ECON 400/400G  371
ISSUES IN CAPITAL MARKET ECONOMICS

Spring 2013

Course Policies

Outline & Readings

 

External Sites:

Federal Reserve Info:
Federal Reserve System Article Search Engine / FRB of New York / FRB of St. Louis /   Index of SEC Rules  /

Blogs/Discussions/Research
Fama-French Forum/   John Cochrane CGSB Site/ Xavier Gabaix NYU Site/ Streetwise Professor/

Current Data
Bloomberg       Economagic Economic-Financial Data

  




 
   Dr. Brian Goff/414 Grise Hall
Phone (270)745-3855/brian.goff@wku.edu
Last Modified: January 21, 2014
Western Kentucky University

 


COURSE POLICIES

Dr. Brian Goff
GH 414/745-3855
Office Hours for Spring 2013: TTh 9:30-11:30 (appointments & drop-ins welcome other times)

Objective
To acquaint students with several current issues on the border between macroeconomics and financial economics, financial market microstructure, and financial market regulation

Resources
Selected Readings On-Line

Grading (Undergrad)
Exam I                                    =      35%
Exam II                                  =      35%
Assignments                          =       20%
Reading Quizzes                   =       10%
Total                                      =       100%
(A=90-100; B= 80-89; C= 70-79; D = 60-69;  F < 60)

Weekly Reading Quizzes:    Short, multiple choice quizzes over readings

Weekly Assignments/Presentations:
  Starting with Class 5; students will make 10 minute powerpoint presentations on a listed topic.  These presentations may be done with teams up to 3 members.  The powerpoint slides should be printed and turned in.  The aim of the presentation is to summarize the material (or the most important parts of it) in ways that best communicate it to the other students using cut/past graphics, data, bullets.  Remember, more is not always better.  Clear, accurate -- keep those words in mind along with emphasizing connections to background economic ideas (this isn't journalism class, it's econ).  You are encouraged to refer to other sources that may enhance your understanding and presentation.  There will be 2 graduate teams with more difficult material (some weeks).

Exams: These will be short answer/multiple choice tests. 

Miscellaneous
Students with disabilities who require accomodation (academic adjustments and/or auxilary aids or services) for this course must first contact the Office of Student Disability Services in DUC A-200.  Last day to drop the course with a W is listed in the WKU Academic Calendar.

 

 



COURSE OUTLINE & READINGS (subject to changes)

Note:  If a link is dead, please email me as soon as possible.   Use Wikipedia, Investopedia, or similar sources to look up terms and concepts 
Some articles, if accessed from off-campus, require going through WKU's E-Journal  system.  Go here
http://www.wku.edu/Library/ejrnloff.htm# for instructions


Week 1 (Jan 29) Administration & Basic Ideas in MacroFinance & Market Microstructure I 
 
Class Administration
Statistical Primer and Review: Using Gretl  (GA Assistance and Gretl Primer)
Market Level Stock Price Basics: Time Series Behavior and Conceptual Background


Assignment for Next Week: 
Shiller Monthly Stock Data (Gretl)  Shiller Annual Stock Data (Gretl) 

All Students:
1) Open Gretl and become comfortable with key features (opening files, generating new variables, generating stats, opening command log, using console)
2)Open the Shiller Monthly file, and compute real (CPI adjusted) values of SP, GDP, and PCE by multiplying each variable by the present CPI (2013=238) and dividing by the CPI in each period
3) Generate (annual) percent changes (example: SPrpca = (SPr-SPr(-12))/SPr(-12) ) for real SP500 Index, real GDP, and real Personal Consumption Expenditures  (for small differences apx equal to d(logSPr)
4) For the following sample periods generate summary statistics for these variables
(use the console and summary command to do them all at once)
                            1871.01-2013.12:  SPrpca
                            1947.01-2013.12: SPrpca, gdprpca, pcerpca
5) By hand calculate the "Sharpe Ratio" of each variable = Mean/Standard Deviation
6) Run an OLS regression for full sample with real SP as dependent variable and one lag of real SP as independent variable
7) Print (clearly) brief answers to the following questions on the back of your printed output
     -- What are the mean annual percent changes in these variables?
     -- How do the standard deviations compare?
     -- How do the Sharpe Ratios compare?
     -- What is the coefficient in the regression and what does it mean?

Grad Students:
G1) Run the OLS  real SP regression again with its 1-period lag, and save the residuals
G2) Run a regression using the residuals as the dependent variable and their 1-period lag as the independent variable
G3) Select 3 subsample time frames (of at least 3 years); Run the real SP and its lag regression and see if you can find a period where the coefficient in the regression differs significantly from 1
G4) Generate a simulated random walk
      -- Open Gretl Console under Tools; series simrw=0,  genr simrw = simrw(-1) + randgen(N, 0, 1), genr simrw = simrw + 50  (recenters to 50)
      -- Run the same regression for this variable, the ADF, and Print a time series plot for it
G5) Prepare 2-3 Powerpoint slides explaining what G1-G3 mean
             

Related Links:   Fama   on Market Efficiency    coin flipping                                                         


Week 2 (Feb 5 ) Stocks, Random Walks, and Efficient Markets
Reading Quiz: 
Efficient Capital Markets -- CEE    (pdf) Fama DFA Interview       Wiki on Present Value 


Assignment for Next Week:  Shiller Forecasting Regressions  Shiller Monthly Stock Data (Gretl)          
All Students:
1) Run a regression with real SP500 annual returns (annual percent change in real SP) and its one period lag
2) Run a regression with real SP500 annual returns and 1-period lag of Shiller PE ratio as independent variable
3) Print (clearly) brief answer to the following questions on the back of your printed output
     -- Do one month lagged returns in stock returns or one month lagged price-earnings ratios help predict current percent changes in stock returns?
     -- How does this relate to the efficient markets/random walk discussion?

Grad Students:
G1) Compute percent changes in real stock returns over and real earnings over 12 months and over 60 months (e.g. SPpc12= (SPr - SPr(12))/SPr(12)
G2) Run regressions with 12 and 60 month percent changes in real SP and with Shiller's PE ratio as the independent variable
G3) Run regressions with 12 and 60 month percent changes in real earnings with Shiller's PE ratio as the independent variable
G4) Prepare 2-3 Powerpoint slides explaining what you found and what it means
                             

Related Links: Mehra on Equity Premium       The Mismeasurement of Risk  Barro Disasters NBER   Macro Finance Puzzles (p. 2-3 only)

                                



Week 3 (Feb 12Beyond Random Walks, Predictability of Stock Prices
Reading Quiz:   
Cochrane on Efficient Markets Today      Vox Barro on Disasters and Equity Premium       

Assignment for Next Week:
Undergrads:  10 minute Powerpoint explaining methods and results in Events That Shook The Market   (Ray Fair Yale)
Grads:  15 minute Powerpoint explaining
Rational Revolutions (Chicago GSB technical background to article )



Related Links: 
Campbell on Long Run Returns    Short and Long Run Stock Return Behavior      Cochrane Long Run Stock Perspective   Stock Price Graphics FileRay Fair Simulation Model   Fama Minn Fed Interview    (pdf) Fama DFA Interview     Manne on Market Efficiency     Fama Long Interview        Fama   on Market Efficiency     Apple's New Normal        Ray Fair Simulation Model 




 

Week 4 (Feb 19Topics on Stock Prices
Reading Quiz:   
Bubble, Bubble (frb-stl)   Tulipmania (JSTOR link through WKU)                                                   
                      

Assignment for Next Week:     Interest Rate Data              
All Students:   
1) Compute summary statistics on 1 year bond (returntb1) and SP 500 (returnsp) nominal annual returns (annual percent changes)  using the monthly data
2) Generate a time plot of these two series
3) Run a regression with returntb1 as the y-variable and returnsp as the x-variable
4) Compute a real 10 year bond rate by using tb10yrreal = tb10yr - inflation1yr
5) Generate a time plot of tb10yr, tb10yrreal, and tb10yrtips (real rate as estimated by trading on inflation-indexed 10 year bonds)

6) Compute the difference in the Baa corporate rate (rbaa) and Aaa rate (raaa) and difference in TB10yr and TB1yrsm
7) Plot the two variables computed in #6 along with the recession variable
8) Print the output and print answers to the following questions on the back of your printed results
   

Grad Students:
Group 1) Explore the relationship between bond and stock returns over a) different time periods and b) over different horizons
Group 2) Explore the relationship between predicting recessions with lagged values of the variables from #6 above
Group 3) Explore the high real rates for the late 1970s/early 1980s with alternative ways of computing real rates and with differences in Baa-Aaa
                (hint: real rates are shown as very high during periods of low growth; that doesn't make sense)


All Groups Prepare a few slides explaining your explorations

                                     

Related Links:    
Bubble Regressions      Campbell Bubble in Bond Market?    Stock Market Crashes and Depressions (Barro and Ursua)     




Week 5 (Feb 26) Yield Curve, Forward Rates,  and Recessions
Reading Quiz
  Is There A Bubble in the Bond Market (Campbell)  


Assignment for Next Week:  Fama-Bliss Data Gretl 
All Students:
1) Generate a time plot of y1, y2, f2 (y1 = actual 1 yr rate; y2=actual 2 year rate; f2 = implied 1 year rate in year 2)
2) On back of plot, draw a simple graphic illustrating the meaning of y1, y2, f2
3) Generate a time plot of f2y1 and yy21 (f2y1 = difference f2 and y1; yy21=difference in y2 and y1)

4) Suppose the price of a 1 year bond is 98 and it pays nothing until the end of the 1 year, show how to calculate its yield (interest) rate (wiki)
Grad Students:  
G1) Regress yy21 as dependent variable on f2y1 as independent
G2) Regress yy51 as dependent variable on f5y1 as independent
G3) Regress rx2 as dependent variable on fy21  (rx2 is return on 2 year bond minus yield on 1 yr)
G4) Regress rx5 as dependent variable on fy51
G5) Print output and prepare a few PPT slides addressing the following issues:
      -- Before Fama-Bliss, the expected coefficients on the "yy" regressions were 1.0 with high R2; can you explain why?
      -- What did you find for the coefficients and why the divergence from what was expected?
       -- Prior to FB, the expectation on the excess return (rx) regressions was for coefficients of 0 and low R2
      -- What did you find?  What does it mean? 


Related Links:  STL Fed Monetary Trends    Campbell Risk and Returns Stocks and Bonds Slides   Cochrane Notes   



Week 6 (Mar 5
Fama-Bliss on Yield Curve and Forward Rates
Reading Quiz:
Understanding the Term Structure of Interest Rates  (StL Fed)   Wiki on Yield Curve    Wiki on Forward Rates     



Related Links:  STL Fed Monetary Trends    Bond Valuation   Forward Rates Excel File  

 


Week 7 (Mar 12) Spring Break

                           


Week 8 (Mar 19Exam I


Assignment for April 2:  Cross Country Interest Rates and Debt/GDP       OECD MacroFinance Data   (Excel File with Country Codes)      
Note:  The OECD data file is a panel data 1961-2013 for OECD members (included only in years of membership).  It merges (some) variables from IMF's World Economic Outlook database,  World Bank World Development Indicators database and Global Financial Development database.  This last one (GFDD) is the most useful on this assignment.  In the Gretl file, these variables have names from data11 to data104 and appear at the bottom of the datafile.  All variables have labels.  Gretl doesn't handle text input so Country Codes are just numbers in the Gretl file.  Names appear with Codes in the Excel file. 

All Students
1) Generate time series plot of the Debt/GDP ratios for the US, Japan, Spain, France, Germany, Greece  (use variable #133 in Gretl file)

Grad Students
G1) Run a regression for country interest rate on long run bonds (variable #212)
imitating the one in Hamilton's fiscal tipping points (Debt/GDP, Debt/GDP^2, Current Account/GDP, CA/GDP^2) 
          Current Account to GDP is variable #121
G2) Run the regression again but put in country specific dummy variables (country fixed effect)
G2) Generate a PPT presentation of your results and address these questions:
          -- why use the square of debt/GDP?
          -- what role does the country fixed effect play?
          -- how do the results change with country effects?





Week 9 (Mar 26)  



 
Week 10 (April 2)
Macro Problems from Debt, Fiscal Tipping Points
Reading Quiz:   Bass Chicago CGSB Video     Fiscal Tipping Points           Japan  US


Assignment for Next Week: 
Measuring Financialization and Its Impact  OECD MacroFinance Data   (Excel File with Country Codes)   

All Students
1) Generate a time series plot of data103 (stock market capitalization to GDP) for US, UK, Iceland, and one country of your choosing

Grad Students
G1) Construct two measures of the degree of financialization of an economy (services-based, asset or liability based)
G2) Using plots, summary stats, and/or regressions, show how the financial crisis of 2008 impacted countries with low, medium, and high degrees of financialization (by one of your measures)


Related Links:  Related Links: S&P Global Credit Risk Report    Predicting Sovereign Debt Crisis    Goff PPT on Crisis   Modigliani-Miller     Japan  US       SoberLook 1  SoberLook2 


          


    


Week 11 (April 9)
Financialization and Debt (How Much Is Too Much)
Reading Quiz: 
Cochrane on Financialization   Crisis & Finanicalization in UK, US, Iceland     Jenkins on Cyprus      

 

Assignment for Next Week Rent-Sales Price Ratio, Gold Silver Prices   Housing Data    Gold Silver Data
Note:  The housing data is from Shiller.  It lists a housing price index (HPI) and rental price index (CPIRENT) for 1914-2013.  The metal prices data is monthly from 1968.1 to 2014.1.  It lists prices of gold and silver in dollars per ounce.
All Students:

1)  Compute a time plot of housing price index and rental price index (on same plot)
2)  Generate a time plot of gold prices and silver prices (on same plot)
3) Compute a housing price to rent price ratio using 1980 as the base year (ratio = 100 for 1980)
4) Compute a gold to silver price ratio using 1980 as the base year again
3) Generate time plots for the price-rent and for gold-silver price ratios (separate graphs)

    -- Print answers to the following questions on the back of the printed output:
    -- When are these ratios unusually high and low?
    --  How did the gold-price ratio behave before, during, and after the financial crisis of the fall of 2008?
   

Grad Students
Group A)
1)  Regress the log of silver prices as the dependent variable with the log of gold prices as the dependent variable; save the residuals     

2) Plot the residuals
3) Regress the residuals on their one period lagged values
4) Using the plots for all students, the estimates in steps 1-3, as well as adding other variables to the data set,
    -- when are gold prices high relative to silver and vice versa?
   --  are the residuals stationary (returning to zero, lag coefficient less than 1)?
   -- does changing the time frame make any difference?
   -- are the residuals predictable by some other variable?
   -- does the plot of the ratio make seemingly permanent increases in its mean?  what might explain this?
5) Generate a 10 min PPT explaining your findings and answers


Group B)
1) Follow the same procedures as Group A but using housing price index and rental price index






Week 12 (Apr 9) Rental-Sales Prices Real Estate, Gold-Silver Prices (Arbitrage, Cointegration)
Reading Quiz:   FRB Boston Why So Many Bad Real Estate Decisions?      Hamilton May 08     Dallas Fed on Real Estate Prices         More Dallas Fed (Grad Only)                  



Related Links:   Error Correction Model of M2 Richmond Fed    Gold Silver Price Rent Graphics   



Week 13 (Apr 23 Topics in Market Microstructure: Market Making, Transactions Costs, Bid-Ask Spread
Reading Quiz:  Wiki Market Maker  Bid Ask Spread    NYSE    CBOT   Bond Market   Foreign Exchange Market   FIX 



Assignment for Next Week:

Grad Students:
G1) Select one of the 3 items below.  Prepare a 10 minute PPT presentation explaining the issue and the economics behind it.  You may work in 2 person teams.  I have listed links as starting points.  You should do some investigative work from there

-- Futures Market Speculation and Spot Price Bubbles  Streetwise Professor   and Econbrowser (James Hamilton) for posts between 2008 and 2012
-- Centralized Clearing     
Streetwise Professor   for posts over last 6 years (look under counterparty risk also)    Hamilton June 08Hamilton (Nov 09)              
-- Front-Running   WSJ Book Review     Streetwise Professor  
-- Insider Trading Restrictions  
Insider Trading Debates  + CEE on Insider Trading 




Week 14 (April 30)  Topics in
Market Microstructure and Regulation

Student Presentations



Related Links: 
WSJ Market Data Center;   NYSE CME Grouputures  1987 Market Crash  See Wiki for Stock, Bond, Futures
                      

 

 


Week 15 (May 7) 
Exam II 

 

 

 

Week 16   Finals 
 







Monthly Interest Rates


 Ray Fair "Events that Shook the Market" 

 

       
Standard deviation (biniomial applet); law of large numbers -- sequence applet; dice appletcoin flipping;


  Compute two VARs (use default lag settings), one with 3-month treasury, commercial paper, fed funds, and cd rates
                                                      one with aaa, baa, and 10-year treasury 
            

 

                                            
Grad only:  present 3-5 slides on growth of debt from 1980 to 2008 (overall debt and different categories: commercial, household, public ...) considered relative to measures of ability to pay  OR losses to large stockholders of large financial firms in 2008 crash

Related Links:  Crisis Timeline   Goff PPT on Crisis   Systemic Risk & Financial Crisis   Bubbles or How Unusual Stock Market of 2008  Crisis and Bank Opaqueness



Various Empirical Explorations
10 Minute Presentation on one of the following

Demographic Shifts and Markets
Key Questions: What impacts will demographic shifts have on asset values?
                         How accurate are long run demographic predictions?

Data on Demographics and Stock Values:    Vox Demographics and Stock Predictability +  "Future Shock" + Milken Rebuttal  
 

 The Search for Safe Assets
 
Key Questions:  What assets do people seek out when markets are troubled?
                           What are attributes of these assets that are common and what are different (up/down movements; variance; ...)?

Beckworth Post 


          
Search out references on forces behind gold and silver prices; Present data on movements of these series (and their ratio and difference); examine the cointegration of these time series (be careful with unit of time);

Financialization 
Key Questions:  Did the financial industry grow too large?
                          What changes to the financial industry might best reduces changes of future bubbles/crashes?

See as well as WSJ article on Cyprus that I sent by Holman Jenkins; Explore/examine World Financialization Data



 Federal & State Fiscal Problems  
Key Questions: What States are facing the biggest fiscal issues?
                         What fiscal issues does the US federal government face?
                         If things are so bad, why are U.S. Treasuries so valuable right now?

Assignments/Presentations:

Undergrads: Using the links below or other data  (basic) or other basis, present 2-5 slides (10 min or less) desribing which states are at greatest fiscal risk and why; The Pension Bomb    Northwestern Study   Pew Center Map   Fiscal Health of US States 

Additional Resources:  Josh Rauh Stanford  (Rauh detailed papers) Crisis in Local Govt Pensions  Are State Pensions Sustainable 

Grads:  Present 3-5 slides (
10 Minute Presentation) describing the projected fiscal condition of the US over the next 20 years and factors that may make it better or worse.  Incorporate some of the analysis of Cochrane into your presentation.  Read over the Prescott article and consider why growing debt (to some extent) makes sense with a demographic "shock" like the baby boom
   CBO Budget Outlook to 2012       Conference on Looming Fiscal Crisis       Unpleasant Monetarist Arithmetic (Cochrane) 
Needed Quantity of Government Debt (Prescott) Barro on Ricardian Equivalence



Euro Debt Crisis  
Key Questions: Why is there a debt crisis in Europe?  
                          What do sovereign defaults look like?
                          Why are currency and debt crises usually connected?

Assignments/Presentations:  
Undergrads use 3-5 slides (10 min or less) to summarize  
FRB Richmond Overview    Northern v. Southern Europe  

Grad:  1 page summary on reading above + 
present 3-5 slides (10 min or less) on   FRB Richmond Econ of Sovereign Defaults 

Related Links:   Global Credit Risk ;   Cochrane-WSJ Contagion and other Euro Myths   Jenkins WSJ - None Dare Call it Default    Monetary Challenges     Predicting Debt Crises       Unpleasant Monetarist Arithmetic (Cochrane)



 

Why are FX rates hard to predict or explain?

 

Fx Rates:   Why are FX Rates Hard to Predict +  FX Rate Conundrum     Micro-Macro Disconnect and PPP    or    Can Oil Prices Forecast Exchange Rates 


Related Links:  Rational Speculation & Exchange Rates  (JME)  
  Conflicts and Commodity Prices        Exchange Rates and Business Cycles   

 

MacroFinance Policy Issues & Questions
Key Questons: 

Assignments/Presentations:  Undergrads read 3 of following articles.  Grad students read all plus Robust Capital.  Assemble a 10 minute PPT that addresses 1) source(s) of 2008 crash; 2) Fed reactions to crash; 3) Future Policy Changes/Improvements.   Don't simply do a summary.  Read/assess/weigh the points and try to come to your own conclusions

 Boston Fed President on Crisis & Policy        William Poole Key Questions about Fed Actions (Book Review)    Cochrane on Financial Crisis and Policy + Hamilton Reply   
NY Fed President Lessons from the Crisis     Jenkins Next Bailout the Last   
   Taming Too Big To Fail (Dallas Fed Speech)   

Grad Student Extra:  Robust Capital Regulation  

Measuring Bank Specific Systemic Risk    Influences on Systemic Bank Risk     Fed Reactions to Crisis (Dallas Fed)

 

 

Does CEO Pay Make Economic Sense?   Is CEO Pay Really Inefficient?   CEO Pay Jenkins  (Reply to Question)  CEO Pay Reynolds 
How Sustainable/Unstustainable Is Kentucky's Long Run Fiscal Situation?  
Excel File on KY   (update for 2012;  for more info see KTRS report Financial or Actuarial http://ktrs.ky.gov/05_publications/index.htm

How Much Did the Size of a Nation's Financial Sector (finanialization) Matter for the 2008 crash and Why:  World Financialization Data
Examining the Relationship between Gold & Silver Prices since 2007
Relationships between Stock Prices and Commodity Prices
Similarities and Differences in the Crashes of 1929 and 2008

Ideas and Policies for Regulation of Systemic Risk:  Vox Critical Assessment Dodd-Frank    Zingales - JAcctResearch May 2009)
Do Central Banks (such as the Fed) Increase or Decrease Systemic Risk?
Insider Trading:   
Insider Trading Debates  + CEE on Insider Trading  
Convergence and Divergence in Eurozone Bond Spreads and What's Down the Road? 
Was There a Real Estate Bubble and How Would One Decide?  
   Shiller Real Estate Data
What's Been Driving Commodity Pricing:     Hamilton June 08Hamilton (Nov 09)  +  SWP Stuck on Stupid + SWP Reply to Hamilton + Vox on Financialization of Commodities      
 

                                                                      
Commodity Price Boom in Perspective     Did Easy Money Fuel Commodity Boom     

 

Limits on Short TransactinsOverstock.comLimits on Short TransactionsInvestopedia  
SEC Study on Marked to Market Accounting

 

 

 


 

Debates about Financial Market Regulation Part 2
Wiki Terms: Clearinghouse; Counterparty Risk;
Principal-Agent Problem
Undergrad Assignment (15 min. PPT on Core Issues in Financial Market Regulation & Analysis of Dodd-Frank Legislation

;   Krozner Corporate Governance CEE     (SWP - Agency Problems 9-09)
Grad Assignment:  Basics of Clearinghouses and Reasons for and Against Centralized Clearinghouse System  (See above + Wiki  and  SWP - Counterparty Risk 8-09   SWP - 5-09)                       


Related Links:   
Criminalizing Agency Costs   Homan Jenkins (WSJ articles); Overview of Issues in Corprate Governance (frb-ny 2002)
Squam Lake Working Group on Financial Regulation (Clearinghouses; Overall; ...)
 
(SWP 1-09)