Four essays on hyperinflation, money demand, and the stock market.

Abstract

During the last twenty-five years, Bolivia, Nicaragua, and Peru have undergone dramatic changes in their economic landscape going from regimes of macroeconomic stability to periods of hyperinflation and back to macroeconomic stability. These profound changes have brought with them similar changes in the economic relations studied by empirical macroeconomists. The relation between money and inflation, in particular, seems to be characterized by a case of hysteresis. This dissertation casts doubt on estimates of money demand functions obtained using recent cointegration techniques. It is shown that realistic estimates of the semi-elasticity of money demand can be generated by processes for which there is no cointegration between the log of real money balances and inflation. A simple statistical model is proposed and estimated to explain the monetary experiences of these countries. This model is used to perform a Monte Carlo study that examines the influence of regime-switches and different orders of integration on the estimation of cointegrating vectors. The results indicate that if these possibilities are not taken into account, the researcher may obtain spurious estimates of the semi-elasticity of money demand with respect to inflation. In the last chapter of this dissertation, the assumption of a constant expected return on stocks is relaxed; the zero-coupon bond rates implied by the term structure are used to discount future dividends and to construct an ex-post present discounted value of dividends, P*. This P* is closely related to the term premium. If movements in the term premium are the cause of---or at least are correlated with---movements in the expected return on stocks, this method should help explain the apparent excess volatility of stock prices first documented by Shiller. The results are mixed. One the one hand, relaxing the assumption of a constant expected return and modeling the discounting process as it done here helps in explaining more of the variation displayed by stock prices, particularly towards the end of the sample. On the other hand, this specification is still incapable of explaining the movements of, and especially the level of, the P/D in the middle of the sample.