John B. Donaldson

Methodological and Empirical Issues in Real Business Cycle Theory

Abstract In this paper, we argue that the major impact of the RBC literature has been to propose a new methodology for macroeconomics. This methodology is distinguished first by the importance it attributes to the empirical description of the phenomena to be explained and, second, by the use of this description in conjunction with ‘quantitative theorizing’, i.e., the construction of computable general equilibrium models whose characteristic statistics match those of the data. In accordance with this approach, we first report on the current state of knowledge concerning business cycle regularities and conclude that additional empirical effort is called for in order to arrive at the appropriate basis for theorizing. We then examine the performance of existing models and evaluate the case for integrating monetary factors and demand shocks into them. Lastly we review the recent efforts to explain the employment variability puzzle, and argue that the search for a solution naturally leads to the incorporation of significant non-Walrasian features into the RBC framework.

Efficiency wages and the business cycle puzzle

Abstract The main thrust of this work is to open the Real Business Cycle (RBC) methodology to non-Walrasian considerations and, reciprocally, to submit some non-Walrasian models to the discipline of the RBC approach. In doing so, we provide a first RBC model with involuntary unemployment and a suboptimal equilibrium path. We also demonstrate the promise and difficulty of resolving the business cycle puzzle by appealing to quantity rationing in the labor market.

Labour Relations and Asset Returns

This paper proposes a dynamic GE model with standard business cycle properties that also achieves a satisfactory replication of the major financial stylized facts. We ride on two major ideas. First, we show that operating leverage, originating in the priority status of wage claims given the observed business cycle characteristics of the latter, magnifies the risk properties of the residual payments to firm owners and justifies a substantial risk premium. Further we build on the observation that the low frequency variations in income shares constitute a significant source of risk, one that is unlikely to be insurable. When we price this risk in an incomplete market framework, we obtain a GE model with return volatilities close to observations and a sizable equity premium. This is accomplished in a world of low risk aversion and standard utility function but with agent heterogeneity. Workers with restricted access to financial markets are insured by firms and the consumption and preferences of firm owners solely determine the pricing kernel. Copyright 2002, Wiley-Blackwell.

THE STRUCTURE OF INTERTEMPORAL PREFERENCES UNDER UNCERTAINTY AND TIME CONSISTENT PLANS

Analyse de la structure des preferences intertemporelles, necessaire pour obtenir une planification consistante

Comparative Dynamics of an Equilibrium Intertemporal Asset Pricing Model

This paper uses recursive competitive theory to develop a general equilibrium asset pricing model. In this framework all prices and rates of return are endogenously determined, thus enabling us to analyze the effects of changes in preferences, technological uncertainty, and expectations on the structure of security prices. In particular we focus on how the market risk premium varies with changes in the underlying economic environment, an issue which other asset pricing models have chosen not to address.

On the term structure of interest rates

Abstract This paper tests the one good stochastic growth model with respect to its ability to explain the term structure of real interest rates. We undertake both a qualitative and quantitative analysis. First we assess the changing shape of the yield curve over the model economys ‘business cycle’ and compare our results with what is empirically observed. Second, we employ the model to study various implications of informational and allocative efficiency, properties which the artificial economy must possess. It is found, for example, that long-term rates are less volatile than short-term rates and that holding premia can be highly correlated over time. Third, we study the time-varying risk premium implicit in the economys forward rate structure. A purely quantitative assessment of the models explanatory power is also provided.

Stochastic growth with correlated production shocks

This paper extends the stochastic growth model of Brock and Mirman [J. Econ. Theory 4 (1972), 497–513] to allow the production shocks to be correlated over time. The resultant optimal savings and consumption policies depend not only upon the current level of output but also upon the most recent realization of the random shock. The properties of these policy functions are studied and it is shown that the Markov process on output, capital stock and consumption resulting from the application of these policies converges to a stationary distribution.

The equity premium and the allocation of income risk

Abstract This paper examines the extent to which the equity premium puzzle can be resolved by taking account of the fact that stockholders bear a disproportionate share of output uncertainty. We do this in the context of a non-Walrasian RBC model where risk reallocation is justified by borrowing restrictions. The risk shifting mechanism we propose has the same effect as would arise from an increase in the risk aversion parameter of the representative agent and thus contributes to a rise in the equity premium. As with more standard RBC models, it remains that our model is unable to replicate key financial statistics. In particular, the observation that the equity return is more variable than national product cannot be accounted for under standard technology assumptions.

On the superneutrality of money in a stochastic dynamic macroeconomic model

Abstract This paper explores the robustness of the superneutrality of money result to the introduction of uncertainty. While, qualitatively, superneutrality fails to obtain in our model, quantitatively the observed Tobin effect is insignificant. The equilibrium time paths of real variables are nearly unaffected by changes in the money growth rule. We argue that our conclusions reinforce the theoretical case for superneutrality.

RISK BASED EXPLANATIONS OF THE EQUITY PREMIUM

This essay reviews the family of models that seek to provide aggregate risk based explanations for the empirically observed equity premium. Theories based on non-expected utility preference structures, limited financial market participation, model uncertainty and the small probability of enormous losses are detailed. We impose the additional requirements that candidate models yield consistent inter temporal portfolio choice and that a representative agent can be constructed which is independent of the underlying heterogeneous economys initial wealth distribution. While many models are able to replicate a wide variety of financial statistics including the premium, few satisfy these latter criteria as well.