I demonstrate that ratings-based capital rules, including both the current Basel Accord and its proposed revision, can be reconciled with the general class of credit value-at-risk models. Each exposure's contribution to VaR is portfolio-invariant only if (a) dependence across exposures is driven by a single systematic risk factor, and (b) no exposure accounts for more than an arbitrarily small share of total portfolio exposure. Analysis of rates of convergence to asymptotic VaR leads to a simple and accurate portfolio-level add-on charge for undiversified idiosyncratic risk. There is no similarly simple way to address violation of the single factor assumption.

An extensive collection of continuous-time models of the short-term interest rate is evaluated over data sets that have appeared previously in the literature. The analysis, which uses the simulated maximum likelihood procedure proposed by Durham and Gallant (2002), provides new insights regarding several previously unresolved questions. For single factor models, I find that the volatility, not the drift, is the critical component in model specification. Allowing for additional flexibility beyond a constant term in the drift provides negligible benefit. While constant drift would appear to imply that the short rate is nonstationary, in fact, stationarity is volatility-induced. The simple constant elasticity of volatility model fits weekly observations of the three-month Treasury bill rate remarkably well but is easily rejected when compared with more flexible volatility specifications over daily data. The methodology of Durham and Gallant can also be used to estimate stochastic volatility models. While adding the latent volatility component provides a large improvement in the likelihood for the physical process, it does little to improve bond-pricing performance.

This paper develops a welfare-based model of monetary policy in an open economy. We examine the optimal monetary policy under commitment, focusing on the nature of price adjustment in determining policy. We investigate the implications of these policies for exchange-rate flexibility. The traditional approach maintains that exchange-rate flexibility is desirable in the presence of real country-specific shocks that require adjustment in relative prices. However, in the light of empirical evidence on nominal price response to exchange-rate changes—specifically, that there appears to be a large degree of local-currency pricing (LCP) in industrialized countries—the expenditure-switching role played by nominal exchange rates may be exaggerated in the traditional literature. In the presence of LCP, we find that the optimal monetary policy leads to a fixed exchange rate, even in the presence of country-specific shocks. This is true whether monetary policy is chosen cooperatively or non-cooperatively among countries.

Is the stock market boom a result of the baby boom? This paper develops an overlapping generations model in which a baby boom is modeled as a high realization of a random birth rate, and the price of capital is determined endogenously by a convex cost of adjustment. A baby boom increases national saving and investment and thus causes an increase in the price of capital. The price of capital is mean–reverting so the initial increase in the price of capital is followed by a decrease. Social Security can potentially affect national saving and investment, though in the long run, it does not affect the price of capital.

Recently many papers have used the arrest rate to measure punishments in crime-rate regressions. However, arrest rates account for only a portion of the criminal sanction. Conviction rates and time served are theoretically important, but rarely used, and excluding them generates omitted variable bias if they are correlated with the arrest rate. This paper uses the most complete set of conviction and sentencing data to show that arrest rates are negatively correlated with these normally excluded variables. Consequently, previous estimates of arrest-rate effects are understated by as much as 50%. Also, conviction rates, but not sentence lengths, have significant explanatory power in standard crime-rate regressions.

Movements in the stock market can have a significant impact on the macroeconomy and are therefore likely to be an important factor in the determination of monetary policy. However, little is known about the magnitude of the Federal Reserve's reaction to the stock market, in part because the simultaneous response of equity prices to interest rates makes it difficult to estimate. This paper uses an identification technique based on the heteroskedasticity of stock market returns to measure the reaction of monetary policy to the stock market. We find a significant policy response, with a 5 percent rise (fall) in the S&P 500 index increasing the likelihood of a 25 basis point tightening (easing) by about a half.

We find that dual-class firms experience less underpricing than single-class firms and explore several hypotheses which explain this phenomenon. Compared to single-class firms, dual-class companies have slightly higher post-IPO institutional ownership and experience fewer control events. Although dual-class firms achieve a lower underpricing cost, they trade at lower prices relative to earnings and sales than single-class IPOs. This pricing differential, combined with evidence that dual-class managers earn higher compensation and that dual-class shares are common among media and entertainment industry IPOs, suggests that dual-class ownership structures protect private control benefits.

We survey the evidence bearing on measurement error in the CPI and provide our best estimate of the magnitude of CPI bias. We also identify a weighting bias in the CPI that has not been previously discussed in the literature. In total, we estimate that the CPI overstates the change in the cost of living by about 0.6 percentage point per year, with a confidence interval that ranges from 0.1 to 1.2 percentage points. Roughly half of this bias is accounted for by the CPI's inability to fully capture the welfare improvement from quality change and the introduction of new items. Our bias estimate is smaller than that found in several earlier studies, in part because the BLS has recently made a variety of improvements to its procedures; our study highlights several potential areas for further improvement.