At the chair of Financial Markets and Macroeconomics, you examine the microeconomic foundations of financial markets in economy-wide models. Which questions are you currently working on?
My current projects include the development and application of nonlinear methods to model the joint interaction of financial markets and the macroeconomy. Methodologically I am working on tractable methods that capture the risk that originates in the macroeconomy and is priced in asset prices, enabling Bayesian estimation through risk sensitive linear approximation and by improving the accuracy of existing local (perturbation) approximation methods.
In an application, I am investigating the impact of alternate monetary policy instruments on bond risk premia (term premia) which should help assess the impact of monetary policies such as forward guidance and maturity swapping in central bank portfolios to target longer term interest rates. Additionally, I am extending the model uncertainty framework of Lars Peter Hansen and Thomas Sargent to allow for a comparability with risk sensitive preferences for understanding the microfoundations of the pricing of risk. Finally, I am working on improving the forecasting power of structural macroeconomic (DSGE) models by relaxing standard restrictions on the serial correlation of exogenous process and jointly estimating ARMA orders with the models structural parameters.
The empirical approach is very important for your research. What are the particular challenges related to this?
Many asset pricing phenomena, such as the risk premia on equity and bonds, are inherently nonlinear yet the standard macroeconomic approach for estimating models relies on linearity in models when engaging in likelihood-based estimation. While the underlying macroeconomic models can generally be expressed in a nonlinear form commensurate with the potential to match these asset pricing phenomena, the estimation of these nonlinear models presents considerable computational challenges. Improving the numerical accuracy of tractable nonlinear methods and developing alternative approximations that capture the salient interaction between macroeconomic risks and financial markets’ pricing thereof provide two fruitful directions to help ameliorate these challenges.
Which issues do you address in your teaching?
A solid foundation in the assumptions, mechanics, and consequences of the macroeconomic models we use to analyze the economy is important at all levels of instruction from introductory macroeconomic courses at the bachelor’s level to specialized PhD courses. With this foundation, students are able to ask and address relevant questions, both positively and normatively, independently. I hope to instill students with a way of thinking rather than a collection of facts, such that they can address the issues that are of interest to them themselves. Along the way in developing this way of thinking, students should understand the importance of economic growth, the benefits and pitfalls of independent and coordinated action by fiscal and monetary authorities, understand the pivotal role of expectations in issues ranging from the pricing of assets, to the response of the macroeconomy to policy actions, to the valuation of employment, and to the setting of prices by individual firms.
What does the IMFS’s interdisciplinary approach of legal and economic research mean for your work?
The interdisciplinary approach provides a singular opportunity to confront theoretical recommendations from economics with the legal framework that defines the subset of possibilities available in our society. Likewise, the opportunity goes both ways, putting me in a position with my colleagues from law to inform the construction and interpretation of this framework with economic theory.
As the role of expectations I spoke of before alludes to, there can be a divergence between the intentions of policy and the actual consequences thereof as people and institutions respond to the incentives laid out before them. Both many incentives directly and the mechanisms for their transmission are codified in our laws – any practical application of economic theory requires an understanding of the legal framework within which this application will take place and fruitful legal analyses would take economic theory into account when assessing likely outcomes. The focus of the IMFS on combining expertise in monetary and financial economics with expertise in central bank and currency law is located at a particularly important nexus of legal and economic interaction.
