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The Economics Of Money Banking And Financial Markets

In recent years a number of industrialized countries have adopted a strategy for monetary policy known as `inflation targeting.' We describe how this approach has been implemented in practice and argue that it is best understood as a broad framework for policy, which allows the central bank `constrained discretion,' rather than as an ironclad policy rule in the Friedman sense. We discuss the potential of the inflation-targeting approach for making monetary policy more coherent and transparent, and for increasing monetary policy discipline. Our final section addresses some additional practical issues raised by this approach.

Inflation targeting : a new framework for monetary policy? / Ben S. Bernanke, Frederic S. Mishkin.

The Theory of Stochastic Processes

This paper studies performance-sensitive debt (PSD), the class of debt obligations whose interest payments depend on some measure of the borrower’s performance. We demonstrate that the existence of PSD obligations cannot be explained by the trade-off theory of capital structure, as PSD leads to earlier default and lower equity value compared to fixed-rate debt of the same market value. We show that, consistent with the pecking order theory, PSD can be used as an inexpensive screening device, and we find empirically that firms choosing PSD loans are more likely to improve their credit ratings than firms choosing fixed-interest loans. We also develop a method to value PSD obligations allowing for general payment profiles and obtain closed-form pricing formulas for step-up bonds and linear PSD.

/pdf/performance-sensitive-debt-302prejz3l.pdf

Performance-Sensitive Debt

When entering a monetary union, member-countries change the nature of their sovereign debt in a fundamental way (e.g., they cease to have control over the currency in which their debt is issued). As a result, financial markets can force these countries’ sovereigns into default. In this sense, member countries of a monetary union are downgraded to the status of emerging economies. This makes the monetary union fragile and vulnerable to changing market sentiments. It also makes it possible that self-fulfilling multiple equilibria arise.I analyze the implications of this fragility for the governance of the Eurozone. I conclude that the new governance structure (ESM) does not sufficiently recognize this fragility. Some of the features of the new financial assistance are likely to increase this fragility. In addition, it is also likely to rip member-countries of their ability to use the automatic stabilizers during a recession. This is surely a step backward in the long history of social progress in Europe. I suggest a different approach to deal with these problems.

A Fragile Eurozone in Search of a Better Governance

In search of retail investors: The effect of retail investor attention on odd lot trades

This paper provides an overview of studies that estimate the inflation risk premium using inflation‐linked bond (ILB) yields. I categorize existing studies, outline their research designs and compare their estimates for the inflation risk premium. Furthermore, the importance of accounting for ILB illiquidity and an overview of existing ILB liquidity proxies are demonstrated. A discussion of current literature developments, such as the zero lower bound, and an outline for future research directions conclude the paper.

https://onlinelibrary.wiley.com/doi/pdf/10.1111/joes.12265

Estimating inflation risk premia using inflation-linked bonds: a review

This article proposes a novel way to construct an index for economic policy uncertainty that does not depend on language proficiency. We use two specific features of search volume extraction on Goo...

https://tandfonline.com/doi/pdf/10.1080/1540496X.2018.1559140

A Language-Independent Measurement of Economic Policy Uncertainty in Eastern European Countries

We extract information on relative shopping interest from Google search volume and provide a genuine and economically meaningful approach to directly incorporate this data into a portfolio optimization technique. By generating a firm ranking based on a Google search volume metric, we can predict future sales and thus generate excess returns in a portfolio exercise. The higher the (shopping) search volume for a firm the higher we rank the company in the optimization process. For a sample of firms in the fashion industry, our results demonstrate that shopping interest exhibits predictive content which can be exploited in a real‐time portfolio strategy yielding robust Alphas around 5.5%.

https://onlinelibrary.wiley.com/doi/pdf/10.1002/for.2547

Valuable information in early sales proxies: The use of Google search ranks in portfolio optimization

I revisit Svensson’s (1993) test of inflation target credibility by applying it to the European Central Bank (ECB)’s credibility regarding the maintenance of price stability. By selecting seven European bond pairs, each consisting of an inflation-linked and nominal bond, I show that Svensson’s test is applicable during relatively calm times but does not work properly during the recent financial and sovereign debt crisis. Risk premia and flight-to-liquidity effects bias yields of both bond types and hamper a meaningful analysis during this time. However, in line with existing literature, the ECB’s credibility can be confirmed during calm financial times.

Revisiting Svensson’s test of inflation target credibility

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