Bryan Stanhouse

Rational speculative bubbles in the gold futures market: An application of dynamic factor analysis

The existence of speculative bubbles in financial markets has been a longstanding issue under debate. Many financial economists believe that, given the assumption of rational expectations and rational behavior of economic agents, an asset should be priced according to its “market fundamentals.” Others argue that self‐fulfilling rumors of market participants can influence asset prices as well. These self‐fulfilling rumors are initiated by events extraneous to markets and are often called bubbles. The rationality of both expectations and behavior often does not imply that the price of an asset be equal to its fundamental value. In other words, there can be rational deviations of the price from this value—rational bubbles. A rational bubble can arise when the actual market price depends positively on its own expected rate of change, as normally occurs in asset markets. Since agents forming rational expectations do not make systematic prediction errors, the positive relationship between price and its expected rate of change implies a similar relationship between price and its actual rate of change. Under such conditions, the arbitrary, self‐fulfilling expectation of price changes may drive actual price changes independently of market fundamentals; we refer to such a situation as a rational price bubble.-super-1

Reserve Requirements and Control of the Money Supply: A Note

In the 1930s, if not earlier (see, e.g., [3, 4]), 100 percent reserve advocates argued that there were optimal reserve ratios on demand and time deposits. Using controllability of the money supply as their criterion, thesy concluded that controllability would be complete with 100 percent recerves under the assumption, probably justified by monetary conditions of the time, that uncertainty existed only between currency and demand deposit demand. Along with the superiority of 100 percent reserve plans, there was the presumption that the higher the reserve requirement the better up to 100 percent. With the large postwar growth in time deposits, folklore seems to have developed to the effect that reserve requirements on both demand and time deposits should be equal, and presumably equal at the highest possible level, if not actually 100 percent. In a more recent context, economists have been concerned with deviations of the actual money stock M from the optimal money stock M*. That is, monetary economists typically minimize E[M-M*]2, where M* is a magnitude consistent with desired level of a final target or a vector of final targets. In this paper, we partition this expected loss function into bias and variance components. We rewrite E[M-M*]2 as E[E(M)-M*]2 + E[M-E(M)]2. E[E(M)-M*]2 is the squared bias and represents the social disutility of monetary authorities selecting an expected level of the money supply that is different from M*. E[M-E(M)]2 is the variance component and is the economic loss incurred due to the Feds inability t° perfectly achieve the expected money stock. Following the lead of 100 percent reserve advocates, we assume that controlling the money supply (either Ml or M2 or both) means minimizing deviations of the actual money stock from its expected value. Our analysis shows that minimizing

A framework for evaluating operating targets

Abstract The objective of this paper is to provide an analytical framework to evaluate the relative effectiveness of reserve or monetary base operating targets. We begin the paper by constructing an IS schedule and an expanded LM schedule. Uncertainty is introduced into the model by including stochastic error terms in the product and money market. Then we detail the impact of the exogeneously determined operating target as a constraint upon the equilibration process in the monetary and real sectors. In particular, the operating target determines the structure of the disturbances in the respective markets and the economic target depending upon how fast the markets clear. Since the deviation of the relevant targets from their mean values depend upon the operating target, the standard deviation of the targets are derived for the alternative operating strategies. Using illustrative macroeconomic and money market parameters, loss functions are calculated to provide a basis to evaluate the relative desirability of reserves and the monetary base as the policy instrument. The stability of various intermediate targets as well as one final target, nominal income, is analyzed as is the crucial role played by required reserve ratios. The robustness of these results is also analyzed for various parametric changes.

The Optimal Redemption Schedule of Serial Municipal Debt: A Dynamic Reconciliation of Revenues, Reinvestment Rates and the Term Structure

The purpose of our research is to developan algorithm that optimally schedules municipaldebt redemptions. It is our hypothesis thatsegmented investor demand, the existing termstructure, the temporal behavior of municipalproject revenues and reinvestment opportunitiesfor interim revenue surpluses are all factorswhich should impact the optimal debt schedulingproblem in a unique and economically meaningfulway. For example, investor preference for shortermaturities and an upward sloping term structureof interest rates should, ceteris paribus,increase the proportion of debt scheduled to berepaid early in the redemption horizon. Ifinvestor demand is limited to a relatively smallgeographic area, such limited demand should bereflected in higher yields. If municipal projectrevenues increase over time then a largerproportion of the debt should be scheduled to beredeemed later. Unfortunately, realisticacknowledgements of the nature of the municipaldebt financing problem create an objectivefunction and a set of constraints which are fartoo complex to yield simple reduced formpresentations of the optimal principalredemptions. Consequently, solutions to theoptimal debt schedule and tests of theconjectures articulated above weresimulated.

Debt Schedules of Tax‐Exempt Bonds Using NIC

Municipal bonds are a large proportion of the total number of securities offered every year. The volume outstanding is more than that of all federal agency debt. It is important that the issuance procedure be as cost efficient as possible. This research develops a model to minimize the net interest cost of a municipal bond issue. Net interest cost remains a highly popular award criteria. The model incorporates the level and shape of the yield curve, the schedule of revenue to be received, and the segmented nature of the municipal market.

The Impact of Volatility on Duration of Amortizing Debt with Embedded Call Options

D uration and its applications are a major concept in fixed-income analysis. Duration has a long h s tory as a tool to immunize bond portfolio returns and protect against interest rate shocks. More important for this article, Hopewell and Kauhan [1973] propose it as a measure of price volatdity in that, in the simplest terms, price volatdity due to a change in interest rates is proportional to duration. Bierwag [1977] and Chambers, Carleton, and McEnally [1988] among many others provide further analyses of the duration concept. Given the concept’s usefulness, a considerable body of research has addressed the characteristics of duration. It is clear that it typically, but not always, increases with maturity (deep dlscount bond duration may decline very slightly at some maturity that is quite long), and always declines with coupon payments and yield to maturity (interest rates). Almost all financial markets and investment textbooks give such fundamental features bf duration. One of the major shortcomings of conventional duration as a price volathty measure has been an inabllity to deal with debt instruments that have embedded options such as call features. In fact, asset and liabllity management computer programs for banks typically ignore the impact of embedded options upon duration. Even federal bank regulators fiequently do not incorporate them into interest rate risk measures; see Feid [1993]. For debt instruments with embedded options, the list of factors affecting duration becomes longer, and the impact of all factors becomes much more complex and a large proportion of debt instruments, includmg bonds, amortizing mortgages, and amortizing bank loans, are callable. Research by Pinkus and Chandohl [1985]; DeRosa, Goodman, and Zazzarino [1993]; Kalotay, Williams, and Fabozzi [1993]; Goodman and Ho [1997]; Hayre and Chang [1997); and Anderson, Barber, and Chang [1993] addresses this knowledge gap and makes valuable contributions, but does not eliminate the problem. For example, DeRosa, Goodman, and Zazzarino [1985] dlscuss three types of duration for mortgage-backed securities cash flow, cash flow adjusted for prepayment rates, and option-adjusted spread duration and compare them. Anderson, Barber, and Chang [1993] adjust conventional duration of mortgage-backed securities for interest rate sensitivity of prepayments and find that adjustments can significantly reduce mortgage-backed duration. Goodman and Ho [1997] examine how to hedge mortgage portfolios in terms of “option-adjusted” or “empirical duration.” Hayre and Chang [1997] thoroughly analyze the difference between “effective duration” and “empirical” duration, where the latter adjusts effective duration for recent historical relation-