We integrate Friedman’s plucking model and the gap version of Okun’s law by embedding output and the unemployment rate in a bivariate unobserved components model with Markov-switching to investigate their asymmetric co-fluctuations in the U.S. We demonstrate that the plucking property of unemployment, through stable Okun’s law, transmits to output. Our model additionally deciphers two puzzling dilemmas in trend-cycle decomposition: First, by considering stochastic rather than deterministic trend growth, we identify an unprecedented deceleration in U.S. potential output in the aftermath of the 2007−09 financial crisis. Second, including unemployment as an auxiliary variable in the bivariate model yields a robust and insensitive estimation of parameters and components with an insignificant correlation between shocks to the trend and symmetric cyclical components, which we refer to as correlation irrelevance.

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This paper is submitted to the Journal of Money, Credit, and Banking (JMCB)

We propose the concept of inefficient plunges to characterize asymmetric deviations of market price from the efficient price with the aim of examining the efficient market hypothesis. To gauge market inefficiency, we present an asymmetric Fads model, which allows for both inefficient plunges in the transitory component and a switching variance in the permanent component by embedding a Markov-switching process in an unobserved components model. Applying the model to the S&P 500 and the FTSE 350 reveals that inefficient plunges are deep, steep, and transient. This finding suggests that market inefficiency is a regime-dependent and asymmetric phenomenon, meaning that although the U.S. and U.K. stock markets are efficient during normal times, they are considerably below efficient prices during crises. Overall, the asymmetric Fads model proposed in this study supports the adaptive market hypothesis and casts doubt on the efficient market hypothesis. 

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This paper is submitted to the Journal of Empirical Finance (JEF) 

Output in the U.S. and the U.K. recovered slowly following the 2007−09 financial crisis, even though unemployment rates returned to pre-crisis levels. To explain this mismatch, by using Okun’s law and a dynamic factor model to estimate the counterfactual recovery, we identify a change in regime in the aftermath of the financial crisis as the main determinant of the slow recovery. Additionally, by applying a trend-cycle decomposition, performed based on the difference version of Okun’s law, we distinguish between three driving forces of the slow recovery: declining trend growth began in the 1960s; unprecedented trend deceleration in U.S. potential output started during the 2007−09 financial crisis; and unusually sluggish cyclical recovery known as hysteresis effects. Further, we develop an open-economy hierarchical dynamic factor model to demonstrate that spillovers of real activity shortfall from the U.S. explain at least half of the productivity puzzle in the U.K.

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This paper is ready to be submitted.