Under what conditions will a multinational corporation alter its operations to manage its risk exposure? We show that multinational firms will engage in operational hedging only when both exchange rate uncertainty and demand uncertainty are present. Operational hedging is less important for managing short-term exposures, since demand uncertainty is lower in the short term. Operational hedging is also less important for commodity-based firms, which face price but not quantity uncertainty. When the fixed costs of establishing a plant are low or the variability of the exchange rate is high, a firm may benefit from establishing plants in both the domestic and foreign location. Capacity allocated to the foreign location relative to the domestic location will increase when the variability of foreign demand increases relative to the variability of domestic demand or when the expected profit margin is larger. For firms with plants in both a domestic and foreign location, the foreign currency cash flow generally will not be independent of the exchange rate and consequently the optimal financial hedging policy cannot be implemented with forward contracts alone. We show that the optimal financial hedging policy can be implemented using foreign currency call and put options and forward contracts.

In 1982, Dimensional Fund Advisors launched a mutual fund intended to capture the returns of small-cap stocks. The ‘9–10 Fund’ is based on the CRSP 9–10 Index, an index of small-cap stocks constituting the ninth and tenth deciles of NYSE market capitalization, although the 9–10 Fund incorporates investment rules and a trading strategy that are aimed at minimizing the potentially excessive trade costs associated with such illiquid stocks. As a result, the 9–10 Fund provided a 2.2% annual premium over the 9–10 Index for the 1982–1995 period. We show that both the investment rules and the trade strategy components of the Fund’s design contribute significantly to this return difference.

This paper considers conceptual and practical issues that arise in measuring labor's share of national income. Most importantly: How are workers defined? How is compensation defined? The current definition of labor compensation used the Bureau of Economic Analysis (BEA) includes the salary of business owners and payments to retired workers in labor compensation. An alternative series to the BEA's standard series is presented. In addition, a simple method for decomposing labor compensation into a component due to raw labor' and a component due to human capital is presented. Raw labor's share of national income is estimated using Census and CPS data. The share of national income attributable to raw labor increased from 9.6 percent to 13 percent between 1939 and 1959, remained at 12-13 percent between 1959 and 1979, and fell to 5 percent by 1996.

Recently, several central banks have lost their bank supervisory responsibilities, in part because it has not been shown that supervisory authority improves the conduct of monetary policy. This paper finds that confidential bank supervisory information could help the Board staff more accurately forecast important macroeconomic variables and is used by FOMC members to guide monetary policy. These findings suggest that the complementarity between supervisory responsibilities and monetary policy should be an important consideration when evaluating the structure of the central bank.

The dynamics of the unobservable short rate are frequently estimated directly using a proxy. We examine the biases resulting from this practice (the “proxy problem”). Analytic results show that the proxy problem is not economically significant for single-factor affine models. In the two-factor affine model of Longstaff and Schwartz (1992), the proxy problem is only economically significant for pricing discount bonds with maturities of more than five years. We also describe two different numerical procedures for assessing the magnitude of the proxy problem in a general interest rate model. When applied to a nonlinear single-factor model, they suggest that the proxy problem can be economically significant.

As a consequence of optimal investment choices, a firm's assets and growth options change in predictable ways. Using a dynamic model, we show that this imparts predictability to changes in a firm's systematic risk, and its expected return. Simulations show that the model simultaneously reproduces: (i) the time‐series relation between the book‐to‐market ratio and asset returns; (ii) the cross‐sectional relation between book‐to‐market, market value, and return; (iii) contrarian effects at short horizons; (iv) momentum effects at longer horizons; and (v) the inverse relation between interest rates and the market risk premium.