| The essays are set out in three chapters, each investigating the asymmetric volatility of stock returns, the stock prices run-up in the 1990s, and the time-inconsistent problem of monetary policy, respectively. In the first essay, I investigate implications of recurrent, but infrequent, regime switches in stock market volatility on the persistence of volatility and on the negative correlation between returns and volatility. I find: (i) Endogenous regime switches account for most of persistence in volatility; (ii) After controlling for the leverage effect, inter-regime volatility feedback is a main source of the negative correlation between returns and volatility; (iii) The leverage effect is the main source of the negative correlation within a volatility regime. The second chapter examines whether the mean earnings growth increased enough to explain to the stock prices run-up in the 1990s. Two types of time variation in the mean are considered and tested separately: one-time permanent structural break at an unknown point and a gradual change in the form of a random walk. For the earnings growth of the S&P 500 index for 1951–2000, tests favor the null hypothesis of no time variation. Yet it is found that when a reasonable variation is allowed, the mean growth rate following a random walk is substantially higher in the 1990s, consistent with the New Economy and rational exuberance. The third chapter tests the implication of the time-inconsistent monetary policy, long-run co-movement between inflation and unemployment, to examine its ability to explain the dramatic change in inflation dynamics: rise in the 1960s and 1970s and fall in the 1980s and 1990s. Using correlations of VAR forecast errors at various horizons, I find a positive long-run relationship for 1961–1979 but not for 1980–2000, suggesting that the time-inconsistency problem that had prevailed during periods of rising inflation has disappeared during periods of declining inflation, the tenure of Volcker and Greenspan. |
