SOLVING STOCHASTIC SADDLEPOINT SYSTEMS: A QUALITATIVE TREATMENT WITH ECONOMIC APPLICATIONS

Marcus Miller and Paul Weller

No 268343, Economic Research Papers from University of Warwick - Department of Economics

Abstract: We examine the effect of introducing stochastic shocks into a linear rational expectations model with saddlepoint dynamics generated by a forward-looking asset price. We derive the fundamental differential equation governing the path of the asset price as a function of the "sluggish" variable. The equation does not admit of closed form solutions in general, but we provide a complete qualitative characterization of the solution paths which are symmetric about equilibrium. These are the relevant solutions to consider in the presence of symmetric boundary conditions. We present two applications. The first analyzes how financial markets might react to the implementation of fiscal stabilization policy where public expenditures are only adjusted when GNP moves outside a threshold around a target level. Bond prices are perfectly flexible and move to satisfy an arbitrage condition. The second examines exchange rate behavior in the presence of a currency subject to a known realignment rule requiring an adjustment to monetary policy.

Keywords: Financial Economics; Research Methods/Statistical Methods (search for similar items in EconPapers)
Pages: 34
Date: 1988-10-10
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Citations: View citations in EconPapers (10)

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Related works:
Working Paper: Solving Stochastic Saddlepoint Systems: A Qualitative Treatment with Economic Applications (1989)
Working Paper: SOLVING STOCHASTIC SADDLEPOINT SYSTEMS: A QUALITATIVE TREATMENT WITH ECONOMIC APPLICATIONS (1988)
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Persistent link: https://EconPapers.repec.org/RePEc:ags:uwarer:268343

DOI: 10.22004/ag.econ.268343

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