Knowledge that Transforms

This paper presents evidence on the characteristic speculative dynamics of returns on stocks, bond, foreign exchange, real estate, collectibles, and precious metals. It highlights four stylized facts. First, returns tend to be positively serially correlated at high frequency. Second, they are weakly negatively serially correlated over long horizons. Third, deviations of asset values from proxies for fundamental value have predictive power for returns. Fourth, short term interest rates are negatively correlated with excess returns on other assets. The similarity of the results across markets suggests that they may be due to inherent features of the speculative process.

This paper examines postwar U.S. term structure data and finds that for almost any combination of maturities between one month and ten years, a high yield spread between a longer-term and a shorter-term interest rate forecasts rising shorter-term interest rates over the long term, but a declining yield on the longer-term bond over the short term. This pattern is inconsistent with the expectations theory of the term structure, but is consistent, with a model in which the spread is proportional to the value implied by the expectations theory.

OPTIMAL LEARNING BY EXPERIMENTATIONThis paper analyses the dynamic decision problem of an agent who is initially uncertain as to the true shape of his payoff function, but who obtains information aboutit over time by observing the outcome of his past decisions.In the long run, the action is a short run optimum given the beliefs, but may not be an optimum for the true payoff function.We derive conditions under which the limit action is optimal for the true payoff function and establish the robustness of the results.Finally we study the adjustment process in an example where such complete learning does not achieve in the long run.

International differences in the cost of production of a key intermediate product can mean that a domestic firm is dependent on supplies from a foreign vertically integrated firm. This paper considers the incentives for the foreign firm and foreign country to supply the domestic firm when the firms compete in a Cournot or Bertrand market for the final product. The vertical supply decision is significantly affected by domestic supply conditions for the input and a domestic tariff on final product imports. Optimal policy by the exporting country may require a tax on both exports, or a subsidy on both exports.

In the intertemporal asset pricing model, investments in spot foreign currencies involve time-varying risk proportional to the conditional covariance of the value of the position with the intertemporal marginal rate of substitution of domestic currency. We detect such risk premia in deviations from uncovered interest rate parity using weekly spot currency prices and Eurocurrency interest rates. Our tests use the conditional capital asset pricing model with a world equity index as benchmark to represent aggregate wealth.

This paper extends earlier work on unsustainable monetary policies by endogenizing the regime switch that ultimately restores sustainability. Within this framework we analyse exchange rate based stabilization programmes and show how constraints on Central Bank borrowing during an exchange crisis influence timing and nature of the post-collapse equilibrium. Such constraints introduce non-neutralities; more restrictive pre-collapse credit policies increase the post-collapse inflation rate. External shocks can destroy consistency between fiscal programmes and inflation targets, causing reserve losses, exchange rate changes and higher inflation. Balance of Payments crises are the mechanism through which fiscal imbalances translate into higher inflation rather than an alternative explanation of it.

This paper reexamines the empirical evidence for mean-reverting behavior in stock prices. Comparison of data before and after World War II shows that mean reversion is entirely a prewar phenomenon. Using randomization methods to calculate significance levels, the authors find that the full sample evidence for mean reversion is weaker than previously indicated by Monte Carlo methods under a normal assumption. Further, the switch to mean-averting behavior after the war is about to be too strong to be compatible with sampling variation. The authors interpret these findings as evidence of a fundamental change in the stock returns process. Copyright 1991 by The Review of Economic Studies Limited.

We develop a model of repeated product improvements in a continuum of sectors. Each product follows a stochastic progression up a quality ladder.

This paper examines the empirical relation between nominal exchange rates and macroeconomic fundamentals for five major OECD countries between 1974 and 1987. Five theoretical models of exchange rate determination are considered. Potential non-linearities are examined using a variety of parametric and nonparametric techniques. The authors find that the poor explanatory power of the models considered cannot be attributed to nonlinearities, arising from time-deformation or improper functional form. Copyright 1991 by The Review of Economic Studies Limited.