreads are high in times when inflation news are harder to interpret. This is relevant for periods such as the early 1980s, when the joint dynamics of inflation and growth was not well understood.

Inflation and the price of real assets

In the 1970s, U.S. asset markets witnessed (i) a 25% dip in the ratio of aggregate household wealth relative to GDP and (ii) negative comovement of house and stock prices that drove a 20% portfolio shift out of equity into real estate. This study uses an overlapping generations model with uninsurable nominal risk to quantify the role of structural change in these events. We attribute the dip in wealth to the entry of baby boomers into asset markets, and to the erosion of bond portfolios by surprise inflation, both of which lowered the overall propensity to save. We also show that the Great Inflation led to a portfolio shift by making housing more attractive than equity. Apart from tax effects, a new channel is that disagreement about inflation across age groups drives up collateral prices when credit is nominal. ; This paper is an extension of Monika Piazzesi's and Martin Schneider's work while they were in the Research Department of the Federal Reserve Bank of Minneapolis.

Bond positions, expectations, and the yield curve

This paper implements a structural model of the yield curve with data on nominal positions and survey forecasts. Bond prices are characterized in terms of investors' current portfolio holdings as well as their subjective beliefs about future bond payoffs. Risk premia measured by an econometrician vary because of changes in investors' subjective risk premia that are identified from portfolios and subjective beliefs but also because subjective beliefs differ from those of the econometrician. The main result is that investors' systematic forecast errors are an important source of business cycle variation in measured risk premia. By contrast, subjective risk premia move less and more slowly over time.Bonds - Prices ; Consumer behavior

Inflation Illusion, Credit, and Asset Pricing

This paper considers asset pricing in a general equilibrium model in which some, but not all, agents suffer from inflation illusion. Illusionary investors mistake changes in nominal interest rates for changes in real rates, while smart investors understand the Fisher equation. The presence of smart investors ensures that the equilibrium nominal interest rate moves with expected inflation. The model also predicts a nonmonotonic relationship between the price-to-rent ratio on housing and nominal interest rates -- housing booms occur both when the nominal rate is especially low and when it is especially high. In either situation, disagreement about real interest rates between smart and illusionary investors stimulates borrowing and lending and drives up the price of collateral. The resulting housing boom is stronger if credit markets are more developed. We document that many countries experienced a housing boom in the high-inflation 1970s and a second, stronger, boom in the low-inflation 2000s.

Momentum traders in the housing market: survey evidence and a search model

This paper studies household beliefs during the recent US housing boom. To characterize the heterogeneity in households’ views about housing and the economy, we perform a cluster analysis on survey responses at different stages of the boom. The estimation always finds a small cluster of households who believe it is a good time to buy a house because house prices will rise further. The size of this “momentum” cluster doubled towards the end of the boom. We also provide a simple search model of the housing market to show how a small number of optimistic investors can have a large effect on prices without buying a large share of the housing stock. ; This paper is an extension of Monika Piazzesi's and Martin Schneider's work while they were in the Research Department of the Federal Reserve Bank of Minneapolis.Housing ; Inflation (Finance) ; Interest rates

Trend and cycle in bond premia

Common statistical measures of bond risk premia are volatile and countercyclical. This paper uses survey data on interest rate forecasts to construct subjective bond risk premia. Subjective premia are less volatile and not very cyclical; instead they are high, only around the early 1980s. The reason for the discrepancy is that survey forecasts of interest rates are made as if both the level and the slope of the yield curve are more persistent than under common statistical models. The paper then proposes a consumption based asset pricing model with learning to explain jointly the difference between survey and statistical forecasts, and the evolution of subjective premia. Adaptive learning gives rise to inertia in forecasts, as well as changes in conditional volatility that help understand both features. ; This paper is an extension of Monika Piazzesi's and Martin Schneider's work while they were in the Research Department of the Federal Reserve Bank of Minneapolis.Bonds

Housing, Consumption, and Asset Pricing

This paper considers a consumption-based asset pricing model where housing is explicitly modeled both as an asset and as a consumption good. Nonseparable preferences describe households' concern with composition risk, that is, fluctuations in the relative share of housing in their consumption basket. Since the housing share moves slowly, a concern with composition risk induces low frequency movements in stock prices that are not driven by news about cash flow. Moreover, the model predicts that the housing share can be used to forecast excess returns on stocks. We document that this indeed true in the data. The presence of composition risk also implies that the riskless rate is low which further helps the model improve on the standard CCAPM.

Individual behaviour in the cash/shadow economy in Australia: Facts, empirical findings and some mysteries

This paper first gives an explanation of the behaviour which motivates individuals to engage in the shadow economy. It will be shown that people who fear being caught by tax authorities will be less likely to work in the shadow economy and those who earn more money in the official economy will also work less in the shadow economy. The result of a logistic regression shows that if others are seen to be engaged in the shadow economy then this increases subsequent demand for such activities. It was found that on average, a shadow economy worker earned AUS$2135.31 during the year 2000, and households spent AUS$2,293.00 for these services. Using micro-data to calculate an overall aggregate figure for the estimated size of the shadow economy in Australia during the year 2000, it was found that between 4.81% and 8.8% of the gross national income (GNI) was earned in the cash economy.