Euler Equation Approach Research Articles

Leverage and Investment Cash Flow Sensitivity: Evidence from Muscat Securities Market in Oman

This article investigates the investment cash flow sensitivity (ICFS) and the effect of leverage on the firms’ ICFS by using data from 66 non-financial companies from Muscat Securities Market, Oman for a 7-year period from 2013 to 2019. We used a dynamic panel investment model based on the Euler equation approach and ran dynamic panel regressions using the dynamic panel system generalized method of moments (GMM). We run two regressions: first, testing the sensitivity of investment to the availability of the internal funds; second, testing the effect of firms’ leverage levels on the sensitivity of investment to cash flows. The results showed a significant sensitivity of investment to cash flows for the sample companies. The positive coefficient for the cash flow variable indicates the presence of financing constraints. The results showed that leverage has a significant effect on the ICFS of the companies, indicating that the companies with higher leverage have ICFS.

Optimal Control in a Multiagent Opinion Dynamic System

The paper considers a multiagent system of opinion dynamics modeling a finite social network opinion transformation. In the system, there is an influencer or a player who is interested in making the agents' opinions in the system close to the target opinion. We assume that the player can influence the system only at a limited number of time periods. The player minimizes his costs by selecting moments to control the multiagent system at these moments, while at any time period he observes the agents' opinions. The optimization problem is solved using the Euler-equation approach. The numerical simulations represent the proposed method of finding the optimal solution of the problem.

Adaptive learning with term structure information

This paper builds on the Euler-equation approach to adaptive learning (AL) by considering term structure information in addition to macroeconomic data. We consider a medium-scale DSGE model where the term structure expectations hypothesis is imposed. The model estimated under AL using term structure information has a better fit. Estimation results show that term structure provides useful real-time information in forecasting macroeconomic variables above and beyond that provided by revised macroeconomic data. In particular, term structure information greatly improves the matching of AL expectations to the corresponding forecasts reported in the Survey of Professional Forecasters, which further contributes to the empirical validity of AL.

Intertemporal substitution in import demand and the role of habit formation: an application of Euler equation approach for Pakistan

The study examines the importance of intertemporal substitution in import demand considering the role of habit formation. A two-goods version of the permanent income model is used in which time-non-separability in consumers’s preferences is assumed. The model is estimated using annual data for Pakistan at disaggregated level covering the period from 1977 to 2017. The objective of the study is to estimate elasticities of substitution along with parameters of habit formation for consumption goods at a disaggregated level. The study employs co-integration for the estimation of parameters of elasticities of substitution and generalized method of moments (GMM) for the estimation of the parameters of habit formation from Euler equations. The estimates of intertempral elasticity of substitution suggest that the nature of commodity group (necessity/luxury) plays an important role when consumers are making intertemporal choices. Moreover, the study finds that intratemporal elasticity of substitution is larger than intertempral elasticity of substitution in almost all cases in Pakistan, suggesting that imported and domestic goods are best described as substitutes in Edgeworth-Pareto sense. In addition, the inclusion of habit formation delivers results with plausible signs and the habit formation process seems significant for certain commodity groups including tea, beverages, tobacco products and drugs. The study concludes that there is a possibility of crowding out effect on domestic consumption and the depreciation of local currency may improve Pakistan’s balance of trade.

Financial conditions, financial constraints and investment-cash flow sensitivity: evidence from Saudi Arabia

PurposeThe purpose of this paper is to examine whether the sensitivity of investment to cash flow varies with exogenous financial conditions.Design/methodology/approachA dynamic model of investment based on the Euler equation approach is employed to investigate the impact of macro-financial factors on the sensitivity of investment to cash flow. The sample comprises data from 84 non-financial firms listed on Saudi stock market over the period 2007–2018.FindingsThe results show that the sensitivity of investment to cash flow is positive, implying the presence of financing constraints for Saudi firms. Evidence also reveals that better financial conditions relax firms' financing constraints. However, contractionary monetary policy, poor financial development and liquidity crisis strengthen the dependence of firms on internally generated funds when undertaking new investment projects.Practical implicationsThe empirical results have useful policy implications. First, policymakers should pay attention to the importance of policymaking based on the monetary demand of microeconomic entities. In monetary contraction periods, firms face greater challenges in accessing external finance. These firms are likely to experience under-investment which at a macro level would translate into lower investments and economic growth for the country. Second, policymakers are encouraged to implement complementary measures that, coupled with existing financial reforms, may promote efficiency, competitiveness and transparency in firms' operations. Finally, managers and investors should consider financial structure and condition as important factors in their investment decision.Originality/valueThis study extends previous research by investigating whether the widely reported positive investment and cash flow relationship can be observed using data from an emerging market, specifically Saudi Arabia. It also sheds light on the investment-cash flow debate under a macroeconomic perspective and provides further evidence on the impact of financial crisis on the investment-cash flow (ICF) sensitivity.

Bounded rationality and heterogeneous expectations: Euler versus anticipated-utility approach

By using Bayesian techniques, our paper investigates behavioral New-Keynesian DSGE models derived under two parsimonious alternatives to introduce heterogeneous expectations: the Euler equation and the anticipated-utility approach. First, we explore the relation between the expectation formation processes and the model determinacy for a broad range of parameterizations by using global sensitivity analysis and Monte Carlo filtering. Second, we perform model comparison to assess how much the two alternatives are consistent with macro and expectation survey data. Our main results are twofold: (1) model determinacy is strongly undermined by the presence of boundedly rational agents; (2) a behavioral model based on Euler equation approach fits the data decisively better than one based on anticipated utility.

The Euler-Equation Approach in Average-Oriented Opinion Dynamics

We consider the models of average-oriented opinion dynamics. An opinion about an event is distributed among the agents of a social network. There are an optimization problem and two game-theoretical models when players as centers of influence aim to make the opinions of the agents closer to the target ones in a finite time horizon minimizing their costs. The optimization problem and the games of competition for the agents’ opinion are linear-quadratic and solved using the Euler-equation approach. The optimal strategies for optimization problem and the Nash equilibria in the open-loop strategies for the games are found. Numerical simulations demonstrate theoretical results.

Debt holdings and investment cash flow sensitivity of listed firms

PurposeThe purpose of this paper is to examine the effect of debt holdings on the sensitivity of firms’ investment to availability of internal funds.Design/methodology/approachFor a panel data set of 27 Ghanaian listed firms for the period 2007–2013, the paper applies the Euler equation approach to the empirical modeling of investment.FindingsThe study finds support for the assertion that listed firms face less severe corporate control problems and lower financing constraints, and thus, have lower investment cash flow sensitivities. The study also finds that a significant positive sensitivity of investment to internal funds is associated with firms that have high debt holdings.Practical implicationsAn implication of this study is that firms with high debt holdings face greater challenges in accessing external finance. These firms are likely to experience under-investment which at a macro level would translate into lower investments and economic growth for the country.Originality/valueEmpirical literature document that in the presence of market imperfections, investments of financially constrained firms become sensitive to the availability of internal finance. There are also contradictory evidences regarding the pattern of the observed investment cash flow sensitivity. This study examines the effect of debt holdings on the sensitivity of firms’ investment to availability of cash flow. This is yet to be empirically tested despite some theoretical explanations.

New Estimates of the Elasticity of Marginal Utility for the UK

This paper provides novel empirical evidence on the value of the elasticity of marginal utility, eta , for the United Kingdom. eta is a crucial component of the social discount rate (SDR), which determines the inter-temporal trade-offs that are acceptable to society. Using contemporaneous and historical data, new estimates are obtained using four revealed-preference techniques: the equal-sacrifice income tax approach, the Euler-equation approach, the Frisch additive-preferences approach and risk aversion in insurance markets. A meta-analysis indicates parameter homogeneity across approaches, and a central estimate of 1.5 for eta . The confidence interval excludes unity, the value used in official guidance by the UK government. The term structure of the SDR is then estimated. The result is a short-run SDR of 4.5% declining to 4.2% in the very long-run. This is higher and flatter than the UK official guidance. The difference stems from incorrect calibration of social welfare and estimation of the diffusion of growth. Other things equal, the results suggest that current UK guidance might need to be updated.

Asymptotic Analysis of a Deterministic Control System via Euler's Equation Approach

This paper provides necessary conditions in order to guarantee the existence of an unique equilibrium point in a deterministic control system. Furthermore, under additional conditions, it is proved the convergence of the optimal control sequence to this equilibrium point. The methodology to obtain these statements is based on the Euler's equation approach. A consumption-investment problem is presented with the objective to illustrate the results exposed.

Financial conditions and corporate investment: evidence from Vietnam

PurposeThis study aims to investigate the influence of macro-financial conditions on firm-level capital allocation as a micro-transmission mechanism of monetary policy in Vietnam.Design/methodology/approachThe authors employ a dynamic model of investment based on the Euler equation approach that allows for financial frictions. The financial conditions are proxied by a composite index of the current states of financial variables, including interest rates, exchange rates, stock prices, and credit demand – which captures short-term shocks in monetary transmission channels. Corporate financing constraints, as a reflection of financial frictions, are measured by the sensitivity of investment to internal funds, which are extensively examined in terms of both negative and positive cash flows.FindingsIn the presence of a non-monotonic (or U-shaped) investment–cash flow relation, the empirical evidence from Vietnamese listed firms indicates that financial conditions affect investment behavior for only firms with negative cash flows, in the sense that better financial conditions alleviate the level of “negative” financing constraints (i.e. the sensitivity of investment to negative cash flow). This effect is greater for larger firms and more likely pronounced for firms without state ownership.Originality/valueThis study contributes to the literature on corporate financing constraints in a manner of considering the macroeconomic dimension, specifically exploring the asymmetric impacts of financial conditions on the investment sensitivity to cash flow.

Dynamic Potential Games: The Discrete-Time Stochastic Case

This paper concerns a class of nonstationary discrete-time stochastic noncooperative games. Our goals are threefold. First, we give conditions to find Nash equilibria by means of the Euler equation approach. Second, we identify subclasses of dynamic potential games. Finally, within one of this subclasses, we identify a further subclass for which Nash equilibria are also Pareto (or cooperative) solutions.

(Un)expected retirement and the consumption puzzle

In this work we revisit the retirement consumption puzzle using Italian panel data. As emphasised in the literature, the observed consumption drop might be due to unexpected wealth shocks at retirement which modify optimal consumption plans. Using an Euler equation approach, we test the impact of unexpected retirement on the consumption patterns of individuals around the age of retirement by using the panel component of the Survey of Household Income and Wealth (SHIW). This dataset contains information on the expected age of retirement which can be used to distinguish between expected and unexpected retirement. Furthermore, we investigate the heterogeneous behaviour of individuals with different levels of education and wealth. We find evidence of a consumption drop at retirement especially for low educated people and individuals with little wealth. The consumption drop at retirement, on average, does not seem to be a response to unexpected retirement. Disaggregating our sample, we find that the consumption drop persists among low educated people with little wealth available, irrespective of whether retirement was expected or not. Highly educated people, conversely, do smooth their consumption, unless they have low wealth and are hit by an unexpected shock at retirement in which case they are forced to drop consumption.

(Un)expected Retirement and the Consumption Puzzle

In this work we revisit the retirement consumption puzzle using Italian panel data. As emphasized in the literature, the observed consumption drop might be due to unexpected wealth shocks at retirement, which modify optimal consumption plans. Using an Euler equation approach, we test the impact of unexpected retirement on the consumption patterns of individuals around the age of retirement by using the panel component of the Survey of Household Income and Wealth (SHIW). This data set contains information on the expected age of retirement, which can be used to distinguish between expected and unexpected retirement. We furthermore investigate the heterogeneous behaviour of individuals with different levels of education and wealth. We find evidence of a consumption drop at retirement, especially for low-educated people and individuals with low wealth. The consumption drop at retirement seems to be rationally planned by individuals, rather than a response to unexpected retirement.

The impact of shareholding structure on firm investment: Evidence from Chinese listed companies

This paper examines the impact of shareholding concentration and the class of shareholders on firm investment. We apply the Euler equation approach to the empirical modeling of investment for a panel dataset of 786 Chinese listed companies during 1998–2004. We find that a significant positive sensitivity of investment to internal funds is associated with firms that have a low level of shareholding concentration, large proportion of state shares and low proportion of publicly-owned shares. We find that cash flow is insignificant for high levels of legal person or public shareholding. We interpret this in the context of the impact of both liquidity constraints and corporate governance issues.

Euler Equation Approach for Emerging-market Macro Models

This paper focuses on how to obtain numerical solutions to emerging-market DSGE models with occasionally binding constraints by using the Euler equation, rather than using value functions of households. The main point is that the Euler-equation approach works in a fast and simple way for a variety of recent emerging-market macro models. An important reason behind this point is that it is relatively easy to pin down the functional form of aggregate equilibrium conditions in these models. The time-iteration method is applied to Euler equations of a small open-economy with overborrowings. It is discussed how to use the Euler equation approach to recent models of sovereign debt and to show that the presence of the Laffer-curve of debt-revenues leads us to use the piecewise parameterized-expectations approach.

Consumption Model of Imported Products: Indonesian Case

It is evident that Indonesian consumers were proud to consume imported products. Instead of buying and consuming national or local product, people consider of buying and consuming imported product will higher their self-esteem, especially products origin from developing country such as USA, Europe, and Japan. In accordance with macroeconomics theory, this fact will lead to lower Indonesian foreign exchange as the trading transaction mostly using USD. Therefore, the objective of the research was to develop consumption model of imported products. Euler equation approach was used with GNP per capita, interest rates, inflation rates, exchange rates, and income are influencing variables.

On the Euler equation approach to discrete--time nonstationary optimal control problems

We are concerned with deterministic and stochastic nonstationary discrete--time optimal control problems in infinite horizon. We show, using Gâteaux differentials, that the so--called Euler equation and a transversality condition are necessary conditions for optimality. In particular, the transversality condition is obtained in a more general form and under milder hypotheses than in previous works. Sufficient conditions are also provided. We also find closed--form solutions to several (discounted) stationary and nonstationary control problems.

Relative energy price and investment by European firms

A dynamic model of investment is estimated with data on non-financial firms in 15 European countries across 25 industries over 1991–2006. A rise in real energy price reduces the degree of persistence in the investment adjustment cost function. Panel results suggest that in manufacturing a 1% rise in real energy price reduces investment by a country's firms by 1.9% relative to that by firms in other countries with a smaller effect for non-manufacturing firms. The negative effect of a higher relative price of energy on firm-level investment is significantly less marked the larger the firm. Results imply that stabilizing the relative price of energy would steady firm investment with greater gains in stability at smaller and medium sized firms. Results are robust to consideration of country business cycle effect and firm leverage. Estimation of investment is based on the Euler equation approach with over 21,000 observations. Individual country regressions imply that a rise in the relative price of energy price has a statistically significant negative effect on firm-level investment in 14 out of 15 countries. To avoid dynamic panel bias estimation is by generalized method of moments with instrumental variables.

Capital Market Imperfections and Financialization of Real Sectors in Emerging Markets: Private Investment and Cash Flow Relationship Revisited

Summary The paper analyzes the impacts of cash flow from multiple investments in real and financial sectors on the new fixed investment spending of real sector firms. The empirical results based on the Euler equation approach and semi-annual firm level data from two major emerging markets, Mexico and Turkey, suggest that profits and rates of returns from fixed and financial assets have differential effects on fixed investment spending of real sector firms. Accordingly, increasing availability and accessibility of alternative investment opportunities in financial markets can become instrumental in channeling real sector savings to short-term financial investments instead of long-term fixed capital formation and thus lead to deindustrialization.