Robert E. Cumby

Relative Labor Productivity and the Real Exchange Rate in the Long Run: Evidence for a Panel of OECD Countries

The Balassa-Samuelson model, which explains real exchange rate movements in terms of sectoral productivities, rests on two components. First, for a class of technologies including Cobb-Douglas, the model implies that the relative price of nontraded goods in each country should reflect the relative productivity of labor in the traded and nontraded goods sectors. Second, the model assumes that purchasing power parity holds for traded goods in the long-run. We test each of these implications using data from a panel of OECD countries. Our results suggest that the first of these two fits the data quite well. In the long run, relative prices generally reflect relative labor productivities. The evidence on purchasing power parity in traded goods is considerably less favorable. When we look at US dollar exchange rates, PPP does not appear to hold for traded goods, even in the long run. On the other hand, when we look at DM exchange rates purchasing power parity appears to be a somewhat better characterization of traded goods prices.

Estimation of the optimal futures hedge

Standard approaches to designing a futures hedge often suffer from two major problems. First, they focus only on minimizing risk, so no account is taken of the impact on expected return. Second , in estima ting the hedge ratio, no allowance is made for time variation in the distribution of cash and futures price changes. This paper describes a technique for estimating the optimal futures hedge that corrects these problems and illustrates its use in hedging Treasury bonds with T-bond futures. Copyright 1988 by MIT Press.

Two-Step Two-Stage Least Squares Estimation in Models with Rational Expectations

This paper introduces a limited-information two-step estimator for models with rational expectations and serially correlated disturbances. The estimator greatly extends the area of applicability of McCallums (1976) instrumental variables approach to rational expectations models. Section I reviews McCallum%s method and discusses in detail the problems surrounding its use in many empirical c/ntexts. Section II presents the two-step two-stage least squares estimator (2S2S1) and demonstrates its efficiency relative to that of McCallum (1979). Section III provides a comparison nf several estim!tors for a two equation macroeconomic model with rational expectations due to Taylor (1979).

Testing for market timing ability: A framework for forecast evaluation

Abstract In this paper we examine the Henriksson-Merton test of market timing and its potential usefulness in evaluating investment advice. The paper proposes a natural extension of the test that is valid under more general assumptions about the distribution of asset returns. We show that the Henriksson-Merton test and its more general counterpart are special cases of standard tests of market rationality and efficiency. Both tests are applied to a group of foreign exchange advisory services.

The international linkage of real interest rates: The European-US connection

Casual observation indicates that in recent years real interest rates in the United States appear to have risen sharply and have remained high relative to historical standards. Many observers have claimed that these high real rates have been transmitted abroad and have lead to high real rates in the rest of the industrialized countries. Concern over the level of real rates has been widespread in the analyses by economic policymakers both in Europe and in the United States. In this paper we present evidence on several questions regarding the movement in short term real interest rates in eight countries that have been raised by the recent policy debates in Europe and the United States: Have ex ante real rates in the United States and Europe been high during recent years? Has there been a link between U.S. real rates and those in other countries? Can this link be quantified?The basic finding in this paper is that real rates have climbed dramatically from the 1970s to the 1980s in both the European countries and the United States. Indeed, real interest rates in the United States are currently at high levels unprecedented in the post war period, which rival the levels that occurred during the Great Depression. Complaints that real interest rates in the United States are exceedingly high seem to be well justified. There is also strong evidence that there is a positive association between movements in U.S. real rates and those in Europe. However,European real rates typically do not move one-for-one with U.S. real rates,still leaving open the possibility that European monetary policy can influence domestic economic activity.

Financial policy and speculative runs with a crawling peg: Argentina 1979-1981

In this paper we present a model of a balance-of-payments crisis and use it to examine the Argentine experiment with a crawling peg between December 1978 and February 1981. The approach taken allows us to examine the evolution of a crisis when the collapse is not a perfectly-foreseen event. The implementation of the model yields plausible values of the one-month ahead probabilities of a collapse of the crawling peg. The probabilities exhibit a sharp increase in the middle of 1980 and indicate a significant loss of credibility throughout the remainder of the year. The results suggest that viability of an exchange rate regime depends strongly on the domestic credit policy followed by the authorities. If this policy is not consistent with the exchange rate policy pursued by the authorities, confidence in the exchange rate policy is undermined.

Testing the Autocorrelation Structure of Disturbances in Ordinary Least Squares and Instrumental Variables Regressions

This paper derives the asymptotic distribution for a vector of sample autocorrelations of regression residuals from a quite general linear model. The asymptotic distribution forms the basis for a test of the null hypothesis that the regression error follows a moving average of order q [greaterthan or equal] 0 against the general alternative that autocorrelations of the regression error are non-zero at lags greater than q. By allowing for endogenous, predetermined and/or exogenous regressors, for estimation by either ordinary least squares or a number of instrumental variables techniques, for the case q>0, and for a conditionally heteroscedastic error term, the test described here is applicable in a variety of situations where such popular tests as the Box-Pierce (1970) test, Durbins (1970) h test, and Godfreys (1978b) Lagrange multiplier test are net applicable. The finite sample properties of the test are examined in Monte Carlo simulations where, with a sample sizes of 50 and 100 observations, the test appears to be quite reliable.

Is it risk?: Explaining deviations from uncovered interest parity

This paper analyzes ex-ante returns to forward speculation and asks if these returns can be explained by models of a foreign exchange risk premium. After presenting evidence that both nominal and real expected speculative profits are non-zero, the paper examines if real returns to forward speculation are consistent with consumption-based models of risk premia. Estimates of the conditional covariance between real speculative returns and real consumption growth are presented and, like ex-ante returns to forward speculation, they exhibit statistically significant fluctuations over time and often change sign.

Consumption risk and international equity returns: some empirical evidence

The paper examines if real stock returns in four countries are consistent with consumption-based models of international asset pricing. The paper finds that ex-ante real stock returns exhibit statistically significant fluctuations over time and that these fluctuations cannot be explained by consumption-based models when the conditional covariances between real stock returns and the rate of change of consumption are assumed to be constant over time. These conditional covariances are then modeled and the paper finds that they too exhibit statistically significant fluctuations over time. However, even when conditional covariances are allowed to change over time, the paper finds that the consumption-based models do not fully explain real stock returns.

Forecasting Volatilities and Correlations with EGARCH Models

Volatility varies randomly over time, making forecasting it d@cult. Formal models for systems with timevarying volatility have been developed in recent years, and widely applied in economics and finance. Models in the Autoregressive Conditional Heteroscedasticity (ARCH) family have been particularly popular. Prior studies of ARCH-type models of securities return variances have looked at a single asset and focused on in-sample explanation of volatility movements, rather than forecasting. This article considers time variation for both volatilities and correlations among returns on broad asset classes in the US. and Japan, specijcally, equities, long-term government bonds, a n d the do l l a r lyen exchange rate. We are most concerned with out-