Many tests have rejected the implications of the consumption CAPM for data on U.S. asset returns. All of the tests, though, assume that the pricing errors satisfy the Central Limit Theorem. I provide empirical evidence that the marginal distributions of the pricing errors are so heavy-tailed that they do not satisfy the Central Limit Theorem. Using recent work on jackknifing, I construct a method of testing asset pricing models with heavy-tailed errors. Using this procedure, I find that the consumption CAPM is not rejected by annual U.S. data.

We study learning in Bayesian games (or games with differential information) with an arbitrary number of bounded rational players, i.e., players who choose approximate best response strategies [approximate Bayesian Nash Equilibrium (BNE) strategies] and who also are allowed to be completely irrational in some states of the world. We show that bounded rational players by repetition can reach a limit full information BNE outcome. We also prove the converse, i.e., given a limit full information BNE outcome, we can construct a sequence of bounded rational plays that converges to the limit full information BNE outcome.

This paper develops a dynamic model of seigniorage in which economies' equilibrium paths reflect the ongoing strategic interaction between an optimizing government and a rational public. The model extends existing positive models of monetary policy and inflation by explicitly incorporating the intertemporal linkages among budget deficits, debt, and inflation. A central finding is that the public's rational responses to government policies may well create incentives for the government to reduce inflation and the public debt over time. A sufficiently myopic government may, however, provoke a rising equilibrium path of inflation and public debt.

Public capital subject to congestion is introduced into an endogenous growth model and the transitional dynamic paths under alternative fiscal policies are characterized. Several new insights are obtained from this more general framework. During the transition, the two capital stocks always approach their common equilibrium growth rate from opposite directions. Government policy induces the more volatile response in the capital stock upon which it impinges most directly: private capital in the case of a tax, public capital in the case of expenditure. Finally, we characterize a time-varying income tax that enables the decentralized economy to replicate both the first-best transitional dynamics and steady-state equilibrium of a centrally planned economy. The steady-state component corrects for externalities that arise when government expenditure deviates from its social optimum, and the effects of congestion. The transitional component corrects for myopic behavior by the representative agent along the adjustment path.

There exist a variety of reasons for the failure to find a unique cointegrating relationship between economic time series where one would normally be expected on the basis of economic theory. Among these are the testing procedure, the span of the data set, the choice of lag length in generating the test statistic, the presence of structural breaks, and the presence of cointegration only beyond some threshold. We propose the concept of regime-sensitive cointegration whereby the underlying series need not be cointegrated at all times. We show that cointegration can be switched off when a common stochastic trend is added. Alternatively, cointegration can be switched on or off because series normally believed to contain a unit actually do not. This implies that a linear combination of such variables need not be cointegrated. To illustrate the concept empirically, we test the hypothesis of interest-rate parity, and related hypotheses, using daily Eurorates for the United States and Canada.

The credibility criterion commonly used in the strategic macroeconomic policy literature, subgame perfection or its variants, ignores a critical problem concerning intertemporal consistency of policy announcements. To capture this additional credibility constraint, this note applies two distinct notions of Renegotiation-Proof, originally proposed in the context of two-person repeated games. Macroeconomic policy games, where the benevolent government interacts with atomistic private agents, offers a new testing ground for these criteria to be evaluated. This note discusses the relative strengths and weaknesses of these criteria.