Essays in financial and monetary economics

The goal of these essays is to better understand the complex inter-relationships between global equity markets, and between the U.S. economy and monetary policy. The first chapter of this dissertation attempts to provide a comprehensive depiction of the dynamics of the correlation structure of international equity returns. In this pursuit, we employ a powerful yet parsimonious dynamic latent factor model with time-varying loadings and stochastic volatility. Such a specification allows us to account for the complex dynamics between international equity returns but is flexible enough to be estimated with a sample of daily data spanning over 20 years across a geographically diverse set of 15 major international markets. We first document that average global and regional correlations have risen steadily over the past two decades. Our main findings are that international equity returns have become increasingly exposed to common sources of variation, and that the entire low-frequency change in equity correlations is due to changing risk exposures rather than changing systematic risk. We also demonstrate significant financial contagion effects during the 1994 Mexican and 1997 Asian crises.;The second chapter investigates the role of the Federal Reserve in the housing crisis. Many in the press had recently made the claim that the Federal Reserve set interest rates too low during 2002-2006, thereby exacerbating the surge in housing investment over this period. Taylor (2007) supported this line of argument and suggested that if the Fed had implemented higher rates during 2002-2006, the housing investment bubble would have been smaller and its bursting would have had less severe consequences. The primary motivation of this chapter is to formally assess Taylor's claim within the context of a New Keynesian dynamic stochastic general equilibrium model augmented to include housing. Since his analysis was entirely in partial equilibrium, Taylor could not address how a higher path of interest rates would affect output, consumption or business investment. Our main finding is that these general equilibrium effects are crucial and that a higher path of rates during 2002-2006 would have pushed the economy toward or into recession.