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UK Macroeconomic Forecasting with Many Predictors: Which Models Forecast Best and When Do They Do So?
Get PDFBlock factor methods offer an attractive approach to forecasting with many predictors. These extract the information in these predictors into factors reflecting different blocks of variables (e.g. a price block, a housing block, a financial block, etc.). However, a forecasting model which simply includes all blocks as predictors risks being over-parameterized. Thus, it is desirable to use a methodology which allows
for different parsimonious forecasting models to hold at different points in time. In this paper, we use dynamic model averaging and dynamic model selection to achieve this goal. These methods automatically alter the weights attached to different forecasting models as evidence comes in about which has forecast
well in the recent past. In an empirical study involving forecasting output growth and inflation using 139 UK monthly time series variables, we find that the set of predictors changes substantially over time.
Furthermore, our results show that dynamic model averaging and model selection can greatly improve forecast performance relative to traditional forecasting methods
Political economics and normative analysis
Get PDFThe approaches and opinions of economists often dominate public policy discussion.
Economists have gained this privileged position partly (or perhaps mainly) because of the obvious relevance of their subject matter, but also because of the unified
methodology (neo-classical economics) that the vast majority of modern economists
bring to their analysis of policy problems and proposed solutions. The idea of Pareto
efficiency and its potential trade-off with equity is a central idea that is understood by all economists and this common language provides the economics profession with a
powerful voice in public affairs. The purpose of this paper is to review and reflect upon the way in which economists find themselves analysing and providing
suggestions for social improvements and how this role has changed over roughly the
last 60 years.
We focus on the fundamental split in the public economics tradition between those
that adhere to public finance and those that adhere to public choice. A pure public
finance perspective views failures in society as failures of the market. The solutions are technical, as might be enacted by a benevolent dictator. The pure public choice view accepts (sometimes grudgingly) that markets may fail, but so, it insists, does politics. This signals institutional reforms to constrain the potential for political failure. Certain policy recommendations may be viewed as compatible with both traditions, but other policy proposals will be the opposite of that proposed within the other tradition.
In recent years a political economics synthesis emerged. This accepts that institutions are very important and governments require constraints, but that some degree of benevolence on the part of policy makers should not be assumed non-existent. The implications for public policy from this approach are, however, much less clear and perhaps more piecemeal.
We also discuss analyses of systematic failure, not so much on the part of markets or politicians, but by voters. Most clearly this could lead to populism and relaxing the
idea that voters necessarily choose their interests. The implications for public policy
are addressed. Throughout the paper we will relate the discussion to the experience of
UK government policy-making
Education and Economic Development in India
Get PDFThis brief survey examines the returns to education in India , and then examines the role of education on both economic growth and economic development with particular
reference to India. Throughout, the objective is to draw out the implications of the empirical results for education policy. The results suggest that female education is of particular importance in India. They also suggest that perhaps because of the externalities it generates, primary education is more important than might be deduced from its relatively low private rate of return
Why is it so Hard to Value Intangibles? Evidence from Investments in High-Technology Start-Ups
Get PDFThe paper uses a range of primary-source empirical evidence to address the question:
‘why is it to hard to value intangible assets?’ The setting is venture capital investment in high technology companies. While the investors are risk specialists and financial
experts, the entrepreneurs are more knowledgeable about product innovation. Thus
the context lends itself to analysis within a principal-agent framework, in which
information asymmetry may give rise to adverse selection, pre-contract, and moral
hazard, post-contract. We examine how the investor might attenuate such problems
and attach a value to such high-tech investments in what are often merely intangible
assets, through expert due diligence, monitoring and control. Qualitative evidence is used to qualify the more clear cut picture provided by a principal-agent approach to a
more mixed picture in which the ‘art and science’ of investment appraisal are utilised
by both parties alik
Intra-Group Competition and Inter-Group Conflict: An Application to Northern Ireland
Get PDFThis paper reviews four economic theories of leadership selection in conflictual
settings. The first of these by Cukierman and Tomassi (1998) labeled the ‘information
rationale’, argues that hawks may actually be necessary to initiate peace agreements.
The second labeled the ‘bargaining rationale’ borrowing from Hamlin and Jennings
(2007) agrees with the conventional wisdom that doves are more likely to secure
peace, but post-conflict there are good reasons for hawks to be rationally selected.
The third found in Jennings and Roelfsema (2008) is labeled the social psychological
rationale. This captures the idea of a competition over which group can form the
strongest identity, so can apply to group choices which do not impinge upon
bargaining power. As in the bargaining rationale, dove selection can be predicted
during conflict, but hawk selection post-conflict. Finally, the expressive rationale is discussed which predicts that regardless of the underlying structure of the game
(informational, bargaining, psychological) the large group nature of decision-making
by making individual decision makers non-decisive in determining the outcome of
elections may cause them to make choices based primarily on emotions which may be
invariant with the mode of group interaction, be it conflictual or peaceful. Finally, the paper analyses the extent to which the theories can throw light on Northern Ireland electoral history over the last 25 years
Experimental evidence of a sunk–cost paradox: a study of pricing behavior in Bertrand–Edgeworth duopoly
Get PDFA well–known implication of microeconomic theory is that sunk costs should have no effect on decision making. We test this hypothesis with a human–subjects experiment. Students recruited from graduate business courses, with an average of over six years of work experience, played the
role of firms in a repeated price–setting duopoly game in which both firms had identical capacity constraints and costs, including a sunk cost that varied across experimental sessions over six different
values. We find, contrary to the prediction of microeconomic theory, that subjects’ pricing decisions show sizable differences across treatments. The effect of the sunk cost is non–monotonic: as it increases from low to medium levels, average prices decrease, but as it increases from medium to
high levels, average prices increase. These effects are not apparent initially, but develop quickly and persist throughout the game. Cachon and Camerer’s (1996) loss avoidance is consistent with
both effects, while cost–based pricing predicts only the latter effect, and is inconsistent with the former
Dynamic Option Adjusted Spread and the Value of Mortgage Backed Securities (Draft 1)
Get PDFWe extend a reduced form model for pricing pass-through mortgage backed securities
(MBS) and provide a novel hedging tool for investors in this market. To calculate the
price of an MBS, traders use what is known as option-adjusted spread (OAS). The
resulting OAS value represents the required basis points adjustment to reference curve
discounting rates needed to match an observed market price. The OAS suffers from
some drawbacks. For example, it remains constant until the maturity of the bond
(thirty years in mortgage-backed securities), and does not incorporate interest rate
volatility. We suggest instead what we call dynamic option adjusted spread (DOAS).
The latter allows investors in the mortgage market to account for both prepayment
risk and changes of the yield curve
Do Institutions Matter for Foreign Direct Investment?
Get PDFIn this paper the role of institutions in determining foreign direct investment (FDI) is investigated using a large panel of 107 countries during 1981 and 2005. We find that
institutions are a robust predictor of FDI and that the most significant institutional
aspects are linked to propriety rights, the rule of law and expropriation risk. Using a
novel data set, we also study the impact of institutions on FDI at the sectoral level.
We find that institutions do not have a significant impact on FDI in the primary sector but that institutional quality matters for FDI in manufacturing and particularly in services. We also provide policy implications for institutional reform
Valuing American Derivatives by Least Squares Methods
Get PDFLeast Squares estimators are notoriously known to generate sub-optimal exercise
decisions when determining the optimal stopping time. The consequence is that the
price of the option is underestimated. We show how variance reduction methods
can be implemented to obtain more accurate option prices. We also extend the
Longsta¤ and Schwartz (2001) method to price American options under stochastic
volatility. These are two important contributions that are particularly relevant for practitioners. Finally, we extend the Glasserman and Yu (2004b) methodology to
price Asian options and basket options