ISSUES IN CAPITAL MARKET ECONOMICS
Outline & Readings
Federal Reserve Info:
Federal Reserve System Article Search Engine / FRB of New York / FRB of St. Louis / Index of SEC Rules /
Fama-French Forum/ John Cochrane CGSB Site/ Xavier Gabaix NYU Site/ Streetwise Professor/
Bloomberg Economagic Economic-Financial Data
Dr. Brian Goff
Office Hours for Spring 2013: TTh 9:30-11:30 (appointments & drop-ins welcome other times)
To acquaint students with several current issues on the border between macroeconomics and financial economics, financial market microstructure, and financial market regulation
Selected Readings On-Line
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
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.
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
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)
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)
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?
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)
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?
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)
Assignment for Next Week:
Week 3 (Feb 12) Beyond Random Walks, Predictability of Stock Prices
Reading Quiz: Cochrane on Efficient Markets Today Vox Barro on Disasters and Equity Premium
Week 4 (Feb 19) Topics on Stock Prices
Reading Quiz: Bubble, Bubble (frb-stl) Tulipmania (JSTOR link through WKU)
Assignment for Next Week: Interest Rate Data
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
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
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)
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
Week 7 (Mar 12) Spring Break
Week 8 (Mar 19) Exam 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.
1) Generate time series plot of the Debt/GDP ratios for the US, Japan, Spain, France, Germany, Greece (use variable #133 in Gretl file)
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)
1) Generate a time series plot of data103 (stock market capitalization to GDP) for US, UK, Iceland, and one country of your choosing
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.
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?
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
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:
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 08 + Hamilton (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
Related Links: WSJ Market Data Center; NYSE CME Grouputures 1987 Market Crash See Wiki for Stock, Bond, Futures
Week 16 Finals
Monthly Interest Rates
Ray Fair "Events that Shook the Market"
Standard deviation (biniomial applet); law of large numbers -- sequence applet; dice applet; coin 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; ...)?
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);
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?
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?
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
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 08 + Hamilton (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.com; Limits 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; ...)