Volume 14, Issue 1

Sticky information monetary models have been used in the macroeconomic literature to explain some of the observed features regarding inflation dynamics. In this paper, we explore the consequences of relaxing the rational expectations assumption usually taken in this type of model; in particular, by considering expectations formed through adaptive learning, it is possible to arrive to results other than the trivial convergence to a fixed point long-term equilibrium. The results involve the possibility of endogenous cyclical motion (periodic and a-periodic), which emerges essentially in scenarios of hyperinflation. In low inflation settings, the introduction of learning implies a less severe impact of monetary shocks that, nevertheless, tend to last for additional time periods relative to the pure perfect foresight setup.

Employing a Bayesian approach, we investigate the impact of international business cycles on the U.K. economy in the context of a smooth transition VAR. We find that the British business cycle is asymmetrically influenced by growth in the U.S., France and Germany. Overall, positive and negative shocks generating in the U.S. or France affect the U.K. in the same directions as the shock. However, a shock emanating from Germany, whether positive or negative, always exerts negative cumulative effects on the U.K. Further, a positive shock arising from Germany adversely affects the U.K. output growth more than a negative shock of the same size.

This paper develops an unobserved components model for U.S. real GDP that allows for both asymmetric transitory movements and correlation between the permanent and transitory innovations. The asymmetry is modeled using Markov-switching in the transitory component in the spirit of Kim and Nelson's (1999) version of Friedman's plucking model. The findings suggest that ignoring the correlation between permanent and transitory movements underestimates the role of permanent movements, whereas ignoring asymmetry in the transitory component underestimates the role of temporary movements in U.S. real GDP. These results imply that both permanent movements and asymmetric transitory shocks are important for explaining post-war output fluctuations in the U.S. and for explaining the recession that began in 2007 in particular.

One of the most widely used option valuation procedures among practitioners is a version of Black-Scholes in which implied volatilities are smoothed across strike prices and maturities. A growing body of empirical evidence suggests that this ad hoc approach performs quite well. It has previously been argued that such a procedure works because it amounts to a sophisticated interpolation tool. We show that this is the case in a formal, asymptotic sense. In addition, we conduct some simulations which allow us to examine the importance of the sample size, the order of the polynomial, and the recalibration frequency in controlled settings. We also apply the ABS approach to daily S&P 100 index options to show that the procedure outperforms the Black-Scholes formula in valuing actual option prices out-of-sample.

We study the impact of positive and negative macroeconomic U.S. and European news announcements in different phases of the business cycle on the high-frequency volatility of the EUR/USD exchange rate. The results suggest that news effects depend on the state of the economy. In general, news increases volatility more in good times than in bad times. News effects are also asymmetric with respect to sign: negative news increases volatility more in good times than in bad times, while there is no difference between the volatility effects of good news in bad and good times.