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This article provides research and financial analysis in regards to bond immunization when short-term interest rates fluctuate at a more rapid pace compared to long-term interest rates. The purpose of this article is to decipher the equation for duration which will produce immunization for a stochastic process in which short-term rates vary in comparison to long-term rates. A process like this can be captured by an additive reciprocal term dependent shift. The formula for this algorithm is included.

This paper tests for the presence of depositor discipline by examining the effects of depository. institutions' risk on the pricing and growth of uninsured deposits. The study analyzes a large panel of thrifts that includes detailed information on each firm's deposit rate schedules, balance sheet composition, and financial condition. This information allows us to develop a time-consistent risk profile for thrifts. Our empirical, findings support the presence of market discipline. Riskier thrifts are found to pay higher interest rates and attract smaller amounts of uninsured deposits. We also find that qualitative results are similar for fully insured deposits, although statistical significance is substantially lower. [ABSTRACT FROM AUTHOR]

The article focuses on the validity of the mean-reverting processes of interest rates as discussed among countries representing the Organisation for Economic Co-operation and Development (OECD). The authors explain the roles that interest rate processes and econometric methodologies play in the fluctuation of interest rates. By examining the cross-country restrictions in association with interest rate processes from various OECD countries, the authors estimate the interest that can be accrued by innovations.

This article presents a challenge to the theory of optimal seigniorage, which predicts that governments use taxes and inflation to raise revenue when needed. It is based on the assumption that currency boards choose how much money to create, produce the money at zero cost, and transfer all the money to the fiscal branch, or the treasury. The authors show that each of these is flawed and that the theory does not always predict when the tax rate on money and output move synchronously. This only happens in certain circumstances.

This article presents comments by the author on the paper "The information Content of Discount Rate Announcements and Their Effect on Market Interest Rates," by Timothy Cook and Thomas Hahn that was published in the May 1988 issue of the periodical "Journal of Money, Credit, and Banking." Cook and Hahn argued that the Federal Reserve used discount rate change announcements to signal movements in the federal funds rate throughout the 1973-79 period. They contend that announced changes in the discount rate provided predictive information to market participants. Investors understood these signals and changed their behavior accordingly, which affected Treasury bill rates. However, scholars V. Vance Roley and Rick Troll, and Michael Smirlock and Jess Yawitz have argued that Federal Reserve's discount rate policy did not reveal any additional information and thus did not have an effect on market interest rates.

This article presents information on the quantity theory of money, which implies that a given change in the rate of growth of the quantity of money provokes an equal change in the rate of growth of income and inflation. The authors combine two existing forms of the theory to create a two-equation macroeconomic model that displays the action of money, prices and interest rates. Data from 1962-1988 is tested to determine if classical monetary forces can explain the behavior of inflation and interest rates.

The article first examines the operating behavior of the Federal Reserve between 1914 and 1917. It is explained that during this period, there were many institutional constraints that had to be relaxed for the Federal Reserve to operate effectively. The article offers some empirical evidence that the 1917 amendments affected the seasonal behavior of notes issues and interest rates. When the institutional behavior of the Federal Reserve is investigated it is revealed that the amendments made during the period were necessary for the successful financing of the First and subsequent Liberty bond campaigns.

The article focuses on the impact of the U.S. Federal Reserve's weekly announcements of changes in the money supply on interest rates. The theory of efficient markets implies that only the unanticipated change in the money supply should have an effect on interest rates. The coefficients on anticipated money supply changes are negative and the coefficients on unanticipated money supply changes are positive. The findings of large and significant price responses to anticipated money puzzle economists who believe strongly that asset markets react quickly to new information.

The article analyzes the consistency of data with nonlinear and linearized expectations model of the term structure with time-varying risk premia. Expectations models have been proposed to fit the real data and empirical results such as a simple linearized version of the expectations model at the cost of approximation errors. The author mentions relevant terms such as risk premium over time, stationarity of interest rates, normality and homoskedasticity of the disturbances, and stringent information-set restrictions. The presence of time-varying risk premia and of conditional heteroskedasticity in disturbances may be reasons for the rejection of the simplified model. This nonlinear model seems to be compatible with postwar U.S. data.

The article analyzes the effects of macroeconomic policy on the term structure of interest rates taking into account the related monetary policy, its term structure, and the growth rate of the economy. The effects of anticipated current monetary changes and their impacts on the anticipated components of the interest rates are tested. The comparison between the effects of temporary and permanent monetary expansions on the real and nominal interest rates is also discussed. The author tests the model and its relationship between short-term real and nominal interest rates.

The article examines the relation between the value of borrowing constraint to the sustainability of government deficits. The recent structure of fiscal policy in the U.S. does not appear to have been sustainable. The author details a test introduced to distinguish sustainable policies from unsustainable ones. The article allows for stochastic real interest rates that are both necessary and sufficient for sustainability. The article reveals the lack of sustainability of recent policy since the discounted value of the debt increased in each of the last three years of the sample.

The article examines money stock control procedures in a rational expectations environment, analyzing its various operating procedures and the interaction between these procedures and economic activity. It investigates the relative efficiency of controlling a monetary aggregate through the use of an interest rate instrument or through various reserve measures under both lagged and contemporaneous reserve requirements, with the finding that borrowed reserve targeting is not necessarily equivalent to an interest rate instrument. The article analyzes the effects of various monetary control procedures in a well-posed rational expectations macroeconomic model. The author draws conclusions concerning the demand for borrowed reserves, and the relation between the demand for money and interest rates.

This article presents information on the impact that interest rates have on the demand for currency. The authors support pervious research that argued that any increase in the interest rate that is expected to last for a significant period of time will impact investments and lower the demand for money. The author extend this research by empirically examining the impact that interest rates increases have on the demand for currency. They discuss some of the policy implications of their findings and suggest how the U.S. Federal Reserve can counteract the impact of a decreasing demand for money.

The article comments on the article "Federal Reserve Policy, Interest Rate Volatility and the U.S. Capital Raising Mechanism" by Benjamin Friedman, published in the November 1982 issue of the "Journal of Money, Credit, and Banking." The article discusses the commitment of the U.S. Board of Governors of the Federal Reserve System to monetary strategy and the purpose of the federal funds rate range. The author provides details on the directive given by the Federal Open Market Committee to the Federal Reserve.

The article provides information on a paper which discusses instrument choice for money stock control with contemporaneous and lagged reserve requirements. The authors suggest that the paper examined is the first to utilize a model which treats output and prices as endogenous and that incorporates rational expectations. The article discusses the importance of distinguishing between banking systems with contemporaneous reserve requirement (CRR) and lagged reserve requirements (LRR). The authors explain that this is important because monetary control is usually poorer with LRR than with CRR. Several equations are presented to help illustrate the study.

The article presents several lender supply and borrower demand conditions for a leverage structure of interest rates, focusing on characterizing the equilibrium of competitive markets. A model of the credit transaction between individuals embedded in a competitive credit market is presented. Conditions necessary for the optimal supply of leverage by price-taking lenders are considered. The author also discusses the restrictions on leverage structure of the risk premium and the contractual interest rate.

This article discusses the lead-lag relationship between various classes of interest rates. The author looks at the results of interest rate relationship analysis where the time series interval is daily rather than monthly. Distributed lag models must be used because Federal Reserve open market operations are primarily conducted in the short-term sector. The author assumes that the effects of open market operations would first be felt in the short-term sector, then gradually disseminate throughout financial markets. It is noted that Lag-zero correlation coefficients are high for the three-month bill rate and the rates on longer-term bills. These relationships remain statistically significant even though the relationships between bond rates and the three-month bill rate tend to decrease as the maturity difference increases.

The article examines the international capital movements of financial institutions. The objective is to show, through a focus on financial institutions, that capital does flow in and out of countries and that aggregate data can make it difficult to discern between the decisions involved in such transactions. Of particular interest here is the degree of demand for short-term claims from the U.S. and Great Britain's ability to supply and the liabilities of the U.S. to Britain. The article concludes that increases in the U.S. interest rate will lead to fewer claims but an increase in liabilities.

Starting with Ingersoll (1977b), the academic literature has repeatedly sought to explain why convertible bonds are called late. The findings here demonstrate there is no call delay to explain. This paper finds that most convertible bonds, given their call protection, are called as soon as possible. For those that are not, there are significant cash flow advantages to delaying. The median call delay for all convertible bonds is less than four months. If a safety premium is desired to assure the conversion value will exceed the call price at the end of call notice period, the median call period is less than a month. [ABSTRACT FROM AUTHOR]

We develop a two-factor general equilibrium model of the term structure. The factors are the short-term interest rate and the volatility of the short-term interest rate. We derive closed-form expressions for discount bonds and study the properties of the term structure implied by the model. The dependence of yields on volatility allows the model to capture many observed properties of the term structure. We also derive closed-form expressions for discount bond options. We use Hansen's generalized method of moments framework to test the cross-sectional restrictions imposed by the model. The tests support the two-factor model. [ABSTRACT FROM AUTHOR]

The outstanding face amount of plain vanilla interest rate swaps exceeds two trillion dollars. While pricing and hedging of such swaps appear to be quite simple, many existing theories are based on the incorrect characterization of a swap as a simple exchange of a fixed for a floating rate note. This characterization is not consistent with standardized swap contracts and the treatment of swaps in bankruptcy. This paper provides an alternative perspective on swaps. [ABSTRACT FROM AUTHOR]

The paper focuses on the valuation of caps, floors, and collars in a contingent claim framework under continuous time. These instruments are interpreted as options on traded zero coupon bonds. The bond prices themselves are used as the underlying stochastic variables. This has the advantage that we end up with closed form solutions which are easy to compute. Special attention is devoted to the choice of the stochastic process appropriate for the price dynamics of the underlying zero coupon bonds. [ABSTRACT FROM AUTHOR]

Customer relationships arise between banks and firms because, in the process of lending, a bank learns more than others about its own customers. This information asymmetry allows lenders to capture some of the rents generated by their older customers; competition thus drives banks to lend to new firms at interest rates which initially generate expected losses. As a result, the allocation of capital is shifted toward lower quality and inexperienced firms. This inefficiency is eliminated if complete contingent contracts are written or, when this is costly, if banks can make nonbinding commitments that, in equilibrium, are backed by reputation. [ABSTRACT FROM AUTHOR]

Unlike most interest rate claim models, the Ho-Lee model utilizes full information on the current term structure. Unfortunately, the model has a major deficiency in that negative interest rates can occur. This article modifies the model such that interest rates are well behaved. [ABSTRACT FROM AUTHOR]

This paper demonstrates that temporal risk aversion makes smoothing consumption over time less attractive, while the usual risk aversion makes it more attractive. As temporal risk aversion increases, the equilibrium interest rate decreases and the equity premium increases. This paper also shows a striking and novel result that an increase in time impatience can lead to either a decrease or an increase in the interest rate, depending on the nature of the nonseparability. [ABSTRACT FROM AUTHOR]

This paper investigates the risk structure of interest rates using pure discount bonds. The most striking feature of our estimates of default-risk premia is the resemblance of their time profile to the theoretical time profile obtained by Merton (1974). [ABSTRACT FROM AUTHOR]

This paper investigates the term structure of interest rates in a multiperiod production and exchange economy with incomplete information. Unable to observe their stochastic investment opportunities, investors engage in dynamic Bayesian inference. This results in the endogenous identification of a more complex production function which generates a richer term structure, resembling the one that actual market prices imply. In addition, this paper introduces a characteristic function of the term structure and demonstrates that, in contrast with a fully observable economy, the widely investigated expectations hypothesis holds true only if interest rates are nonstochastic. [ABSTRACT FROM AUTHOR]

The article presents a response to the article "Death and Taxes: The Market for Flower Bonds," by David Mayers and Clifford W. Smith. The author expresses his views on theoretical and empirical analysis of the demand for flower bonds and the incentives for holding them made by Mayers and Smith. As the authors of the original article suggest, when market interest rates exceed the coupon rate, a flower bond is equivalent to a straight bond plus a term life insurance policy. The author considers the effect of estate taxes among individuals with different levels of taxable wealth.

This note updates Mishkin's empirical work through 1984, confirming his original findings and demonstrating that using period-average interest rates does not produce Makin's result. I also show that lagged money surprises have a significant positive impact on rates, a possibility that Mishkin did not investigate. The next section briefly reviews the efficient markets methodology used in Mishkin, comparing it to the specification found in Makin. Then regressions updating Mishkin's results and incorporating Makin's dependent variable are presented. The paper concludes with an attempt to account for the difference in the two paper's results.
Mishkin's result of a significant positive correlation of unexpected money growth and interest rate surprises is found to still hold after adding the years 1977 through 1984 to the sample. The result "passes" several Chow tests, indicating a degree of temporal stability, and is shown not to depend on whether the interest rate is measured at the end of the quarter or as a period average as Makin claimed. I conjecture that Makin's result is due to an inappropriate restriction in his specification and offer some brief evidence suggesting that this is the case. [ABSTRACT FROM AUTHOR]

COX, INGERSOLL, AND ROSS [1] distinguished various forms of the expectations hypothesis of the term structure of interest rates. They proved that, with one exception, these are consistent with general equilibrium only in the trivial case in which interest rates are nonrandom. The exception is the Local Expectations Hypothesis. Because of this nonexistence result, those who regard the expectations hypothesis as a natural starting point in investigating the term structure of interest rates are motivated to understand under what restrictions the local expectations hypothesis is valid. In our experience, many readers of Cox, Ingersoll, and Ross's paper--particularly those not conversant with stochastic calculus--have difficulty following the discussion. Such readers may find it easier to work through an analysis of the local expectations hypothesis in a more familiar discrete-time framework. This paper provides such an exposition.
The first example above exhibits an exchange economy with a representative risk-averse agent who knows his or her next-period's endowment. Consumption is then locally certain, and the local expectations hypothesis holds. The second example exhibits a production economy. The representative agent knows the next-period rate of growth of wealth and his or her logarithmic preferences make consumption again locally certain; thus, the local expectations hypothesis holds also. In both cases, one-period rates of return on bonds of different maturities are random, so the validity of the local expectations hypothesis is not trivial. In a third example, a risk-neutral agent has zero consumption (a corner solution) until a final date. in this case, the local expectations hypothesis does not hold. We see that the local expectations hypothesis holds if the marginal utility of consumption is locally certain. For this condition to be satisfied, risk neutrality is neither necessary nor sufficient. [ABSTRACT FROM AUTHOR]

With the increasing use of adjustable-rate mortgages for asset/liability management, there exists the need to properly evaluate their price sensitivity to interest rate changes. This paper provides a foundation by deriving the duration of an adjustable-rate mortgage. The properties of this duration are unique and have some important differences from those of fixed-rate securities. One important characteristic of an adjustable-rate mortgage concerns the index used to adjust the mortgage rate. It was found that the index tended to be more important than the adjustment frequency in determining the duration of an adjustable-rate mortgage. [ABSTRACT FROM AUTHOR]

This paper analyzes the market for financial assets in a production and exchange economy with several realized outputs and a single unobservable source of nondiversifiable risk. The paper demonstrates that, for a large class of diffusion outputs and preferences, optimizing consumers first estimate the realizations of the unobservable factor and then use these estimates to determine portfolio and consumption rules. Moreover, the explicit consideration of this unobservable productivity factor affects equilibrium demands and prices. The equilibrium spot rate of interest emerges as the "best estimate" of the unobservable factor, and multiperiod default-free bonds arise as the optimal hedge for the unobservable changes of the stochastic investment opportunity set. [ABSTRACT FROM AUTHOR]

Applying stochastic dominance rules with borrowing and lending at the risk-free interest rate, we derive upper and lower values for an option price for all unconstrained utility functions and alternatively for concave utility functions. The derivation of these bounds is quite general and fits any kind of stock price distribution as long as it is characterized In a "nonnegative beta." Transaction costs and taxes can be easily incorporated in the model presented here since investors are not required to revise their portfolios continuously. The "price" that is paid for this generalization is that a range of values rather than a unique value is obtained. [ABSTRACT FROM AUTHOR]

Stochastic dominance rules (SD) have been extended to the case where investors are allowed to borrow and lend at the riskless interest rate. Stochastic dominance rules with a riskless asset (SDR) are much more effective than SD rules. However, it seems that this benefit is eliminated by an uncertain inflation, since riskless assets become risky once uncertain inflation is considered. We prove in this paper that SDR criteria are valid also in the face of uncertain (and independent) inflation. Moreover, while the mean-variance (MV) efficient set increases with uncertain inflation, the stochastic dominance efficient sets decrease. [ABSTRACT FROM AUTHOR]

The article discusses research relating to money market mutual funds (MMMF). The growth of MMMFs was accelerated by the piecemeal nature of the financial deregulation process. Analysts say the rapid growth and proliferation of the funds is a rational response by the consumer investor to the inability of regulated financial institutions to offer market interest rates on deposit accounts. They describe this as a "demonstration or consumer education effect." The consequences of the deregulation of the financial markets has led to a major distortion of credit flows.

This paper reports a new test of two competing theories of the relation between tax exempt and taxable interest rates. The Miller hypothesis predicts that the tax-exempt rate is 52 percent of the taxable rate, while the institutional demand hypothesis predicts a volatile relationship. The tests in this paper employ a random intercept model to control for the risk of average interest rates. The results favor the Miller hypothesis. Marginal tax rates are found to be close to Miller's predicted 48 percent. The relationship is not influenced by relative demand or supply and the marginal tax rate appears stable over time. [ABSTRACT FROM AUTHOR]

This paper demonstrates that the response of nominal interest rates to changes in inflationary expectations should lie between that predicted by the "Fisher" and "Darby" effects. The exact nature of the response will depend on the relative size of the income and capital gains tax rates, and the relative size of the derivatives of investment and savings to their respective after-tax real rates. The other major conclusion of this paper is that capital gains taxation offsets the negative effect on investment produced by treating depreciation on a historic rather than a replacement cost basis. [ABSTRACT FROM AUTHOR]

This paper provides further evidence on the distributional impact of interest rate ceilings on the small saver. Cross-section data from the 1977 Consumer Credit Survey was used to estimate the implicit losses imposed on different income classes by government regulations. Our findings generally support earlier studies which found the implicit burden to be regressive among income classes. However, the degree of regressivity showed a marked decrease since 1970. These results may be explained by portfolio adjustments of households and financial innovations in response to deposit rate ceilings and accelerating inflation during the 1970s. [ABSTRACT FROM AUTHOR]

A mean-variance risk-return tradeoff relationship is derived for the diffusion process limiting case of a state-preference model, with aggregate consumption serving as a pivotal variable. The model is compared to other recent models along the dimensions of generality and tractable implementation. The incorporation of stochastic interest rates in general equilibrium and arbitrage-based valuation models is examined, and an extension to earlier methods is discussed, in connection with the implementation of "robust" general valuation procedures. [ABSTRACT FROM AUTHOR]

Interest in the behavior of the demand for money by firms has been stimulated in recent years, partly because of unsatisfactory empirical results obtained for firms or the business sector (see, e.g., Goldfeld, Laumas, and Wilbratte). The purpose of this study is to investigate empirically several issues concerning the demand for money by firms in an inflationary environment. [ABSTRACT FROM AUTHOR]

In a recent article published in this Journal Burton Zwick [6] investigates the implications of the interest-induced wealth effect for the response of interest rates to monetary change and to changes in the expected inflation rate. He argues that the introduction of the interest-induced wealth effect into an otherwise conventional macroeconomic model can explain the complete snap-back of interest rates to their original level after a monetary change but prior to a complete adjustment of the price level and the delay in the response of nominal interest rates to a change in the expected inflation rate. He also explores the implications of the interest-induced wealth effect for the existence of neutrality and the dynamic adjustment of interest rates to monetary change at full employment. Zwick's analysis of the interest induced wealth effect is flawed in three ways: (1) He incorrectly integrates the interest-induced wealth effect into his IS-LM framework. (2) Although Zwick's model with wealth effects includes both price and interest-induced wealth effects, Zwick ignores the implications of the price-induced wealth effect. Therefore, his comparative static results for increases in the money supply and the expected inflation rate are inconsistent with the model he presents; and (3) Zwick misspecifies his wealth variable. He assumes that the nominal value of real assets is unaffected by changes in the price level and that the valuation of real assets is affected by nominal rather than real interest rates. [ABSTRACT FROM AUTHOR]

The behavior of commodity markets has been a subject of extended controversy among economists. Much of this controversy revolves around the underlying behavior of futures prices over time. A number of researchers have concluded that there are no systematic patterns to futures price behavior while others maintain that while there may be a priori reasons justifying random behavior, the application of certain mechanical filter rules often leads to substantial profits which is indicative of nonrandom behavior. There are two objectives of this paper. First, the use of statistical tests to determine the presence of systematic behavior and the use of mechanical filters to determine whether profits can be generated will be compared and contrasted. These two approaches appear to lead to different conclusions, so it is of some importance to understand their respective limitations. Second, to provide empirical evidence on the random walk variant of the efficient market model for a very large sample of commodity contracts. It appears necessary to extend the sample in order to reach reliable conclusions. [ABSTRACT FROM AUTHOR]

The article focuses on the impact of spot rates, forward rates, and interest-rate differentials on international finance. The article develops a theory of interest-rate arbitrage within a simple Fisherian framework. The article also investigates some of the implications of Fisherian approach to international finance. A theory of interest-rate arbitrage is also developed under the assumption of perfect capital markets, and introduces the transaction costs into the analysis by recognizing the spread between buying and selling rates for foreign exchange. In the article's final section the implications of the analysis are presented.

The article outlines a framework within which the impact of interest rates on prices may be analyzed by using both Keynesian and the general theory which takes into account capital. The author considers cases in which monetary restriction does not include an increase in the interest rate such as when there is a movement of cash into goods, or there's a money creation through fiscal deficit which doesn't raise bank reserves. The article discusses cases of tight money in which the market rate of interest is raised.

The article discusses the financing of mortgages in California in 1967 using information gathered from the period of 1950 to 1965. California's growth during the period has been funded largely by investments made from "foreign funds" originating outside the state, since the state has grown faster than internal savings can fund. The use of funds from outside the state means that California has had to pay higher mortgage interest than the national average. The author predicts the mortgage and housing markets in California for 1970.