Asset prices, booms and recessions

249 Pages·2006·1.765 MB·English

by  Willi Semmler

Asset Prices, Booms and Recessions
Willi Semmler
Asset Prices,
Booms
and Recessions
Financial Economics
from a Dynamic Perspective
Second Edition
With 45 Figures
and 27 Tables
123
Prof. Willi Semmler
Department of Economics
and Schwartz Center for
Economic Policy Analysis
Graduate Faculty
New School University
65 Fifth Avenue
New York, NY 10003, USA
and
Center of Empirical Macroeconomics
Bielefeld University
Universitätsstraße 25
33615 Bielefeld, Germany
isbn-10 3-540-28784-1 Edition Springer-Verlag Berlin Heidelberg New York
isbn-13 978-3-540-28784-1 Springer-Verlag Berlin Heidelberg New York
isbn 3-540-00432-7 1st Edition Springer-Verlag Berlin Heidelberg New York
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Preface to the Second Edition
Since the publicationof the first edition of thisbook,the links betweeneconomic
activityandglobalfinancialmarketshavegrownonlystrongerandmoreimportant.
Thus, in this new edition, we continue and expand our exploration of a dynamic
frameworkinwhichtostudyFinancialEconomics.Byfinancialmarkets,wemean
thoseactivities,institutions,agentsandstrategiesthattypicallyplaysignificantroles
inthe marketsforbonds,equity,credit,andcurrencies.Economicactivityencom-
passesthoseactionsoffirms,banks,households,andgovernmentsinsofarastheyare
concernedwiththeproductionofgoodsandservices,savings,investment,consump-
tion,etc.Ofcourse,thefinancialmarketplaceisbutasubsetofthelargereconomy.
However,itisanincreasinglyimportantsubsetanditsboundarywiththerestofthe
economyhasbecomeprogressivelymoreblurryovertime.Inthisnewedition,we
willmoreextensivelystudythosemechanismsbywhichtheperformance,volatility,
and instability of financial markets influence, reinforce, and counteract economic
activity.Additionally,weexaminethereverseprocesseswhereinactualorexpected
economic activity acts to sway asset prices, foreign exchange rates, and financial
marketsingeneral.
The focus of the bookis on theories, dynamic modelsand empiricalevidence
as they serve to enhance our understanding of the interrelationships between fi-
nancial markets and economic activity. We illustrate certain real-world situations
wherein the interactions of financial markets and economic activity have shown
themselvesintheUnitedStates,LatinAmerica,Asia,andEurope.Additionally,we
considervariousepisodesofinstabilityandcrisisandhoweconomictheorycanbeof
explanatoryvalue.
In this edition, we have substantially revised several chaptersand updated the
literaturereferences.Chapter13iscompletelynewanddealswithissuesofchoice
inthemanagementofinternationalportfolios.Inanewsection,PartVI,wepresent
threenewchapters,14–16,concerningrecentadvancesinassetpricinganddynamic
portfoliodecision-making.As a pedagogicalaid, we haveaddedan extensivecol-
lectionofexercisescollectedattheendofthebook.
Originally,thebookwasbasedonlecturesdeliveredattheUniversityofBielefeld
inGermanyandatTheNewSchoolforSocialResearchinNewYorkCity.Iamvery
gratefultomycolleaguesatthoseinstitutionsaswellastheseveralgenerationsof
studentswhotookmyclassesinFinancialEconomicsandlistenedtotheselectures
intheirformativestages.Individually,manyofthechaptersofthebookhavebeen
presented at conferences, workshops, and seminars throughout the United States,
Europe,andJapan.Specifically,inItaly,Spain,andPortugal,severalofthechapters
havebeenpresentedinthecontextoftheEuro-wideQuantitativeDoctoralProgram
inEconomics.
VI PrefacetotheSecondEdition
I want to thank Gaby Windhorst for typing many versions of the manuscript.
LucasBernard,Jens Rubart, andLeanneUssher providedvaluableeditorialassis-
tance and Uwe Ko¨ller and Mark Meyer preparedthe figures. I also want to thank
SabineGuschwaforprovidingthedatasetusedfortheestimationpresentedinsec-
tion4.4andmyvariousco-authorswhohaveallowedmetodrawonourjointwork.
Inparticular,IwanttothankToichiroAsada,CarlChiarella,PeterFlaschel,Reiner
Franke,GangGong,LarsGru¨ne,Chih-yingHsiao,LeventKockesen,MartinLettau,
ChristianProano,MalteSieveking,andPeterWo¨hrmann.
Finally,Iwanttonotethatalthoughlinearandnonlineareconometricmethods
areusedthroughoutthebook,amoreextensivetreatmentofthosemethodsforthe
estimationofdynamicrelationshipsisgiveninSemmlerandWo¨hrmann(2002).The
textofthiscanbefoundathttp://www.wiwi.uni-bielefeld.de/∼cem.
Table of Contents
Introduction ................................................ 1
I Money, Bonds andEconomic Activity
1 Money, Bonds andInterest Rates ........................ 9
1.1 Introduction .............................................. 9
1.2 SomeBasics .............................................. 9
1.3 MacroeconomicTheoriesoftheInterestRate .................. 10
1.4 MonetaryPolicyandInterestRates ........................... 13
1.5 MonetaryPolicyandAssetPrices ............................ 14
1.6 Conclusions .............................................. 15
2 Term Structure ofInterest Rates ........................ 17
2.1 Introduction .............................................. 17
2.2 DefinitionsandTheories.................................... 17
2.3 EmpiricalTestsontheTermStructure......................... 19
2.4 Conclusions .............................................. 23
II The Credit Market andEconomic Activity
3 Theories onCredit Market, Credit Riskand Economic
Activity.................................................. 27
3.1 Introduction .............................................. 27
3.2 PerfectCapitalMarkets:InfiniteHorizonandTwoPeriodModels . 27
3.3 ImperfectCapitalMarkets:SomeBasics ...................... 35
3.4 ImperfectCapitalMarkets:Microtheory....................... 37
3.5 ImperfectCapitalMarkets:Macrotheory ...................... 39
3.6 ImperfectCapitalMarkets:TheMicro-MacroLink.............. 43
3.7 Conclusions .............................................. 48
4 Empirical Tests onCredit Marketand EconomicActivity 49
4.1 Introduction .............................................. 49
4.2 BankruptcyRiskandEconomicActivity ...................... 49
4.3 LiquidityandEconomicActivityinaThresholdModel .......... 55
4.4 EstimationsofCreditRiskandSustainableDebt................ 63
4.5 Conclusions .............................................. 76
VIII TableofContents
III The Stock Market and EconomicActivity
5 Approaches to Stock Market andEconomic Activity..... 79
5.1 Introduction .............................................. 79
5.2 TheIntertemporalApproach................................. 80
5.3 TheExcessVolatilityTheory ................................ 82
5.4 HeterogeneousAgentsModels............................... 84
5.5 TheVARMethodology..................................... 85
5.6 RegimeChangeModels .................................... 87
5.7 Conclusions .............................................. 88
6 Macro Factorsandthe Stock Market .................... 89
6.1 Introduction .............................................. 89
6.2 ADynamicMacroModel................................... 90
6.3 EmpiricalResults.......................................... 93
6.4 Conclusions .............................................. 95
7 New Technology andthe Stock Market .................. 97
7.1 Introduction .............................................. 97
7.2 SomeFacts ............................................... 97
7.3 TheModel ............................................... 99
7.4 Conclusions .............................................. 102
IV AssetPricing and EconomicActivity
8 Static PortfolioTheory: CAPMand Extensions.......... 105
8.1 Introduction .............................................. 105
8.2 PortfolioTheoryandCAPM:SimpleForm .................... 105
8.3 PortfolioTheoryandCAPM:Generalizations .................. 110
8.4 EfficientFrontierforanEquityPortfolio ...................... 112
8.5 Conclusions .............................................. 113
9 Consumption Based AssetPricing Models ............... 115
9.1 Introduction .............................................. 115
9.2 PresentValueApproach .................................... 115
9.3 AssetPricingwithaStochasticDiscountFactor ................ 116
9.4 DerivationofsomeEulerEquations .......................... 119
9.5 Consumption,RiskyAssetsandtheEulerEquation ............. 122
9.6 Conclusions .............................................. 126
TableofContents IX
10 AssetPricing Models withProduction ................... 129
10.1 Introduction .............................................. 129
10.2 StylizedFacts............................................. 131
10.3 TheBaselineRBCModel................................... 131
10.4 AssetMarketRestrictions................................... 133
10.5 Conclusions .............................................. 135
V ForeignExchange Market, FinancialInstability and
Economic Activity
11 Balance Sheets and FinancialInstability................. 139
11.1 Introduction .............................................. 139
11.2 TheEconomy-WideBalanceSheets .......................... 140
11.3 Households’HoldingofFinancialAssets...................... 141
11.4 ShocksandFinancialMarketReactions ....................... 143
11.5 Conclusions .............................................. 144
12 Exchange Rate Shocks, Financial CrisisandOutput Loss 145
12.1 Introduction .............................................. 145
12.2 StylizedFacts............................................. 146
12.3 TheStandardExchangeRateOvershootingModel .............. 147
12.4 ExchangeRateShocksandBalanceSheets .................... 151
12.5 ExchangeRateShocks,BalanceSheetsandEconomicContraction 153
12.6 ExchangeRateShocks,CreditRationingandEconomicContractions 159
12.7 ExchangeRateShocks,DefaultPremiaandEconomicContractions 163
12.8 Conclusions .............................................. 167
13 International Portfolioand theDiversificationofRisk ... 169
13.1 Introduction .............................................. 169
13.2 RiskfromExchangeRateVolatility........................... 169
13.3 PortfolioChoiceandDiversificationofRisk ................... 172
13.4 InternationalBondPortfolio................................. 173
13.5 InternationalEquityPortfolio................................ 175
13.6 EfficientFrontierofanInternationalPortfolio .................. 177
13.7 Conclusions .............................................. 177
VI Advanced Modeling ofAssetMarkets
14 AgentBasedandEvolutionaryModelingofAssetMarkets 181
14.1 Introduction .............................................. 181
X TableofContents
14.2 HeterogeneousAgentModels................................ 181
14.3 EvolutionaryModels....................................... 184
14.4 Conclusions .............................................. 187
15 Behavioral Models ofDynamicAssetPricing ............ 189
15.1 Introduction .............................................. 189
15.2 DynamicHabitFormationModels............................ 189
15.3 MovingBeyondConsumptionBasedAssetPricingModels....... 195
15.4 TheAssetPricingModelwithLossAversion................... 198
15.5 Conclusions .............................................. 202
16 DynamicPortfolioChoiceModels ....................... 203
16.1 Introduction .............................................. 203
16.2 WealthAccumulationandPortfolioDecisions.................. 203
16.3 DiscreteTimeDynamicPortfolioChoiceunderLog-Normality ... 206
16.4 ContinuousTimeDeterministicDynamicPortfolioChoice ....... 209
16.5 ContinuousTimeStochasticDynamicPortfolioChoice .......... 215
16.6 Conclusions .............................................. 222
17 Some PolicyConclusions ................................ 223
Bibliography ................................................ 239
Subject Index ............................................... 253