A Credit-Banking Explanation of the Equity Premium, Term Premium and Risk-Free Rate Puzzle

Micro-founded de-centralized financial intermediation in a cash and costly-credit model (see Gillman and Kejak, 2008) results in a cost-distortion of returns implying a lower average nominal and real risk-free rate when compared to standard cash-in advance RBC models. Failure of both short-run and long-run Fisher equation relationships based on observable real and nominal rates and inflation are obtained. The cost-distortion also leads to an unconditionally upward-sloping average yield curve of interest rates which is also convex in shape. The model is capable of producing a positive correlation between the nominal rate and velocity, and a negative correlation between the ex-post real rate and inflation. More importantly, the model also predicts a negative correlation between the ex-ante real rate and the ex-ante expected rate of inflation. Finally, the conditional spread between the usual CCAPM rate as defined by Canzoneri and Diba (2005) and the model-implied money market rate is positively correlated with the stance of monetary policy, offering a new perspective on this systematic link recently studied empirically by Canzoneri et al. (2007a) and theoretically by Canzoneri and Diba (2005).

Cardiff Economics Working Paper E2008/30 (pdf) - version: Dec. 12, 2008 

 

 

Consumption Velocity in a Cash Costly-Credit Model

In a seminal study Hodrick et al. (1991) evaluate the ability of a simple cash- credit model to produce realistic variability in consumption velocity while at the same time successfully explaining other key statistics. Sufficient variability in the latter is found to be associated with far too volatile interest rate behaviour. Introducing habit-formation in consumption into a production-based cash costly-credit model (see Gillman and Benk, 2007) makes the evolution of deposits more rigid relative to credit. The same deposit rigidity leads to a more volatile price of credit, causing credit production overshooting relative to deposits. But only by introducing adjustment costs to investment in addition to habit persistence does credit production overshoot sufficiently to produce realistic variability in consumption velocity. The model succeeds in capturing sufficient variability in consumption velocity without obtaining too volatile interest rates. Also, this model of endogenous velocity does not suffer from indeterminacy problems discussed in Auray et al. (2005). In contrast to Gillman and Benk (2007), the present study examines the role of the price-channel of credit production at business cycle frequency, ignoring or holding fixed the marginal cost channel stemming from credit productivity shocks.

Cardiff Economics Working Paper E2008/31 (pdf) - version: Dec. 1, 2008 

 

 

A real monetary business cycle?

Building on work by Jermann (1998) and Boldrin et al. (2001), I include a monetary sector into a standard RBC model with inelastic physical capital supply and habit persistence in consumption, which is modeled using a cash-in-advance type constraint. But in conjunction with cash, the household also self-produces credit which rises with the nominal rate of interest, so as to result in an LM-type demand for real money balances (see Kejak and Gillman, 2005; Gillman and Kejak, 2008). The demand for real money balances rises with consumption, but it also falls with the nominal rate, as proportionately more credit is produced. As a result of modeling investment (the supply of physical capital) to exhibit a quadratic adjustment cost term as in Canzoneri et al. (2007), real and nominal rates are found to fall following a positive shock to productivity, and the household reallocates it's liquidity portfolio in favour of money. The model is capable of exhibiting pro-cyclical endogenous demand for real money balances which also leads consumption, and the inverted indicator feature of real and nominal rates with respect to both output and consumption. It also explains procyclical and highly persistent inflation expectations and in addition provides a possible explanation for the so-called price puzzle in the structural VAR literature. In general, the model's responses to productivity innovations are observationally indistinguishable from a New Keynesian model's response following a monetary expansionary innovation on the Taylor Rule. But in the present model, real and nominal variables responses result exclusively from productivity-driven movements of a flex-price Wicksellian real rate of interest.

Working Paper 06/02/2009 (pdf) - version: Nov. 1, 2008 

 

 

PhD Thesis 2008: Business Cycles, Velocity and Asset Prices in a Wicksellian Banking Time Economy

This is the current and presumably finalized version of my PhD thesis which I completed at Cardiff Business School under the supervision of Prof. Max Gillman. It's really a compendium of the preceeding three papers, but beyond that, also includes an introductory as well as a concluding chapter.

PhD Thesis (pdf) - version: Sept. 1, 2008 

 

 

Evaluating forecasts of interest rates in linear and non-linear error-correction frameworks

The following paper's aim is to evaluate the respective forecast performance of three distinct but related error-correction models. Coefficient estimates and forecasts are being obtained from a standard linear error-correction, a non-linear threshold error-correction and a non-linear logistic smooth transition error-correction model. These are then compared with a simple AR-model in terms of their forecast accuracy. The algorithms used in estimating the non-linear models are based on two- and three-dimensional grid-searches over appropriate parameters aimed at minimising the RSS-function. The algorithms were coded in GAUSS. The variable to be forecasted is the change in the 3-month U.S. treasury bill and the motivation for non-linear model specification stems from possible transaction costs incurred in switching from one financial instrument into another.

MSc Dissertation (pdf) - version: Dec. 1, 2008 

 

 

Profits from UK Foreign Direct Investment - A view from the micro-data

This article uses the Annual Foreign Direct Investment survey to investigate the changing patterns and the determinants of profits from the foreign subsidiaries of UK–based multinational enterprises. The results show that these profits are greatest in countries which are closely related to the UK historically, linguistically and geographically – particularly the USA and the Netherlands. However, low tax economies and the BRICs (Brazil, Russia, India and China) are also becoming more significant. Econometric analysis shows that factors such as openness to trade, GDP per capita, population, human capital and unit labour costs help to explain the level of these profits.

ELMR, Vol. 5, Issue 4, 2011 - version: April 1, 2011 

 

 

Assessing the accuracy of business-level forecasts

This article presents original work on some aspects of forecasting at the individual business– or firm–level. In particular, two ways are suggested for assessing the accuracy of these forecasts based on the calculation of average percentage errors and the construction of a 95 per cent confidence interval. It is found that the quality of forecasts tend to become increasingly unreliable after two years and that the decay in forecast quality is inversely related to the frequency of the time series – that is the less often a time series is updated/published the faster the deterioration in forecast quality.

ELMR, Vol. 5, Issue 4, 2011 - version: April 1, 2011 

 

 

The impact of the recession of different-sized firms - A view from the micro-data

This article uses quarterly data on turnover to analyse the performance of small, medium and large firms between 2001 and 2009. The analysis draws on two firm–level data sets which are the Monthly Inquiry into Distribution and Services Sector (MIDSS) and the Monthly Production Inquiry (MPI). For the services sector, it is found that small firms were hardest hit by the downturn, followed by medium–sized firms, which in turn have done worse than large firms. For the manufacturing sector the opposite results were reported. The turnover of large firms fell the most, followed by medium–sized firms, with smaller firms contracting the least. In both the services and production sector, volatility in turnover has increased during the sample period and in the run up to the recession – a reflection of greater price and output fluctuations in the last three years.

ELMR, Vol. 5, Issue 2, February 2011 - version: Feb. 1, 2011 

 

 

Employment and intangible spending in the UK's creative industries - A view from the micro data

The UK's creative industries and creative workforce grew faster than the rest of the economy between 1997 and 2008. This article uses micro data to explore the changing patterns of creative employment in the UK's creative industries. The categories of creative employment showing the strongest growth over this period were Advertising and Software ' Computing. It is also shown that the creative industries exhibiting the highest proportions of creative employment are those with the highest proportions of sector- or skill-specific employment. The article then continues to find a broad association between the proportion of creative employment in an industry and the level of spending on intangibles. These intangibles predominately consist of knowledge capital, hence positing a link between an expert creative workforce and indicators of innovation.

ELMR, Vol. 5, Issue 1, January 2011 - version: Jan. 1, 2011