Derive the optimal value of loss function, Financial Accounting

Derive the Optimal Value of Loss Function

A speculative attack and the consequent currency crisis may not be due to excessive money-growth or other misaligned fundamentals, but to self-fulfilling panics under fixed exchange rates." To explain this, consider a small open economy where the policy maker wants to minimize a quadratic loss function given by:

L = ½ (βΠ2t + x2t)

Where, 0<β<1

Subject to the budget constraint:

Rbt = xt + Θ (Πt - Πet)

Where 0< Θ<1

and, Πt = sctual rate of exchange rate devaluation (equal to the inflation rate)

xt = ow of net tax revenue (policy variable)

bt = interest rate (equal to the given world interest rate)

R = interest rate (equal to the given world interest rate)

Πet = exogenously given expected rate of devaluation (inflation)

Assume that Purchasing Power Parity holds so that rate of inflation and exchange rate devaluation coincides.

(a) What is the interpretation of the term Θ (Πt -  Πet )?

(b) If the policy maker does not pre-commit to 'not to devalue', calculate the optimal value of and the loss function.

(c) Derive the optimal value of and the loss function when the policy maker has pre-committed 'not to devalue'.

(d) Show that the loss is higher when the policy maker has pre-committed not to devalue.

(e) What is the condition under which the policy maker finds that it is optimal to devalue even if he faces an additional exogenous cost of devaluation, C > 0.

(f) Show from the conditions you had derived earlier that devaluation is the equilibrium outcome when the expectations of devaluation are sufficiently high.

Posted Date: 2/15/2013 5:40:42 AM | Location : United States







Related Discussions:- Derive the optimal value of loss function, Assignment Help, Ask Question on Derive the optimal value of loss function, Get Answer, Expert's Help, Derive the optimal value of loss function Discussions

Write discussion on Derive the optimal value of loss function
Your posts are moderated
Related Questions

Pre-acquisition losses in subsidiary company on date of acquisition If the subsidiary company has a loss on the date of acquisition i.e. a debit balance in the retained profits

Using CAPM's formula, Return on equity = Risk-free rate + Beta*(Expected market return - risk-free rate) With the given information, Return on equity = 1% + 0.55*(8% - 1%)

Any non-quantifiable factors you feel might influence the decision to accept the proposal. Net present value methods are merely assessments of factors that we can quantify. The

Statement to ascertain profit in analysis method and comparison method, and reconstructed using ledger

how do we calculate bonus issu4 and rights issue

Students are to prepare and report as a financial advisor to an investor as to whether the public company selected is a suitable investment for the investor. In preparing the essay

Explain the term - Providing a service One way of viewing accounting is as a form of service. Accountants provide economic information to their 'clients', who are numerous user

Terry Corporation had 300,000 shares of common stock outstanding at December 31, 2010. In addition, it had 90,000 stock options outstanding, which had been granted to certain execu

The Garraty Company has two bond issues outstanding.Both bonds pay $100 yearly interest plus $1,000 at maturity. Bond L has a maturity of 15 years, and Bond S a maturity of 1 year.