Last update: August 29 2010
Official Booth School page
Teaching materials and class webpags
Vita A chronological listing of all papers, with links and citation information.
Short bio.
Data and Programs for many papers
Soaring (gliders) section
Family web page (Warning: laughing too hard at the Hippo page may cause health problems. The (August 2008) Miley Cyrus spoof featuring Eric and Gene in drag is a masterpiece.)
News, opinion, etc.
Current working papers
Talks
Writing tips and paper topics for PhD students
Books
Published papers, by topic:
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All work is copyright © John H. Cochrane. Copyrights of some published papers are held by the publishers. Please do not keep copies of these files on any other computer system. You are welcome to post links.
Still life with economic allegory, by Sally Fama Cochrane. Larger size. See how good you are at finding symbolism in representational art. Hint: The book is The Wealth of Nations
(Also see the Talks section below)
Greek Myths. May 18 2010 Wall Street Journal Local pdf file Let Greece default to save the Euro. A good currency is a monetary union without fiscal union.
Save the Euro, let Greece go. A video from the IGM Myron Scholes forum on "The Euro In Crisis." March 19 2010 More video from the April 28 Management Conference
The Globe and Mail interview Jan 2010, Article by Dan Richards, and the Full interview, on economics, policy and markets.
New Yorker interview Jan 2010 John Cassidy’s piece in the New Yorker isn’t very flattering about Chicago to say the least. He was decent enough to post the full interviews, which sound a lot more sensible, at least to me. His interview with Gene Fama is here .
Lessons from the financial crisis Jan 2010 (was “Financial crisis and policy”) Regulation 32(4), 34-37. The financial crisis is mainly about too big to fail expectations. The only way out is to limit the government’s authority to bail out.
Inflation or deflation? I’m giving several talks with this title, based on more serious analysis in Understanding fiscal and monetary policy in the great recession (also listed separately under Current working papers) . Here are slides for my talk at the Myron Scholes IGM talk October 28 in Chicago, and the talk I gave at the NBER EFG Oct 23.
Resolution authority Update, October 22 2009 This is a very short article on the “systemic resolution authority.” It’s based on testimony I gave to the House Financial Services committee. No surprise, I’m not a big fan of unlimited power and budgets and no rules.
Lehman and the Financial Crisis September 15 2009 Wall Street Journal oped with Luigi Zingales. Letting Lehman fail was not the central cause of the financial crisis.
Why did Paul Krugman get it so wrong? (ms-word version), September 10 2009. A response to Paul’s New York Times Magazine article. Spare me the hate email, I’ll just flush it. Bloomberg TV Video interview on the post. David Levine wrote a good open letter in a similar spirit. Note: This is just a response to Krugman’s article. A number of people have criticized me for not explaining the alternative, i.e. just what does modern macro and finance have to say about the crisis, exactly what do good models of fiscal stimulus predict, and so forth. Sorry, there’s plenty to say, but that’s a much bigger essay that will have to wait for another day.
What to do about Preexisting Conditions oped for the Wall Street Journal August 17 2009. Health Status insurance op-ed for Investors Business Daily (local link ). April 2 2009 These pieces describe my ideas on how free market health insurance can solve the portability problem and thus let us have a competitive system: People who lose their jobs lose health insurance, often with catastrophic results. Two ways to put the basic idea: 1. You can buy “premium increase insurance” so that if you get sick you can afford higher premiums. 2. You can buy the right to buy health insurance in the future, even if you get sick in the meantime. These opeds summarize “Health-Status Insurance ” written for Cato and “Time consistent health insurance” in the JPE, both here . Articles by Barrons and American Spectator explain the ideas perhaps better than I do.
CSPAN video of the latest University of Chicago Panel on the Financial Crisis. (April 20 2009)
Financial lessons of the great depression . March 30 2009 A panel discussion at the Council on Foreign Relations.
Asset pricing after the crash March 20 2009 This is a piece based on a panel discussion titled “Rethinking asset pricing” at the Spring 2009 NBER Asset Pricing meeting. It includes skeptical views on just how important credit constraints and liquidity really are. Liquidity is the frosting on the cake of finance. There is a lot of frosting these days, but still some cake.
Are we all Keynesians Now? Link to Economist March 15 2009. The Economist had an online debate on this proposition, headlined by Luigi Zingales and Brad Delong. This was my two cents on the issue. Of course not, right? Some good Keynes quotes and a defense that economics has in fact advanced a bit in 70 years.
Fiscal Stimulus, Fiscal Inflation or Fiscal Fallacies? Jan 27 2009. An analysis of fiscal stimulus. Dropping money from helicopters is “fiscal stimulus,” and that will surely goose demand before it quickly leads to inflation. Usually though, “stimulus” means by debt that the government plans to pay back, and is supposed to work without inflation. Does it? Many arguments reflect classic fallacies. Most of all, the usual arguments imply that our current troubles come from inadequate borrowing and spending! No, our current troubles come instead from a credit crunch, and a “flight to quality” and “precautionary demand” for government debt. Fiscal stimulus could in principle help to quench that demand, but that problem can be more easily and reversibly solved by expanding the Fed and Treasury’s asset purchases. There is a bit of “fiscal theory ” in this analysis, and the current macro situation seems to make a strong case for that framework. Understanding fiscal and monetary policy... (full description under “current working papers” below) extends the analysis quite a bit, especially the “fiscal theory” part.
Update: Paul Krugman and Brad Delong wrote very critical blog posts. However, neither seems to have read past the first few paragraphs. Brad says I think the velocity of money is constant. Keep reading, Brad, down to “A monetary argument for fiscal stimulus..” where it says “if money demand increases dramatically…”. Paul says I treat S=I as an identity, not an equilibrium condition. Keep reading, Paul, down to “aggregate demand has fallen.. deflationary pressure…” where nominal GDP is adjusting to equilibrate S and I. OK, I can’t condense all of macro down to 300 word blog posts, but if you can’t read more than that, don’t write nasty comments. Greg Mankiw and Dani Rodrik had nicer things to say. Greg’s blog is the place to go for intelligent stimulus skepticism. Declan McCullagh of CBS news wrote a nice article collecting many academic stimulus skeptics.
Is now the time to buy stocks? WSJ op-ed . Nov 12 2008. The average investor must hold the market portfolio of stocks and bonds. How can that possibly make sense in the current environment, especially with volatility at 50% per year? I show you how. Who should be buying more, and who should be selling more? Here is the slightly longer and more detailed manuscript , along with a short summary of research -- yes, this really is the summary of 30 years of finance research, not something I made up as I wrote it -- and answers to some common questions. Here I am on CNBC explaining it all in 20 seconds or less. .
The Monster Returns Oct 2 2008 My view of the credit crunch and why the Treasury asset-purchase plan won't work. I think the focus on troubled banks misses the strength of the banking system, and the catastrophic problems in credit markets. It also appeared on the Freakonomics blog
Mortage Bailout Sept 28 2008 A letter to Congress against the TARP plan to buy sick mortgages. Luigi Zingales and Paloa Sapienza get credit for organizing this, with help from Anil Kashyap and Rob Shimer. Disclaimer: This letter was sent to Congress on Wed Sept 24 2008 regarding the Treasury plan as outlined on that date. It does not reflect all signatories' views on subesquent plans or modifications of the bill. A nice map showing where signatories come from courtesy of Mark Stouffer. Before anyone gets as swell head, it's worth reading the petition against Smoot-Hawley signed by 1028 economists.
Earlier Comments on the credit situation Sept 25 2007 given at the GSB Global Financial Markets Forum. Some good aspects of the current situation, some unheralded aspects of the Fed’s policy, some things that went wrong, and the downside of some quick fixes
Visit the IGM webpage for links to lots of alternatives proposed by GSB faculty and related thoughts on how to get out of this mess. The 12 days of bailout video
Milton Friedman Institute
October 26 2008 Gary Becker wrote an insightful v blog post "Observations on the Milton Friedman Institute at the University of Chicago "
October 16 2008 Lars Hansen's Presentation to the faculty meeting.
October 11 2008 A response to the new petition against MFI. Please tell us what concrete proposals you have in mind, if you want to have any sort of productive debate.
Summer 2008 The proposed Milton Friedman institute is in the news, thanks to a faculty protest letter. I was quoted in the New York Times as saying the petition is “drivel.” I believe in documenting what I say, so here are my comments and the full text of the letter so you can judge for yourself. Once you read the letter, with its “neoliberal global order,” “service of globalized capital,” “substitution of monetization for democratization,” you may conclude my quote was a compliment. Certainly, it was not superficial nor lightly considered.
The Milton Friedman Institute has a website and here is the faculty proposal describing how the institute will operate. The protesters have a website , and there is now a new website FriedmanFacts.com trying to counter some of the charges directed at Friedman and the institute. The institute is actively looking for donors. Hurry, it’s not too late to be a “Founder.”
Determinacy and Identification with Taylor Rules August 29 2010. Appendix That big revision you've all been waiting for! This supersedes the two papers titled "Inflation Determnation with Taylor Rules: A Critical Review"and "Identification with Taylor Rules: A Critical Review" (September 2007).
Here's the basic point: The first question in macroeconomics is, what determines the price level? The Taylor rule is the current “standard answer:” Most people think Taylor rules stabilizes inflation: Inflation rises, the Fed raises interest rates; this lowers “demand’’ and lowers future inflation. New-Keynesian models don’t work this way. In the models, the Fed reacts to inflation by increasing future inflation. Inflation is “determined” as the unique initial value for which this threatened explosion doesn’t set off hyperinflation. Alas, there is nothing in economics to rule out hyperinflations or more generally non-locally-bounded equilibria. I conclude that new-Keynesian models with Taylor rules don’t determine the price level any better than classic fixed interest rate targets. Price level determinacy requires ingredients beyond the Taylor principle, such as a non-Ricaridan fiscal regime. I survey the new-Keynesian literature to verify that no simple answer to this problem exists. All of the fixes slip in a commitment by the government to blow up the world at some point.
Even if the new-Keynesian model did work, The parameters of the Taylor rule relating interest rates to inflation and other variables are not identified. Thus, Taylor rule regressions cannot be used to argue that the Fed conquered inflation by moving from a "passive" to an "active" policy in the early 1980s.
Understanding fiscal and monetary policy in the great recession: some unpleasant fiscal arithmetic. June 2010 (Big update from 2009 drafts). An “unpleasant monetarist arithmetic” for the great recession. Many facets of the current situation and policy make sense if you ask about joint fiscal and monetary policy. A fiscal inflation will look much different than most people think. A short simple version, my presentation at the Fall NBER EFG conference. Slides for my talk at the Myron Scholes IGM talk October 28 with lots of pictures. Appendix with the algebra for governmet debt valuation equations
State-Space vs. VAR models for Stock Returns Draft, July 24 2008. In a “state-space” model, you write a process for expected returns and another one for expected dividend growth, and then you find prices (dividend yields) and returns by present value relations. I connect state-space models with VAR models for expected returns. What are the VAR or return-forecast-regression implications of a state-space model? What state-space model does a VAR imply? I start optimistic. An AR(1) state-space model gives a nice return-forecasting formula, in which you use both the dividend yield and a moving average of past returns to forecast future returns. The general formulas leave me pessimistic however. One can write any VAR in state-space form, and we don’t really have solid economic reasons to restrict either VAR or state-space representations. Still, the connections between the two representations are worth exploring, and if you’re doing that this paper might save you weeks of algebra. First draft, so beware the typos.
Decomposing the Yield Curve First big revision, March 14 2008. With Monika Piazzesi; early draft presented at the September 2006 Brookings Papers on Economic Activity conference. We work out an affine term structure model that incorporates our bond risk premia from “Bond Risk Premia” in the AER. There are lots of interesting dynamics – level, slope and curvature forecast future bond risk premia, and we discover that market prices of risk are really simple. We use the model to decompose the yield curve – given a yield (forward) curve today, how much is expected future interest rates, and how much is risk premium? How does the yield or forward rate premium correspond to the term structure of expected return premia? Was the “conundrum” a conundrum? The big revision gets rid of much of the chat and focuses on one, successful affine model. Slides from 2010 AFA meetings
A Mean-Variance Benchmark for Intertemporal Portfolio Theory Big revision Feb 21 2008 (was December 5 2005). Applies good old fashioned mean-variance portfolio analysis to the entire stream of dividends rather than to one-period returns. Appendix
Portfolio theory Feb 20 2007 This is a draft of a portfolio theory chapter for the next revision of Asset Pricing. I (of course) take a p = E(mx) approach to portfolio theory before covering the classic Merton-style direct approach. I emphasize the importance of outside income.
Writing tips and paper topics for PhD students
Writing tips for PhD students. May 2005 Avoid all those big red marks. Use this as a checklist before you ask me to read your paper!
Paper topic suggestions for PhD students. (2003 so a bit out of date) A list of doable topic ideas for class papers and second year papers. Some are potential thesis topics.
Asset pricing Revised Edition. This link gives you a sample chapter. Click here to go to the Princeton Unversity press website where you can order the book. (It is sometimes cheaper at Amazon.com or Barnes and Noble.com. In Chicago, it’s available at the seminary COOP bookstore.) If you are teaching a class that uses the textbook, you can get solutions to the problems by emailing me. Tell me who you are, and what class you're teaching. Here's the current Typo list for the first edition (and a few think-os too, I have to admit). These typos are all removed in the revised edition. The Texts and Review Papers have a number of good (well, I think so) articles that you may find useful in classes and go beyond the material in the book. Portfolio theory is a draft of a Chapter on portfolio theory for the next edition.
Financial Markets and the Real EconomyVolume 18 of the International Library of Critical Writings in Financial Economics, John H. Cochrane Ed., London: Edward Elgar. March 2006. Edited volume of collected articles
The Dog that Did Not Bark: A Defense of Return Predictability Review of Financial Studies 21(4) 2008 1533-1575Taken alone, returns may not look that predictable. However, price-dividend ratios vary, so either returns or dividend growth must be forecastable (or both). Implications for dividends, and long-run forecasts give strong statistical evidence against the null that returns are not forecatsable. I address the Goyal-Welch finding that forecasts do badly out of sample, and the long literature criticizing long-run forecasts. The most important practical takeaway: even if you assume that all variation in market p/d ratios comes from time-varying expected returns, and none corresponds to dividend growth forecasts, you will typically find that market-timing strategies based on fitting the regression don’t work. Corrected Table 6. Three numbers were wrong in the published version. Thanks to Camilla Pederson for catching it.
Two Trees (with Francis Longstaff and Pedro Santa-Clara), Review of Financial Studies 21 (1) 2008 347-385. We solve the model with two Lucas trees, iid dividends and log utility. Surprise: it has interesting dynamics. If one stock goes up it is a larger share of the market. Its expected return must rise so that people are willing to hold it despite its now larger share.
Bond Risk Premia with Monika Piazzesi. Published in American Economic Review 95:1, 138-160. We forecast one year bond excess returns with a 44% R2! More importantly, a single factor, a single linear combination of yields or forward rates, forecasts one-year returns of all maturity bonds. Read here the Appendix with lots of extra analysis. (Updated Sept 2006 to fix typos in forward rate formulas.) The NBER working paper has lots of cool stuff, including links to macro and the covariance with level result, that got trimmed from the published paper. Data and programs. Look at the pretty plot of how our forecasts work out of sample since we wrote the paper (Until the 2008 financial crisis, in which the Fama-Bliss procedure breaks down.) Read the Response to Ken Singleton regarding his criticism of our results in a paper with Dai and Yang, and then published in his book Empirical Dynamic Asset Pricing (Princeton, 2006). Overheads, useful if you want to teach the paper
International Risk Sharing is Better Than You Think, Or Exchange Rates are Too Smooth with Michael Brandt and Pedro Santa Clara. Published Journal of Monetary Economics 53 (4) May 2006 671-698. Original July 2001 (NBER WP 8404) The equity premium means that marginal rates of substitution are very volatile, with more than 50% standard deviation. Exchange rates are the ratio of marginal rates of substitution, and they only vary by about 12%. Therefore, marginal rates of substitution must be highly correlated across countries. Risk sharing is better than you think.
Stocks as Money: Convenience Yield and the Tech-Stock Bubble. May 2002. The “arbitrage opportunity” in Palm vs. 3Com stock might be like the arbitrage opportunity between money and treasury bills. I document many similar features, including high turnover in the “overpriced” security. Presented at the Chicago Fed Conference on asset price bubbles, April 2002.
The Risk and Return of Venture Capital (published version) Journal of Financial Economics, Volume 75, Issue 1, January 2005, 3-52. Last Manuscript Estimates the mean return, standard deviation, alpha and beta of venture capital investments, correcting for selection bias that we only see returns for successful projects. Even if you don’t like venture capital, the selection bias correction is interesting. Original December 2000. Appendix containing data and program descriptions plus extra algebra. See above data and programs link for data and programs.
“By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior” Journal of Political Economy, 107, 205-251 (April 1999) (With John Y. Campbell) JSTOR Manuscript with extra appendices A utility function with a slow-moving habit generates slow-moving countercyclical risk aversion. In turn this generates time-varying price/dividend ratio that forecasts stock returns, does not forecast dividends, and so forth. Balancing intertemporal substitution with precautionary savings gives a constant interest rate, the usual problem with habit models. The NBER working paper version includes a time-varying interest rate, which also generates yield spreads that forecast bond returns.
Explaining the Poor Performance of Consumption-Based Asset Pricing Models (With John Y. Campbell). Journal of Finance 55(6) (December 2000) 2863-2878. The CAPM outperforms the consumption-based model in artificial data from the habit persistence model used in "By force of Habit.."
Beyond Arbitrage: Good-Deal Asset Price Bounds in Incomplete Markets (With Jesus Saa-Requejo.) Journal of Political Economy 108, 79-119, 2000 We add a Sharpe ratio or discount factor volatility constraint to the standard no-arbitrage restriction and obtain useful bounds on option prices in environments that don't allow perfect replication. Most importantly we show how to do this in multiperiod and continuous-time, continuous-trading environments, and there are lots of applications and pretty pictures. Final manuscript with algebra appendix
“A Cross-Sectional Test of an Investment-Based Asset Pricing Model” Journal of Political Economy, 104 (June 1996) A factor model with two investment returns (roughly, investment growth) to explain the cross section of stock returns. It is also where I first thought about conditional vs. unconditional models, scaling factors in GMM, and (somewhat dangerous) plots of average returns vs. predicted.
“Asset Pricing Explorations for Macroeconomics”,1992 NBER Macroeconomics Annual 115-165. (With Lars Peter Hansen) Many variations on Hansen-Jagannathan bounds, including bounds that reflect the low correlation of consumption growth with asset returns, and bounds that reveal interest rate variation by variation in the conditional mean discount factor. A plea to take macro-finance seriously, aimed both at macro and finance audiences. It’s the only way to tell or even define if prices are “rational”, and what else sets marginal rates of transformation to marginal rates of substitution?
“Explaining the Variance of Price-Dividend Ratios” Review of Financial Studies (1992) 5:2, 243-280 Variance of p/d = its ability to forecast returns + its ability to forecast dividend growth. It’s all the former, none the latter. The paper includes an alternative to Campbell-Shiller decomposition, and discount factor bounds coming from price-dividend moments.
“Volatility Tests and Efficient Markets: A Review Essay” Journal of Monetary Economics 27 (May 1991) 463-485. A review essay supposedly about Shiller’s book. It got me to think hard about volatility tests, and prove that they are exactly equivalent to regressions that forecast returns from price-dividend ratios.
Production-Based Asset Pricing and the Link Between Stock Returns and Economic Fluctuations. Journal of Finance 46 (1) (March 1991) 209-237. The q theory works pretty well if you difference it – investment growth is nicely correlated with stock returns, and the I/K ratio forecasts future stock returns. JSTOR
"Good-deal option price bounds with stochastic volatility and stochastic interest rate." (With Jesus Saa-Requejo) Jan 1999 A real continuous-time, two-state variable application of the good deal technology.
A rehabilitation of stochastic discount factor methodology July 2000 A short note showing how Kan and Zhou (1999) went wrong. Adapted from comments on Jagannathan and Wang given at the spring 2000 NBER asset pricing meeting. This version contains an algebraic appendix to derive the last equation in the paper.
Rethinking Production Under Uncertainty 1993. Standard production technologies y(t) = shock(t) f(k) allow transformation across time but not across states of nature. Hence, the marginal rates of transformation needed to construct a true “production based asset pricing model” are undefined. This paper starts to think about how one might sensibly construct a technology that allows producers to transform goods across states of nature, and hence to construct a real “production-based” model, independent of preferences. Also did not result in a published paper, as I got stuck on an identification problem.
Production Based Asset Pricing 1988. NBER working paper 2776. This one uses two technologies and two states to infer contingent claims prices from production decisions, and matches the equity premium and term premium. It has nothing to do with the “Production-based” papers that came later in the Journal of Finance and JPE. I abandoned the project because it’s too easy – there are no probabilities in firm decisions with this standard technology, so it’s very easy to get contingent claims prices that differ from probabilities.
Recent work by Frederico Belo and Urbann Jermann may finally break through the identification problems and make the approaches of these last two papers work.
Can Learnability Save New-Keynesian Models? JME link . Journal of Monetary Economics 56 (2009) 1109–1113. This is a response to Bennett McCallum’s “is the New-Keynesian Analysis Critically Flawed” which says yes. I think McCallum got it backwards -- the bounded equilibrium is not learnable, the explosive ones are learnable. Furthermore, I’m not convinced that a hypothetical threat by the Fed to take us to an “unlearnable” equilibrium is a satisfactory foundation for price level determination.
"A prince, who should enact that a certain proportion of his taxes be paid in a paper money of a certain kind, might thereby give a certain value to this paper money." That's it, really. (Adam Smith, Wealth of Nations, Vol. I, Book II, Chapter II. Thanks to Ross Starr for the quote).
Money as Stock 2004. (Original August 1999). Journal of Monetary Economics The fiscal theory of the price level made simple. The `government budget constraint' is not a constraint. I reopen the security market at the end of the day in a cash in advance model, and show that the price level is still determinate. I also resolve the criticism that the fiscal theory mistreats the "government budget constraint." Another big revision. Much shorter and better written.
"Long term debt and optimal policy in the fiscal theory of the price level" Econometrica 69, 69-116 (2001). The fiscal theory with long term debt, and how to match the fiscal theory with business-cycle variation in debt and inflation. We typically write fiscal theory models with one-period debt, but the maturity structure turns out to matter a lot. For example, if the government pays off a perpetuity, then the price level is determined by the coupon coming due each year and that year’s taxes, with no present value of future taxes. I also resolve the empirical puzzle that inflation and deficits seem not to commove. That’s exactly what we expect of a government that’s trying to smooth inflation in the face of fiscal shocks.
"A Frictionless model of U.S. Inflation" NBER Macroeconomics Annual, April 1998.
The fiscal foundations of monetary regimes (paper, and powerpoint presentation) January 2003. The choice of monetary regime – interest rate rule, exchange rate peg, currency board, dollarization, etc. depends on fiscal constraints, especially for developing countries. Talk given at the 2003 NBER/NCAER Neemrana conference, India.
The Fed and Interest Rates -- A High Frequency Identification Jan 2002 with Monika Piazzesi. We measure monetary policy shocks by how they surprise daily bond markets. There's a beautiful Taylor rule in interest rate forecasts.
What do the VARs Mean? Measuring the Output Effects of Monetary Policy Journal of Monetary Economics 41:2 April 1998 277-300 (Revision of NBER WP 5154 June 1995; (Manuscript with a bit clearer pdf). Responses to monetary policy shocks seem long and drawn out. Do we need models with extensive frictions? No, because the response of policy to polich shocks is also drawn out. If you allow expected policy to affect output and inflation, you can make sense of drawn out impulse-response functions with a very short structural response, but a long-lasting impulse.
“Shocks” Carnegie-Rochester Conference Series on Public Policy 41, (December 1994) 295-364. A comprehensive look at which shocks matter and which don’t, including technology, money, oil and credit. None of the above accounts for much of economic fluctuations or inflation. Monetary policy shocks in particular account for very little output fluctuation and zero inflation variation. “Consumption” shocks, reflecting information agents see but we do not see do a pretty good job, but are harder to integrate into economic theory.
The Return of the Liquidity Effect: A Study of the Short Run Relation Between Money Growth and Interest Rates” Journal of Business and Economic Statistics 7 (January 1989) 75-83. In the short run, we expect money growth and interest rates to be negatively correlated – the “liquidity effect.” In the long run, they should be positively correlated – the “inflation effect.” I used bandpass filters to isolate the “runs” and confirmed this prediction. This paper was part of my PhD thesis, and inspired by reading a misleading graph in a Wall Street Journal Op Ed that claimed we were in a new “super-neutrality” regime in which the correlation was always positive.
Health-Status Insurance. Final version Feb 18 2009. In Cato's Policy Analysis No 633. If you get sick and lose health insurance you are stuck -- your premiums skyrocket or you may not be able to get insurance at all. The article shows how private markets can solve this problem. If you get sick, your health premiums go up but a separate "premium increase insurance contract" pays a lump sum so that you can afford the higher health premiums. The big advantage is freedom and competition: now health insurance can freely compete for all customers all the time. This piece is written for a nontechnical popular audience, with a lot of policy discussion. The idea comes from a 1998 JPE paper which explains the idea with lots of equations but also much more detail and answers to "what ifs."
“Time-Consistent Health Insurance” Journal of Political Economy, 103 (June 1995) 445-473. None of us has health insurance, really. You get sick, you lose your job or get divorced, and now you have a preexisting condition. This paper shows how to implement “premium increase insurance” that gets around the problem. If you get sick, you get a lump sum that allows you to pay higher insurance premiums. It allows a private-market solution to the main problem of health insurance attracting regulation.
A Simple Test of Consumption Insurance” Journal of Political Economy 99:5 (October 1991) 957-976. Are consumers effectively insured against idiosyncratic shocks, either by formal institutions such as charities, private insurance, government programs, or by informal mechanisms such as gifts and “loans” from relatives, friends and neighbors? I test for insurance using regressions of consumption growth on exogenous variables. Thinking through the specification of the regressions is not easy. I reject full insurance for long illness and involuntary job loss, but not for spells of unemployment, loss of work due to a strike and an involuntary move.
Permanent and Transitory Components of GNP and Stock Prices” Quarterly Journal of Economics CIX (February 1994) 241-266. This is my favorite solution to the permanent/transitory decomposition issue for GNP and stock prices. I use bivariate autoregressions of consumption and GNP, and of dividends and stock prices. Consumption and dividend growth are unpredictable, so act as stochastic trends for GNP and stock prices. A movement in stock prices with no current change in dividends is completely transitory, so can be labeled an “expected return” shock. A movement in stock prices with a change in dividends is permanent and so is a “permanent earnings” shock. Note the QJE switched Figure II and III.
A Critique of The Application of Unit Root Tests Journal of Economic Dynamics and Control 15 (April 1991) 275-284. Running a battery of unit root/cointegration tests and then imposing the answers on subsequent analysis is a bad idea. Alas, there is no substitute for plotting the data and thinking about what makes sense.
Multivariate Estimates of the Permanent Components in GNP and Stock Prices Journal of Economic Dynamics and Control, 12 (June/July 1988) 255-296. (With Argia M. Sbordone). This paper sits halfway between the “random walk in GNP” JPE and “permanent and transitory components” QJE. The “random walk” is univariate. Here, we realized that consumption could tell you a lot about the permanent component of GNP. Here, we use that insight in spectral and variance-ratio calculations. The answers are the same as in “permanent and transitory components”, but I now prefer the simpler VAR treatment in that paper. When GNP or stock prices are cointegrated with a random walk the subtle long-horizon and “nonparametric” techniques needed in the “random walk in GNP” really are no longer needed; short order models to produce good long-term forecasts.
How Big is the Random Walk in GNP? Journal of Political Economy 96 (October 1988) 893-920. Short-order ARMA models suggest that GNP looks a lot like a random walk. But short-order ARMA models are fit to match one-step ahead forecasts, and can do a poor job of capturing long-term forecastability. I used a variance-ratio statistic (variance of long-term differences / variance of one-year differences) to show that there is a lot of mean-reversion in GNP that short-order ARMA models miss. I think the subsequent “permanent and transitory components” answers the substantive question better, but the warning about using long-term implications of short-term models remains worthwhile today.
“The Sensitivity of Tests of the Intertemporal Allocation of Consumption to Near-Rational Alternatives” American Economic Review 79 (June 1989) 319-337. Many tests of the permanent income model or consumption based asset pricing models exploit predictions that imply trivial utility costs. For example, adjusting consumption when you get the check rather than when you get the news can have utility costs of a few cents. Since our models abstract from small real-world costs and frictions, I proposed the idea of using the region of trivial utility costs as a measure of “economic standard errors” for model predictions.
Macroeconomics in Russia” in Economic Transition in Eastern Europe and Russia: Realities of Reform, Edward Lazear Ed., Hoover Institution Press, 1995. Imagine for a moment that the Federal Reserve imposed the following policies in the United States: Every company must pay for all its inputs before they are shipped, and taxes must also be prepaid. But there is no trade credit, and banks do not make working capital loans to purchase inputs. Checks take 90 days to clear… Chaos would result… This is roughly what happened in Russia during the summer of 1992. The story… points to the importance of macroeconomic policies, and the unintended macroeconomic effects of policy, in understanding developments in Russia and the Former Soviet Union. It also suggests that many macroeconomic problems are not inevitable consequences of the transition to a market economy, but rather that they are avoidable unintended effects of partial liberalizations.
Inflation Stabilization in the Reforming Socialist Economies: The Myth of the Monetary Overhang” Comparative Economic Studies 33:2 (1991) 97-122. (With Barry W. Ickes.)
Financial markets and the Real Economy (latest proofs, August 2007) Everything you wanted to know, but didn’t have time to read, about equity premium, consumption-based models, investment-based models, general equilibrium in asset pricing, labor income and idiosyncratic risk.
Famous First Bubbles: The Fundamentals of Early Manias Journal of Political Economy 109, (October 2001),1150-1154. Review of the very nice book by Peter Garber, looking at the facts behind the tulip “bubble” and related myths. It turns out they are mythical. I had a lot of fun with this one.
Liquidity, Trading and Asset Prices. Jan 2005. A review of these issues in the NBER asset pricing group, published in the winter 2005 NBER reporter.
New Facts in Finance April 1999. This is a review essay of the transition from unpredictable returns and CAPM to predictable returns and multifactor models. Economic Perspectives XXIII (3) Third quarter 1999 (Federal Reserve Bank of Chicago), also NBER working paper 7169.
Portfolio Advice for a Multifactor World April 1999. This is a review and interpretation of how portfolio theory should adapt in a multifactor, predictable world. See especially the three dimensional update of the two fund theorem. Economic Perspectives XXIII (3) Third quarter 1999 (Federal Reserve Bank of Chicago), also NBER working paper 7170.
"Where is the Market Going? Uncertain Facts and Novel Theories" Will stocks average 9% for the next 50 years? The equity premium, return predictability, and a review of Economic Perspectives XXI: 6 (November/December) 1997 (Federal Reserve Bank of Chicago), also NBER Working paper 6207
Investments notes. Jan 2005. Notes for MBA investments classes. Summary of background (statistics, regression, time series, matrices, maximization) and a concise treatment of some of the standard topics (bond notation and expectations hypothesis, bond pricing)
Time series for macroeconomics and Finance Lecture notes for PhD time series course. Jan 2005 revision finally includes the figures!
Solving real business cycle models by solving systems of first order conditions Set of lecture notes from 1993. Still, underground copies are circulating, so you can get a fresh one here.
A Skeptical Appraisal of Frictions in the Financial Crisis September 2010. Notes and Pictures. This is a 2 hour lecture for Ph.D. students at the Deutsche Bank Symposium hosted by the Booth School September 2010. It offers a skeptical view of the emerging consensus that the financial crisis is all about "bubbles" "liquidity spirals" "fire sales" "capital constraints" at commercial banks and so on. I do think there was a run on repo and short term financing. Good old fashioned macro asset pricing works a lot better than you might have thought.
Hedge Funds. April 15 2010 Slides for presentation to Booth Hedge Fund student group. They update "Options, Portfolios and Hedge Funds" below, but also cut out a lot of material, so the original is still worthwhile too.
Discount rates Apri 10 2010 Slides for a presentation given at Research Associates meeting, San Diego. Efficiency won years ago. Now the big issue is how discount rates vary over time and across assets, and the many unappreciated implications of that fact.
Introduction for Darrell Duffie . January 2010 Introduction for Darrell’s AFA presidential speech.
Lessons from the financial crisis Jan 2010 (was “Financial crisis and policy”) Regulation 32(4), 34-37. Article based on a talk given at Cato, Nov 6, NY. The financial crisis is mainly about too big to fail expectations. The only way out is to limit the government’s authority to bail out
Portfolio Formation in the new Financial World October 6,8 2009 Slides for a talk on new ideas in portfolio theory.
Asset pricing after the crash March 20 2009 This is a piece based on a panel discussion titled “Rethinking asset pricing” at the Spring 2009 NBER Asset Pricing meeting. It includes sceptical views on just how important credit constraints and liquidity really are. Liquidity is the frosting on the cake of finance. There is a lot of frosting these days, but still some cake.
Introduction for Gene Fama October 10 2008. Gene gave a talk on the history of the efficient markets hypothesis for the American Finance Association history project. This is my introduction. I try in 6 ninutes flat to say why the efficient markets hypothesis is important and a great intellectual achievement. Video of Gene's speech from the IGM website.
Efficient Markets Today Talk given at the Conference on Chicago Economics Nov 10 2007. A second “discount rate” revolution has followed the first efficient-markets revolution, and dramatically changes how we think about financial markets. Alpha and beta are dead.
Comments on the credit situation given at the GSB Global Financial Markets Forum, Sept 25 2007. Some good aspects of the current situation, some unheralded aspects of the Fed’s policy, some things that went wrong, and the downside of some quick fixes. Video of the event.
Options, portfolios and hedge funds. August 2005 Slides for a talk reviewing hedge funds that I’ve given several places. Big points: hedge fund returns look like options, hedge fund betas are a lot bigger than you think, the effects of the option-like nature of hedge fund compensiation, and how do you form a portfolio of hedge funds. (Is fund A shorting something that fund B is going long, and that you already have in your portfolio? If so, what a great way to lose money fast!)
Cost of Capital. Slides for a talk on cost of capital given at NABE conference, Sept 25 2005. The old advice to use the CAPM and 6% for cost of capital doesn’t make any sense now that we know expected returns vary over time.
Asset Pricing and the Equity Premium Slides for the Smith-O’Brian Lecture, Notre Dame University, October 8 2004. (An update of several related talks)
Bond Supply and Excess Bond Returns May 2008. Comments on Robin Greenwood and Dimitri Vayanos’ paper for the IGM “Beyond Liquidity ” conference at the GSB Gleacher center, May 9-10 2008. The paper from Dimitri’s website . I learned two important lessons in reading and thinking about this paper. 1) When arbitrageurs are limited by risk-bearing capacity, “downward-sloping” demands depend on correlations. The paper and my comments have a lovely example in which arbitrageurs are asked to hold more long-term bonds and less short-term bonds. The result is that all yields go up! Why don’t long yields go up and short yields go down? Because risks are described by a one-factor model, so all that matters is how much overall duration risk arbitrageurs have to hold. 2) We’re probably doing a bad job of correcting for serial correlation in all predictive regressions. Typically, we think expected returns move slowly over time. The right hand variable also moves slowly over time, but doesn’t capture all of the expected return variation. This situation means that residuals have a slow-moving AR(1) plus an unforecastable component, which is the same thing as an ARMA(1,1). This structure will be very poorly captured by standard “nonparametric” procedures such as Newey-West, since you’re unlikely to put in enough lags to capture the long-run component, and also poorly captured by parametric procedures like fitting an AR(1). “Short” samples make the problem worse. More in the comments.
Risks and Regimes in the Bond Market. April 2008. Comments on Atkeson and Kehoe’s paper for the 2008 Macroeconomics Annual. Risk premia are important for understanding interest rates, and monetary policy. I see no evidence for “anchored expectations” in interest rate data. Once you take account of risk premiums, expected long run interest rates are still very volatile. The yield curve has not become more downward sloping on average, as it should if inflation risks have decreased. If anything, risk premia in long-term bonds are increasing. Atkeson and Kehoe advocate a fascinating view that risk premia cause monetary policy, not vice versa.
‘Macroeconomic Implications of Changes in the Term Premium’ by Glenn Rudebusch, Brian Sack and Eric Swanson. Comments given at the conference “Frontiers in Monetary Policy Research” at the St. Louis Federal Reserve, October 19 2006. Of course, I can’t stick to the topic and offer a survey instead. In particular, lots of salty comments on the “conundrum” in long bond prices (silly, in my view). The paper from the St. Louis Fed website.
“A new measure of Monetary Policy” by Christina and David Romer, presented at the July 2004 EFG meeting.
What ends recessions? by David and Christina Romer, 1994 NBER Macroeconomics Annual 58-74. JSTOR What are monetary policy shocks? The fed never says “and another 50 bp for the heck of it.” This led to “What do the VARs mean?” above
“Why Test the Permanent Income Hypothesis? Comments on ‘The Response of Consumption to Income: a Cross-Country Investigation’” by John Campbell and N. Gregory Mankiw, European Economic Review 35 (4) May 1991. Why indeed, now that we think of equilibrium models, not a “consumption function.”
What Should Macroeconomists Know About Unit Roots? Comments on ‘Pitfalls and Opportunities: What Macroeconomists Should Know About Unit Roots’” by John Campbell, 1991 NBER Macroeconomics Annual 6, (1991), 201-210 JSTOR Another blistering critique of the (mis) use of unit root econometrics.
“Daily Monetary Policy Shocks and the Delayed Response of New Home Sales” by James D. Hamilton. Comments given at April 2007 NBER Monetary Economics program meeting, NY. Includes some new thoughts on “what’s a monetary policy shock?”
“The Returns to Currency Speculation” by Craig Burnside, Martin Eichenbaum, Isaac Kleshchelski and Sergio Rebelo. Comments given at Jan 2007 AEA/AFA meetings.
Anomalies by Lu Zhang, presented at the November 2004 AP meeting.
Me, polishing the tail before takeoff. Ok, nobody ever polishes the tail that way, but it made for a good photograph. Photo by Chris Strong for the Booth alumni magazine
Ready for takeoff at the 2007 18 meter national contest. Photo by Paul Remde. Finishing at Hobbs 2006, and landing at Ephrata 20009
Ok you’re not really a glider pilot, but this looks a lot more fun than asset pricing, doesn’t it? Go to the SSA (Soaring Society of America) web page to see what gliders look like and where you can try it. The sailplane racing association has more information about glider contests. If you go out to an airport, say “trial lesson” and make them put you in front. Don’t say “ride” or they’ll treat you like a tourist, stuff you in back and charge you too much.
Chicago Glider club (where I fly)
Videos (youtube links): Aerobatics over the Alps; Soaring over the Alps
Chicago Glider club CFI training page
Northern Illinois contest
Contest Corner
MacCready and other theory of how to fly contests
Safety and Rules
Miscellaneous writing
2010 NISC results (text format); results in excel format. (Use to see if I calculated your score right). Last update May 31
Sky Soaring contest Day 1 results May 29
Sky Soaring contest Day 2 results May 30
NISC rules for 2010. Read the rules! We're making a big change, moving to SSA contest style rules. Update May 5 2010 -- new start/finish height 4500 / 1500 MSL
2009 NISC results (mht format); results in excel format. Only one rule change for 2009: CGC road operations mean 1000’ finish, at CGC only.
NISC rules for 2008; rules in doc format; The rules contain a short guide to flying the contest and a summary of important rules changes for 2008.
2008 NISC results; results in excel format. Logs. (This is a big zipped file. Right click and save as. Updated Aug 18)
2007 NISC results
The worldwide soaring turnpoint exchange has the turnpoint and landpoint database (updated April 2008). You’ll have to cut these down to fit in a Cambridge model 20.
Some long tasks using Northern Illinois turnpoints.
Illinois Soaring forecast links. My weekend morning forecast ritual
Since Feb 2006 I have been writing the “contest corner” column for Soaring Magazine. Here’s a list of topics I have in mind for future columns. Feel free to suggest other topics or to let me know which of these you want to hear sooner rather than later.
Here are drafts of upcoming columns and repository of old columns.
Invitation to contests. Feb 2006
Local contests. April 2006
Contest Finishes. It’s a “how-to” article, with no ranting and raving about rules. June 2006
Sports class growing pains. Handicaps, team selection and more. August 2006
Upwind and downwind The theory of upwind and downwind turnpoints. Oct 2006
Circling in Psychological Sink Musings on how to produce a contest-winning attitude. Dec 2006
Thermal Detectors Feb 2007
Distance Rules Explains the new scoring formulas that give more distance points. April 2007
Goodbye Rolling Finish Feb 2008. Explains the new finish penalty that replaces rolling finishes under a finish cylinder.
Start anywhere March 2008. Explains the new start procedure, with some things to watch for.
MAT strategy July 2008. Some unconventional ideas on MAT strategy. Up/down wind vs. cross-wind; playing the upwind-low game; keeping options open.
Fun With MAT December 2009. The “Long MAT” as an alternative to the AST, and some other ideas on fun tasks using MAT rules. Let’s break out of the rut!
Flarm August 2010. A report of my experience with Flarm at the worlds, and thoughts about getting it going in the US. Video (wmv format) showing what the Parowan midair would have looked like if the pilots had flarm. (Courtesy Lee Kuhlke)
Karl Striedieck classics
These are most of Karl’s “contest corner” articles. They are copyright © Karl Striedieck, so check with him before republishing or reproducing. Dates are my best guesses based on the Soaring Magazine index
The US Team and the Rules December 2003
Tweaking the TAT November 2002
User Friendly Contests December 2000
World View Jan 2001
A Better Sniffer August 2002
Bridging the Gap Feburary 2003
Club/Sports issues October 2000
The SRA December 2001
Contest Fees June 2004
Crewless Pilots December 1999
Going it Alone (more crewless pilots, not how Karl wins contests without leeching.)
Deadlines
GPS flight recorders
GPS starts I August 1999
GPS starts II July 2001
H2woe November 2004
MAT Rules report May 1999
Mommy, where do rules come from March 2000
Odds and ends May 2003
Rules Complication August 2000
Tasking October 2002
The CD June 2002
The Scoring Program
The Troops February 2004
The Turn Area Task
Just a little Faster Please Jan 2007. Condensed and rewrote the article for publication in Germany. This version is better, except the numbers are all m/s and km. Slovenian translation. German version
Just a Little Faster Please July 2000. Article for Soaring Magazine on applying new MacCready theory.
"MacCready Theory with Uncertain Lift and Limited Altitude" Technical Soaring 23 (3) (July 1999) 88-96. This version cleans up some typos that crept into the published version. Acrobat 3.0 pdf file Programs contains matlab and gauss programs for making the calculations.
"The start time game in competition soaring" Technical Soaring 22 (2) (April 1998) 56-64 . This article analyzes when to start early, when to start late, when a big gaggle will form, and so on. Acrobat 3.0 pdf file.
Notes for talk given at the Midwest mini-convention, Feb 2000 MS-Word doc file. Same general stuff as in "Just a little faster please"
Safer Finishes
Soaring Magazine article, arguing for a high finish gate or "hard deck" and no rolling finishes to reduce accidents on and near the home airport. Draft if you have problems with the published version.
Contest Safety Feb 2002 Power point slides for presentation at 2002 convention. Where are the accidents, what can you do to avoid them, and what can rules do to make contests safer.
Plea for the 500 foot rule. Message to r.a.s. Sept 2003 on the high finish
Added time FAQ. A short and less technical explanation of the 15 minute time addition, with a response to frequently asked questions from the spring 2003 r.a.s. debate.
Time for distance Draft of a Soaring magazine article to explain a scoring improvement for turn area tasks. (ms doc file)
Views on Tonopah A sidebar to accompany the Soaring Magazine coverage of the 2002 15 meter nationals at Tonopah (ms doc file)
Newcastle fields. Powerpoint drawings from ground tours of fields around NCI.
"Decisions at Littlefield" July 2000. Draft of a sidebar to the 2000 Standard nationals for Soaring Magazine.
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visitors since Nov 20 2009
