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2004

Economics Working Papers, 2004

Copies may be downloaded on pdf, or hard copies may be requested from Joshua Hall, Working Paper Coordinator.

04 - 01: Chow, K. Victor and Hu, Ou. and Nesbit, Todd.

Conditional Mean Dominance: Testing for Sufficiency of Anomalies.

Abstract: Extensive empirical literature of anomalies suggests that an asset reallocation by buying a subset of the market portfolio and selling simultaneously another subset of the market portfolio, according to predictable past history and/or fundamental information of firms, generates excess returns. This article demonstrates that evidence of (unconditional) excess returns is necessary but insufficient to prove the existence of anomalies. Instead, the existence of anomalies is confirmed under the condition that portfolio reallocation generates additional or excess utility for all investors. We show that for all risk-averse investors, conditional mean dominance (CMD) is necessary and sufficient for increasing expected utility from an asset reallocation strategy. The CMD rule is separated from an individual preference function and is free from any modeling specification of the return generating process. Also, the statistical test of CMD is simple and standard. Empirically, the CMD test sufficiently confirms the value and momentum effects but strongly rejects the size effect in the U.S. equity market. Specifically, there are significantly negative conditional size premiums corresponding to a downside market. In addition, the contrarian effect is weak.

04 - 02: Chow, K. Victor, Liao, Sunny and Hu, Ou.

Conditional Mean Dominance: Testing for Sufficiency of Anomalies.

Abstract: Extensive empirical literature of anomalies suggests that an asset reallocation by buying a subset of the market portfolio and selling simultaneously another subset of the market portfolio, according to predictable past history and/or fundamental information of firms, generates excess returns. This article demonstrates that evidence of (unconditional) excess returns is necessary but insufficient to prove the existence of anomalies. Instead, the existence of anomalies is confirmed under the condition that portfolio reallocation generates additional or excess utility for all investors. We show that for all risk-averse investors, conditional mean dominance (CMD) is necessary and sufficient for increasing expected utility from an asset reallocation strategy. The CMD rule is separated from an individual preference function and is free from any modeling specification of the return generating process. Also, the statistical test of CMD is simple and standard. Empirically, the CMD test sufficiently confirms the value and momentum effects but strongly rejects the size effect in the U.S. equity market. Specifically, there are significantly negative conditional size premiums corresponding to a downside market. In addition, the contrarian effect is weak.

04 - 03: Douglas, Stratford.

Utilization Rates of Coal-Fired Power Plants in the Eastern U.S. and the Efficiency of Electricity Market Reforms.

Abstract: This paper examines changes in the utilization of coal power plants in the eastern US since federal regulators opened the transmission system to wholesale power markets in 1996. If market reforms increase efficiency of dispatch, utilization rates of highcost plants should fall relative to those of low-cost plants. Using plant-level panel data and a difference-in-difference model, I find that utilization rates of low-cost plants increased relative to those of high-cost plants after 1996, but only in regions with independent system operators. Simulations indicate cost savings on the order of two to three percent.

04 -04: Yakovlev, Pavel.

Do Arms Exports Stimulate Economic Growth?

Abstract: Previous empirical research has yielded mixed results regarding how defense spending affects economic growth. Because defense spending can simultaneously affect growth through several channels and in opposite directions, I would argue that one should not expect to see a consistent overall relationship between these two variables. More conclusive evidence may come from estimating how defense spending affects growth through different channels. In an attempt to examine one of these channels, I use balanced panel data to estimate the relationship between economic growth and net arms exports for 62 countries (and some sub-samples) from 1990 to 1999. Using different econometric techniques, I find that net arms exports have a significant positive effect on economic growth in the entire 62 country sample, non-oil country sub-sample, and OECD sub-sample.

04 - 05: Sobel, Russell S. and Taylor, Jennis J.

The Last 30 Years of Public Choice: An Analysis of Author and Institution Rankings.

Abstract: In this paper we provide a statistical analysis of authorship in Public Choice over the past 30 years. We explore trends in article length and coauthorship, as well as provide rankings of individual authors and institutions by total pages published in the journal. This is the first such ranking of publications in the journal since 1987. We find a significant degree of turnover among the leading authors in Public Choice, and that George Mason University is clearly the leading institution making a large share of the new contributions in the field.

04 - 06: Ovaska, Tomi and Sobel, Russell S.

Entrepreneurship in Post-Socialist Economies.

Abstract: Following the disintegration of the Soviet Union in December 1991, the former Soviet republics and many other Eastern European nations began their transition from socialism to capitalism. Private sector entrepreneurship, an activity that had been illegal for decades, not only became legal but it also became essential for the creation of wealth and economic progress in these countries. In this paper we examine the rates of entrepreneurial activity in these post-socialist economies, and attempt to uncover the policies and institutions that appear to be the most highly correlated with a country's success (or failure) in promoting entrepreneurial activity.

04 - 07: Basistha, Arabinda and Startz, Richard.

Measuring the NAIRU with Reduced Uncertainty: A Multiple Indicator-Common Component Approach.

Abstract: Standard estimates of the NAIRU or natural rate of unemployment are subject to considerable uncertainty. We show in this paper that using multiple indicators to extract an estimated NAIRU cuts in half uncertainty as measured by variance. The inclusion of an Okun's Law relation is particularly valuable. We estimate the NAIRU as an unobserved component in a state-space model and show that using multiple indicators reduces both parametric uncertainty and filtering uncertainty. Additionally, our multivariate approach overcomes the "pile-up" problem observed by other investigators.

04 - 08: Basistha, Arabinda and Nelson, Charles R.

New Measures of the Output Gap Based on the Forward-Looking New Keynesian Phillips Curve.

Abstract: Forward-looking versions of the New Keynesian Phillips curve imply that the output gap, the deviation of the actual output from its natural level due to nominal rigidities, drives the dynamics of inflation relative to expected inflation. We exploit this to set up a bivariate unobserved component model for extracting new estimates of the output gap in the US. The Phillips curve helps us to distinguish between the output gap and a purely transitory component other than the gap. The estimates suggest that the purely transitory component is small and, therefore, the entire transitory component well approximates the gap. The gap estimates are large and persistent even after allowing for correlated trend and cycle shock. Finally, we augment our benchmark model to use the information in the unemployment rate about the gap. The estimates confirm the presence of a large and persistent cyclical component.

04 - 09: Cushing, Brian.

Location-Specific Amenities, Equilibrium, and Constraints on Location Choices.

Abstract: This research considers how preferences for location-specific attributes might constrain migration destination choices. In particular, if, at any given time, most people are consuming their desired location-specific attributes, then unwillingness to give up these attributes may influence the decision to migrate. For those who migrate, these desired attributes might significantly constrain the locations they would consider. This perspective differs substantially from the normal approach that assumes people move toward "good attributes" and away from "bad attributes." The research provides an initial test of a "constrained destination choice" hypothesis by considering "locational attribute constraints" in the context of aggregate place-to-place migration flows for U.S. metropolitan areas during the 1995-2000 time period.

04 - 10: Balvers, Ronald J. and Dayong Huang.

Money and the (C)CAPM: Theory and Evaluation.

Abstract: We consider asset pricing in a monetary economy where liquid assets are held to lower transaction costs. The ensuing model extends the CAPM and the Consumption CAPM by deriving real money growth as an additional factor determining returns. Empirically, the unconditional version of this model compares favorably to other theoretical asset pricing models. Allowing for conditional variation in factor sensitivities improves model performance so the model performs as well as the a-theoretical Fama-French three factor model. The paper further introduces a technique that facilitates derivation of dynamic asset pricing results in discrete time by generalizing Stein's Lemma to multivariate cases.

04 - 11: Balvers, Ronald J. and Yangru Wu.

Momentum and Mean Reversion Across National Equity Markets.

Abstract: A number of studies have separately identified mean reversion and momentum, but this paper considers these effects jointly: Potential for mean reversion and momentum is combined optimally into one indicator, interpretable as a risk-adjusted expected return. Combination momentum-contrarian strategies, used to select from among 18 developed equity markets at a monthly frequency, outperform both pure momentum and pure contrarian strategies. A key assumption is that, among developed markets, only global equity price index shocks can have permanent components, as would be reasonable in a production-based asset-pricing context, given that production levels converge across developed countries. The results hold with basic risk corrections and continue to hold after transactions costs are included. They reveal that it is important to control for mean reversion in exploiting momentum and vice versa.

04 - 12: Balvers, Ronald J. and Yangru Wu.

Optimal Transaction Filters under Transitory Trading Opportunities: Theory and Empirical Illustration.

Abstract: If transitory profitable trading opportunities exist, filter rules are used to mitigate transaction costs. We use a dynamic programming framework to design an optimal filter which maximizes after-cost expected returns. The filter size depends crucially on the degree of persistence of trading opportunities, transaction cost, and standard deviation of shocks. Applying our theory to daily dollar-yen exchange trading, we find that the optimal filter can be economically significantly different from a naïve filter equal to the transaction cost. The candidate trading strategies generate positive returns that disappear after accounting for transaction costs. However, when the optimal filter is used, returns after costs remain positive and are higher than for naïve filters.