On user costs of risky monetary assets

Abstract

We extend the monetary-asset user-cost risk adjustment of Barnett, Liu and Jensen (1997) and their risk-adjusted Divisia monetary aggregates to the case of multiple non-monetary assets and intertemporal non-separability. Our model can generate potentially larger and more accurate CCAPM user-cost risk adjustments than those found in Barnett, Liu and Jensen (1997). We show that the risk adjustment to a monetary asset’s user cost can be measured easily by its beta. We show that any risky non-monetary asset can be used as the benchmark asset, if its rate of return is adjusted in accordance with our formula. These extensions could be especially useful, when own rates of return are subject to exchange rate risk, as in Barnett (2003). Copyright Springer-Verlag Berlin Heidelberg 2005User costs, Monetary aggregation, Risk, Pricing kernel, CAPM, E41, G12, C43, C22,

International Financial Aggregation and Index Number Theory: A Chronological Half-Century Empirical Overview

“…Subsequently Barnett and Wu (2005) found that the explanatory power of the risk adjustment increases, if the assumption of intertemporal separability of the intertemporal utility function, T, is weakened. The reason is the same as a source of the well known equity premium puzzle, by which CCAPM under intertemporal separability under-corrects for risk.…”

“…For example, Divisia monetary aggregates have been produced for Britain (Batchelor (1989), Drake (1992), and Belongia and Chrystal (1991)), Japan (Ishida (1984)), the Netherlands (Fase (1985)), Canada (Cockerline and Murray (1981)), Australia (Hoa (1985)), and Switzerland (Yue and Fluri (1991)), among many others. More recently, Barnett (2007) has extended the theory to multilateral aggregation over different countries with potentially different currencies, and Barnett and Shu (2005) have extended to the case of risky contemporaneous interest rates, as is particularly relevant when exchange rate risk is involved. That research was particularly focused on the needs of the European Central Bank.…”

“…Future research on monetary aggregation and policy can most advantageously focus on extensions to exchange rate risk and its implications for multilateral aggregation over monetary asset portfolios containing assets denominated in more than one currency. The relevant theory for multilateral aggregation with exchange rate risk has been derived by Barnett (2007) and Barnett and Wu (2005). …”

International Financial Aggregation and Index Number Theory: A Chronological Half-century Empirical Overview

“…We believe that the under-correction produced by CCAPM results from its assumption of intertemporal blockwise strong separability of goods and services within preferences. Barnett and Wu (2005) …”

Solving Stochastic Money-in-the-Utility-Function Models

“…1 Stochastic decision problems that include monetary or …nancial assets have been used to address a variety of topics including asset pricing [2,15,29,30,41,51], price dynamics [23,32,40,42,43], intertemporal substitution [26], money demand [21,33], currency substitution and exchange rates [6,34], optimal monetary policy [16,17,18,19,20,25], and monetary aggregation [3,4,5,46]. In each case, the usefulness of the model depends on the derivation of the stochastic Euler equations that characterize the model's solution.…”