Macro-finance Model Research Articles

Spillover Effects Between the Stock Market and the Real Economy in a Mixed-Frequency Agent-Based Macrofinancial Model

Abstract This paper illustrates a behavioral mixed frequency macro-finance model where both real and financial variables are generated on a daily basis. Further, while financial sector data is collected at the same frequency as it is generated (i.e. daily), real data can only be collected on a quarterly basis. Under these circumstances, output and inflation, upon which data is available with a significant delay, become unsuitable as the sole information guide for monetary policy. We suggest that policy makers can deal with this information problem by reacting to the variable on which data is collected on high frequency basis: the stock price.

Bond Supply Expectations and the Term Structure of Interest Rates

This paper investigates the influence of forward-looking government bond supply information on changes in the term structure of interest rates. While traditional arbitrage-free models suggest that bond supply should not impact bond yields, models accounting for preferred-habitat investors and imperfect asset substitutability raise this possibility. By analysing debt supply expectations derived from Germany's Treasury press releases, we find that news about expected bond supply affects bond yields, supporting the notion that supply expectations influence current interest rates. Our study also extends macro-finance models, highlighting the significant role of supply expectations in term structure dynamics. Additionally, we provide insights into the puzzle of German government bond yields falling below the ECB deposit rate.

U.S. macroeconomic news and low-frequency changes in bond yields in Canada, Sweden and the U.K.

This paper investigates the importance of U.S. macroeconomic news in driving low-frequency fluctuations in the term structure of interest rates in Canada, Sweden, and the U.K. We follow two complementary approaches: First, we apply a regression-based framework that aggregates the impact of daily macroeconomic news on bond yields to a lower quarterly frequency. Next, we estimate a macro-finance affine term structure model linking the daily news to lower-frequency changes in bond yields and its expectations and term premia components. Both approaches show that U.S. macroeconomic news is an important source of lower-frequency quarterly fluctuations in bond yields in these open economies, and even more important than their respective domestic macroeconomic news. Furthermore, the macro-finance model shows that U.S. macroeconomic news is particularly important in explaining low-frequency changes in the expectation components of the nominal, real, and break-even inflation rates.

Global natural rates in the long run: Postwar macro trends and the market-implied [formula omitted] in 10 advanced economies

Benchmark finance and macroeconomic models appear to deliver conflicting estimates of the natural rate and bond risk premia. This natural rate puzzle applies not only in the U.S. but across many advanced economies. We use a unified no-arbitrage macro-finance model with two trend factors to estimate the natural rate r∗ for 10 advanced economies. We cover a longer and wider sample than previous studies and draw on new sources to construct yield curves and excess returns. The two-trend model improves the explanatory power of yield regressions and return forecasts. Most variation in yields is due to the macro trends r∗ and π∗, and not bond risk premia, which are flatter than previous estimates. Our r∗ estimates covary with growth and demographic variables in a manner consistent with theory and previous findings.

Debt-stabilizing properties of GDP-linked securities: A macro-finance perspective

We study the debt-stabilizing properties of indexing debt to GDP using a consumption-based macro-finance model. To this end, we derive quasi-analytical pricing formulas for any type of bond/equity by exploiting the discretization of the state-space, making large-scale simulations tractable. We find that GDP-linked security prices would embed time-varying risk premiums of about 40 basis points. For a fixed budget surplus, issuing GDP-linked securities does not imply more beneficial debt-to-GDP ratios in the long-run, while the debt-stabilizing budget surplus is more predictable at the expense of being higher. Our findings call into question the view that such securities tame debt.

Decomposing Uncertainty in Macro-Finance Term Structure Models

Abstract This paper studies the extent to which macro-finance term structure models are susceptible to predictive uncertainty. We propose a general form of arbitrage-free models and quantify the relative importance of unpredictable priced risk variance, as well as macro-finance model uncertainty and learning uncertainty in predictability. Predictive performance and relative contributions of uncertainty sources are dynamically measured based on Bayesian methods, revealing dominating priced risk variance and other important uncertainty sources at different points in time. Macro-finance model uncertainty is high for near-term forward spread forecasts and contributes up to 87% of predictive uncertainty prior to recessions, implying strong dispersion in the information content of macro variables when forming near-term monetary policy expectations. (JEL C1, C3, C5, D8, E4, G1)

Consumption Disasters: A Global Dataset

ABSTRACT A number of studies suggest that macro-finance models incorporating the risk of extremely large drops in consumption can explain many financial phenomena. This literature is based on the data for a limited number of countries and a relatively small number of disasters in the post-World War II period. Our study constructs a global dataset on consumption disasters. We identify 498 consumption disasters in 212 countries after World War II and provide data on the probability, size, and duration of disasters for the total sample and different groups of countries. We also explore the recovery of consumption after disasters.

Macro-Finance Models with Nonlinear Dynamics

We review macro-finance models featuring nonlinear dynamics that have recently been developed in the literature, including models with funding liquidity constraints, market liquidity frictions, and bank run frictions, and discuss the empirical evidence and challenges of this class of models. We also construct an illustrative model featuring financial frictions and nonlinear dynamics for readers who are unfamiliar with the literature. We solve the model using different solution techniques, including both global and perturbation solution methods, and comprehensively compare the accuracy of these solutions. Within this framework, we highlight that local linearization approximations omit important nonlinear dynamics and yield biased impulse responses.

Discount Rates, Debt Maturity, and the Fiscal Theory

ABSTRACTThis paper examines how the transmission of government portfolio risk arising from maturity operations depends on the stance of monetary/fiscal policy. Accounting for risk premia in the fiscal theory allows the government portfolio to affect expected inflation, even in a frictionless economy. The effects of maturity rebalancing on expected inflation in the fiscal theory depend directly on the conditional nominal term premium, giving rise to an optimal debt‐maturity policy that is state‐dependent. In a calibrated macrofinance model, we demonstrate that maturity operations have sizable effects on expected inflation and output through our novel risk transmission mechanism.

Finance, Managerial Inputs, and Misallocation

In standard macrofinance models, financial constraints mainly affect small or young firms but not large or old ones due to the self-financing mechanism, and the dispersion of marginal revenue product of capital (MRPK) of a firm cohort is less persistent than in the data. We extend a standard model by allowing firms to hire managers, and large firms hire disproportionately more managers, consistent with data. In our model, financial constraints and the dispersion of MRPK persist, and even large firms are likely to be constrained. The productivity loss from financial frictions is also substantially amplified. (JEL D24, D25, G32, L25, M10, O16, P31)

A Macro-Finance Model with Sentiment

Abstract This paper incorporates diagnostic expectations into a general equilibrium macroeconomic model with a financial intermediary sector. Diagnostic expectations are a forward-looking model of extrapolative expectations that overreact to recent news. Frictions in financial intermediation produce non-linear spikes in risk premia and slumps in investment during periods of financial distress. The interaction of sentiment with financial frictions generates a short-run amplification effect followed by a long-run reversal effect, termed the feedback from behavioural frictions to financial frictions. The model features sentiment-driven financial crises characterized by low pre-crisis risk premia and neglected risk. The conflicting short-run and long-run effect of sentiment produces boom–bust investment cycles. The model also identifies a stabilizing role for diagnostic expectations. Under the baseline calibration, financial crises are less likely to occur when expectations are diagnostic than when they are rational.

The term structure of macroeconomic risks at the effective lower bound

This paper proposes a new macro-finance model that solves the tension between tractability, flexibility in macroeconomic dynamics, and consistency of the term structures of treasury yields with the effective lower bound (ELB). I use the term structures of U.S. nominal and real treasury yields from 1990 to explore the interdependence between inflation expectations, volatility, and monetary policy at the ELB. The estimation reveals that real yields stay elevated during the ELB due to large premia and deflation fears, produced by a persistent shift in inflation dynamics, with low average inflation and heightened inflation volatility.

Deep Learning for Solving and Estimating Dynamic Macro-Finance Models

Deep Learning for Solving and Estimating Dynamic Macro-Finance Models

A continuous-time macro-finance model with Knightian uncertainty

This study presents a continuous-time macro-finance model with Knightian uncertainty to solve the full equilibrium dynamics of the economy and examine the impacts of Knightian uncertainty on systemic risk, which we find to be asymmetric and dependent on the state of the economy. We summarize this phenomenon as the Knightian uncertainty paradox: uncertainty increases systemic risk by reducing market liquidity in the normal regime, but mitigates it by lowering leverage in the crisis regime. Thereafter, we confirm the existence of this paradox using data from China. Additionally, the impacts of macro-prudential policies are evaluated. We confirm that these policies effectively mitigate systemic risk and postpone the Minsky moment; however, they are detrimental to social welfare and retard economic recovery.

The Missing Homebuyers: Regional Heterogeneity and Credit Contractions

Abstract This paper documents an unprecedented decrease in young homeownership since the Great Recession driven by regions with high house prices. Using a panel of U.S. metro areas, I calibrate an equilibrium spatial macro-finance model with overlapping generations of mobile households. The dynamics of regional housing markets is explained by an aggregate credit contraction with heterogeneous local impacts rather than by local shocks. Lower millennial income and wealth amplify its effect. The impact of subsidies to first-time buyers is dampened, because they fail to stimulate regions that suffer from larger busts. Place-based subsidies achieve larger gains. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

A Macrofinance Model for Option Prices: A Story of Rare Economic Events

We propose a macrofinance model that rationalizes robust features in equity index option markets. When rare disasters are followed by economic recoveries, the slope of the implied volatility term structure is positive in good times but turns negative in bad times. Additionally, implied volatility decreases with moneyness in bad times (volatility skew), whereas the shape becomes a smile in good times in the presence of rare economic booms. Our theory contributes to understanding the dynamics of the implied volatility surface yet keeping standard asset-pricing moments realistic. This paper was accepted by Gustavo Manso, finance. Funding: The authors are grateful to HEC Montreal, the University of Texas at Dallas, and particularly to the Canadian Derivatives Institute for generous financial support. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4587 .

A LINKAGE BETWEEN THE FINANCIAL AND THE REAL ECONOMY

The aim of this paper is to present a linkage between the real economy (micro and macro) and the financial economy. This relationship is obtained from the non-arbitrage valuation of equities framework. The paper also investigates if this theoretical relationship is actually observed. For this purpose, it proposes and tests an empirical model for excess returns that includes the linkage as a crucial element. The actual observation of the linkage could be of special importance for the financial economics discipline, since it presents several features that are not usually seen in other asset pricing or macro-finance models: (a) the relationship is explicit and does not depend on the estimation of free parameters; (b) it is derived under arbitrage free arguments and does not introduce subjective concepts as utility function or risk aversion; and (c) it explains the observed level of equity risk premium without entering in contradiction with its theoretical foundations. The conclusions of the performed tests are in favor of the concepts provided by the framework, meaning that further research could offer an alternative understanding of the behavior of financial markets and their connection with the real economy.

Risk pooling, intermediation efficiency, and the business cycle

We develop a tractable macro-finance model in which entrepreneurs cannot pool idiosyncratic risks across firms due to restricted market participation. Costly risk pooling is provided by financial intermediaries who also issue safe assets via balance sheet leverage. We characterize the general equilibrium effects that associate intermediation costs with the dynamics of output and show that higher (lower) cost efficiency fosters (weakens) growth but also amplifies (dampens) its fluctuations. The model predicts negative relationships between the financial sector’s costs-to-assets and leverage ratios and the business cycle, which we find to hold for the US economy.

Cournot Fire Sales

In standard Walrasian macro-finance models, pecuniary externalities due to fire sales lead to excessive borrowing and insufficient liquidity holdings. We investigate whether imperfect competition (Cournot) improves welfare through internalizing the externality and find that this is far from guaranteed. Cournot competition can overcorrect the inefficiently high borrowing in a standard model of levered real investment. By contrast, Cournot competition can exacerbate the inefficiently low liquidity in a standard model of financial portfolio choice. Implications for welfare and regulation are therefore sector specific, depending both on the nature of the shocks and the competitiveness of the industry. (JEL D43, D62, E44, G11, G21, G28, G30)

Monetary Policy and Asset Valuation

ABSTRACTWe document large, longer term, joint regime shifts in asset valuations and the real federal funds rate‐ spread. To interpret these findings, we estimate a novel macrofinance model of monetary transmission and find that the documented regimes coincide with shifts in the parameters of a policy rule, with long‐term consequences for the real interest rate. Estimates imply that two‐thirds of the decline in the real interest rate since the early 1980s is attributable to regime changes in monetary policy. The model explains how infrequent changes in the stance of monetary policy can generate persistent changes in asset valuations and the equity premium.