Derive the optimal value of loss function, Financial Accounting

Assignment Help:

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.


Related Discussions:- Derive the optimal value of loss function

Prepare tally & co.''s journal, Tally & Co. incurred a pretax operating los...

Tally & Co. incurred a pretax operating loss of $100,000 in its first year of operations for both financial reporting and income tax purposes. However, it expects to be profitable

Horizontal analysis - total current liabilities, 1. Complete a horizontal a...

1. Complete a horizontal analysis using the dollar and percent change in the following items from the preceding year to the current year: (one typed page: use a table format with f

Assume the debt financing would cost 15 percent, Seattle Health Plans curre...

Seattle Health Plans currently uses zero debt financing.  Its operating income (EBIT) $1 million, and it pays taxes at a 40 percent rate.  It has $5 million in assests and because

Bankruptcy accounts for individuals and partnerships, BANKRUPTCY ACCOUNTS F...

BANKRUPTCY ACCOUNTS FOR INDIVIDUALS AND PARTNERSHIPS These include a statement of affairs and deficiency account. A statement of affairs takes the following form: v\:*

The expected net present values, A company is considering investing some in...

A company is considering investing some independent proposals, The proposals with their expected net present values and standard deviations are given in the following table.

Venture capital, concept meaning features scope importance origin initiativ...

concept meaning features scope importance origin initiative in india

Value of accounting information, Value of accounting information When a...

Value of accounting information When assessing value of accounting information we are confronted with similar problems. Provision of accounting information can be very expensiv

Calculate the percentage change in equilibrium level, Consider a hypothetic...

Consider a hypothetical banking system in which banks produce only demand deposit accounts. The currency deposit ratio (c) is 30% and the customary cash reserve ratio (r) for deman

Concepts in accounting, Mr. Inherits 30000. Decides to open a salon jj salo...

Mr. Inherits 30000. Decides to open a salon jj salon. On 1/4/2016 commits 10000 to the business Opens an a/c in the bank What will be the money under capital in his books on 1/4/10

BUDGETING, In the context of the public sector, discuss incremental system...

In the context of the public sector, discuss incremental system of budgeting and evaluate their strengths and weaknesses

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd