We explore whether central bank intervention improves liquidity in the interbank market during the current subprime crisis with unique trade and quote data from the e-MID, the only regulated electronic interbank market in the world. Central bank intervention consistently creates greater uncertainty in the interbank market. Prior to the crisis, the cover-to-bid ratio effectively conveys good and bad news from the central bank, but this link is broken during the crisis, suggesting that standard (and special) interventions that do not specifically target interbank asymmetric information fail to improve market liquidity. Our results suggest that the central bank should release stress tests for individual banks, provide interbank loan guarantees, or engage in direct asset purchases rather than simply providing more capital when counterparty risk poses systemic risk to the interbank market.

This paper documents the short- and long-term balance sheet effect of cash flows. We show that cash savings in the short run and debt reduction in both the short and the long run account for a substantial fraction of cash flow use. Although, in the long run, investment exhibits substantial sensitivity to cash flows, investment does not absorb the entire cash flow shock. In fact, the tighter the financial constraints, the smaller the fraction of cash flow absorbed by investment and the more by leverage reduction. Firms stage their response to increases in cash flow, delaying investment while building up cash stocks and reducing leverage. These results suggest that much of the short-run economic effect of cash flow shocks to the corporate sector may be channeled into the corporate debt market rather than the capital goods market, especially when financing constraints tighten.

This paper provides cross-country empirical evidence on term premia. I construct a panel of zero-coupon nominal government bond yields spanning ten industrialized countries and nearly two decades. I hence compute forward rates and use two different methods to decompose these forward rates into expected future short-term interest rates and term premiums. The first method uses an affine term structure model with macroeconomic variables as unspanned risk factors; the second method uses surveys. I find that term premiums declined internationally over the sample period, especially in countries that apparently reduced inflation uncertainty by making substantial changes in their monetary policy frameworks.

Discount‐rate variation is the central organizing question of current asset‐pricing research. I survey facts, theories, and applications. Previously, we thought returns were unpredictable, with variation in price‐dividend ratios due to variation in expected cashflows. Now it seems all price‐dividend variation corresponds to discount‐rate variation. We also thought that the cross‐section of expected returns came from the CAPM. Now we have a zoo of new factors. I categorize discount‐rate theories based on central ingredients and data sources. Incorporating discount‐rate variation affects finance applications, including portfolio theory, accounting, cost of capital, capital structure, compensation, and macroeconomics.

The new-Keynesian, Taylor rule theory of inflation determination relies on explosive dynamics. By raising interest rates in response to inflation, the Fed induces ever-larger inflation, unless inflation jumps to one particular value on each date. However, economics does not rule out explosive inflation, so inflation remains indeterminate. Attempts to fix this problem assume that the government will choose to blow up the economy if alternative equilibria emerge, by following policies we usually consider impossible. The Taylor rule is not identified without unrealistic assumptions. Thus, Taylor rule regressions do not show that the Fed moved from “passive” to “active” policy in 1980.

Due to its distinctive institutional background, Oman offers a valuable opportunity to examine stock price reactions to dividend announcements. In Oman, (1) there are no taxes on dividends and capital gains, (2) there is a high concentration of share ownership, (3) there is low corporate transparency, and (4) firms frequently change their dividends. Our results show that announcements of dividend increases are associated with increased stock prices, while announcements of dividend decreases cause decreases in stock prices. Firms that do not change their dividends experience insignificant negative returns. These results contradict tax-based signaling models, which argue that higher taxes on dividends relative to capital gains are a necessary condition for dividends to be informative.

Exponential affine models (EAMs) are factor models popular in financial asset pricing requiring a dynamic term structure, such as for interest rates and commodity futures. When implementing EAMs it is usual to first specify the model in state-space form (SSF) and then to estimate it using the Kalman filter. To specify the SSF, a structure of the measurement error must be provided which is not specified in the EAM itself. Different specifications of the measurement errors will result in different SSFs, leading to different parameter estimates. In this paper we investigate the influence of the measurement error specification on the parameter estimates. Using market data for both fixed income and commodities we provide evidence that measurement errors are cross-sectionally and serially correlated, which is not consistent with the independent identically distributed (iid) assumptions commonly adopted in the literature. Using simulated data we show that measurement error assumptions affect parameter estimates, especially in the presence of serial correlation. We provide a new specification, the augmented state-space form (ASSF), as a solution to these biases and show that the ASSF gives much better estimates than the basic SSF.

We develop a theory of new-project financing and equity carve-outs under heterogeneous beliefs. In our model, an employee of a firm generates an idea for a new project that can be financed either by issuing equity against the cash flows of the entire firm (“integration”), or by undertaking an equity carve-out of the new project alone (“non-integration”). While the patent underlying the new project is owned by the firm, the employee generating the idea needs to be motivated to exert optimal effort for the project to be successful. The firm's choice between integration and non-integration is driven primarily by heterogeneity in beliefs among outside investors (each of whom has limited wealth to invest in the equity market) and between firm insiders and outsiders: if the marginal outsider financing the new project is more optimistic about the prospects of the project than firm insiders, and this incremental optimism of the marginal outsider over firm insiders is greater regarding new-project cash flows than that about assets-in-place cash flows, then the firm will implement the project under non-integration rather than integration. Two other ingredients driving the firm's financing choice are the cost of motivating the employee to exert optimal effort, and the potential synergies between the new project and assets in place. We derive a number of testable predictions regarding a firm's equilibrium choice between integration and non-integration. We also provide a rationale for the “negative stub values” documented in the equity carve-outs of certain firms (e.g., the carve-out of Palm from 3Com) and develop predictions for the magnitude of these stub values.

Poor countries are more volatile than rich countries, and we know this volatility impedes their growth. We also know that commodity price volatility is a key source of those shocks. This paper explores commodity and manufactures price over the past three centuries to answer three questions: Has commodity price volatility increased over time? The answer is no: there is little evidence of trend since 1700. Have commodities always shown greater price volatility than manufactures? The answer is yes. Higher commodity price volatility is not the modern product of asymmetric industrial organizations -oligopolistic manufacturing versus competitive commodity markets -that only appeared with the industrial revolution. It was a fact of life deep into the 18th century. Does world market integration breed more or less commodity price volatility? The answer is less. Three centuries of history shows unambiguously that economic isolation caused by war or autarkic policy has been associated with much greater commodity price volatility, while world market integration associated with peace and pro-global policy has been associated with less commodity price volatility. Given specialization and comparative advantage, globalization has been good for growth in poor countries at least by diminishing price volatility. But comparative advantage has never been constant. Globalization increased poor country specialization in commodities when the world went open after the early 19th century; but it did not do so after the 1970s as the Third World shifted to labor-intensive manufactures. Whether price volatility or specialization dominates terms of trade and thus aggregate volatility in poor countries is thus conditional on the century.