International Journal of Finance & Economics

This paper develops a model for understanding end-user order flow in the FX market. The model addresses several puzzling findings. First, the estimated price-impact of flow from different end-user segments is, dollar-for-dollar, quite different. Second, order flow from segments traditionally thought to be liquidity-motivated actually has power to forecast exchange rates. Third, about one-third of order flow's power to forecast exchange rates 1 month ahead comes from flow's ability to forecast future flow, whereas the remaining two-thirds applies to price components unrelated to future flow. We show that all of these features arise naturally from end-user heterogeneity, in a setting where order flow provides timely information to market-makers about the state of the macro-economy. Copyright © 2006 John Wiley & Sons, Ltd.

This paper finds that the term structure of credit spreads in project finance is hump-shaped. This contrasts with other types of debt, where credit risk is shown instead to increase monotonically with maturity ceteris paribus. We emphasize a number of peculiar features of project finance structures that might underlie this finding, such as high leverage decreasing over time, long-term political risk guarantees and the sequential resolution of uncertainty along project advancement stages. Our result is particularly relevant given the importance of project finance as a source of long-term capital for infrastructure especially in developing countries and has implications for risk management in the framework of Basel II. Copyright © 2007 John Wiley & Sons, Ltd.

Target-bounds models and buffer stock models in the presence of adjustment costs imply nonlinear functional forms for the aggregate demand for money characterized by smooth adjustment towards long-run equilibrium. This paper presents a stable empirical model for the demand for narrow money in Italy using high quality annual data spanning from Italian unification in 1861 through to 1991. A unique, theory consistent long-run function is obtained jointly with the short-run dynamic demand function by estimating a nonlinear error correction model in the form of an exponential smooth transition regression. The model proposed variance-dominates, encompasses and fits better than various linear and nonlinear alternative specifications. Copyright @ 1999 by John Wiley & Sons, Ltd. All rights reserved.

The saving-investment correlation in the long run may be interpreted as an indicator of the respect of the nation's intertemporal budget constraint. In the context of the single equation method, the existence of such a long-run relationship implies that the levels of the variables as regressors must be cointegrated. Using the new approach to cointegration developed by Pesaran et al. (2001), the paper attempts to ascertain the existence of a long-run relationship between the domestic saving and investment rates in industrialized countries over the period 1880-2001 when it is not known if the variables under consideration are stationary in levels or in differences. Inferences are drawn concerning international capital mobility. Copyright © 2004 John Wiley & Sons, Ltd.

An indicator of financial openness spanning the period 1890-1999 is used to evaluate policies towards the capital account of the balance of payments. Findings include that: financial globalization was deeper in 1890-1913 than subsequently; countries with liberal capital account policies recovered more quickly from the Great Depression than countries that restricted capital account transactions; the correlation between democracy and capital account openness was negative or zero during the gold standard era, in contrast to subsequent periods, when it has tended to be positive; and countries in geographic proximity to one another have tended to behave similarly in their policies towards the capital account. Copyright © 2003 John Wiley & Sons, Ltd.

For most of the post-war period, Europe's capital markets remained largely closed to international capital flows. This paper explores the costs of this policy. Using an event-study methodology, I examine the extent to which restrictions of current and capital account convertibility affected stock returns. The delayed introduction of full currency convertibility increased the cost of capital. Also, a string of measures designed to reduce capital mobility before the ultimate collapse of the Bretton Woods System had considerable negative effects. These findings offer an explanation for the mounting evidence suggesting that capital account liberalization facilitates growth. Copyright © 2003 John Wiley & Sons, Ltd.

This paper tests the properties of the zloty-dollar exchange rate for the possible presence of unknown non-linearities. It concludes that there is strong evidence for the presence of an underlying non-linear process which is possibly chaotic. A non-linear model which allows for discrete switching between regimes seems to capture most of the non-linear behaviour. Copyright @ 1997 by John Wiley & Sons, Ltd. All rights reserved.

This paper seeks to characterize the distribution of extreme returns for US, UK and Japanese equity indices over the years 1963-2000. In particular, the suitability of the following distributions is investigated: Normal, Frechet, Gumbel, Weibull, Generalized Extreme Value (GEV), Generalized Pareto and Generalized Logistic (GL). Daily returns were obtained for each of the countries, and the minima over a variety of selection intervals were calculated. Plots of higher moment statistics for the minima on statistical distribution maps suggested that the best fitting distribution would be either the GEV or the GL. The results from fitting each of these distributions to extremes of a series of US, UK and Japanese share returns supported the preliminary evidence that the GL distribution best fitted the data in all three countries over the period of study. The GL distribution has fatter tails than the GEV distribution; hence this finding is of importance to investors who are concerned with assessing the risk of a portfolio. The paper highlights the important finance implications and in particular the potential for underestimation of risk if distributions without fat enough tails are employed. Copyright © 2006 John Wiley & Sons, Ltd.

Generally a currency crisis is defined to occur if an index of currency pressure exceeds a threshold. This paper compares currency crisis dating methods. For two definitions of currency pressure we contrast ad hoc and extreme value-based thresholds. We illustrate the methods with data of six East Asian countries for the January 1970-December 2002 period, and evaluate the methods on the basis of the IMF chronology of the Asia crisis in 1997-1999. Copyright © 2007 John Wiley & Sons, Ltd.

The international capital market integration and currency crises of the last decade have renewed the debate on optimal exchange rate regimes. Research is mixed regarding what their effect has been on the system of exchange rate regimes and the anchor currencies at the centre of the system. The debate is complicated by growing empirical evidence that the de jure regimes announced by governments often differ from the de facto regimes that are actually applied. In this paper we divide the period 1990-2002 according to the major crises and use the generalized method of moments to identify the individual de facto regimes and relevant anchor currencies for each sub-period. We find that although intermediate regimes as a percentage of the overall database remained stable over the three periods, the type of peg and anchor currencies varied considerably. Pegs on a single currency fell from 62% of the sample in the first period to 49% in the second period, then rose to 66% in the third period. Basket pegs rose from 33% in the first period to 51% in the second period and back to 34% in the third period. Independent floats disappeared after the first period. When we group countries according to their access to capital markets, we find that all nine of the developed countries in the sample followed some type of intermediate regime for all three periods. We also find a trend towards hard pegs in the group of countries that has managed to increase its integration in the international capital markets. Our results also suggest that the US dollar remains the main anchor currency in the international financial system, even after the major currency crises and the rise of the euro. Copyright © 2007 John Wiley & Sons, Ltd.

This paper develops a market-based measure of devaluation expectations derived from the relative stock market performance of companies with different exposures of current and future profits to exchange-rate changes. The measure can be viewed as a complement to measures of devaluation expectations based on interest-rate-parity conditions, survey data or macroeconomic models. Some of the benefits of the measure are that data are available on a timely basis and that the stock market has traditionally been free of central bank intervention. As an illustration, we examine the Mexican devaluation of 1994. Contrary to what might have been expected given the alleged peso overvaluation, high-net-exporting firms outperformed the market beginning in late 1993. This pattern is, on the other hand, consistent with forward-looking stock prices that assigned an increasing probability to a devaluation benefiting exporting firms. Copyright @ 2002 by John Wiley & Sons, Ltd. All rights reserved.

In this paper we examine whether during the 1997 East Asian crisis there was any contagion from the four largest economies in the region (Thailand, Indonesia, Korea and Malaysia) to a number of developed countries (Japan, UK, Germany and France). Following Forbes and Rigobon, we test for contagion as a significant positive shift in the correlation between asset returns, taking into account heteroscedasticity and endogeneity bias. Furthermore, we improve on earlier empirical studies by carrying out a full sample test of the stability of the system that relies on more plausible (over) identifying restrictions. The estimation results provide some evidence of contagion, in particular from Japan (the main international lender in the region), which drastically cut its credit lines to the other Asian countries in 1997. Copyright © 2005 John Wiley & Sons, Ltd.

This paper attempts to provide a conceptual framework for the analysis of counterfactual scenarios using macroeconometric models. As an application we consider UK entry to the euro. Entry involves a long-term commitment to restrict UK nominal exchange rates and interest rates to be the same as those of the euro area. We derive conditional probability distributions for the difference between the future realizations of variables of interest (e.g. UK and euro area output and prices) subject to UK entry restrictions being fully met over a given period and the alternative realizations without the restrictions. The robustness of the results can be evaluated by also conditioning on variables deemed to be invariant to UK entry, such as oil or US equity prices. Economic interdependence means that such policy evaluation must take account of international linkages and common factors that drive fluctuations across economies. In this paper this is accomplished using the Global VAR recently developed by Dees et al. (J. Appl. Econometrics, 2007, forthcoming). The paper briefly describes the GVAR which has been estimated for 25 countries and the euro area over the period 1979-2003. It reports probability estimates that output will be higher and prices lower in the UK and the euro area as a result of entry. It examines the sensitivity of these results to a variety of assumptions about when and how the UK entered and the observed global shocks and compares them with the effects of Swedish entry. Copyright © 2007 John Wiley & Sons, Ltd.

In this paper we examine the causal linkages between the G-7 long-term interest rates by using a new technique, which enables the researcher to analyse relations between a set of I(1) series without imposing any identification conditions based on economic theory. Specifically, we apply the so-called Extended Davidson's Methodology (EDM), which is based on the innovative concept of an irreducible cointegrating (IC) vector, defined as a subset of a cointegrating relation that does not have any cointegrated subsets. Ranking the irreducible vectors according to the criterion of minimum variance allows us to distinguish between structural and solved relations. The empirical results provide support for the hypothesis that larger, more stable economies can achieve policy objectives more successfully by accommodating rather than driving other countries' policies. It appears that the driving force is Canada, which is linked to the USA, UK and France in three out of the four fundamental relations, and which is a reference point for the US, Italian and German rates, which are not cointegrated, seem to be determined by country-specific factors. Copyright @ 2001 by John Wiley & Sons, Ltd. All rights reserved.

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This paper investigates the main sources of instability in Brazil during the currency and financial distress episode of 2002. We test for financial contagion from the Argentine crisis and the impact of factors including IMF intervention and political uncertainty in raising the probability of crisis. The empirical investigation employs a Markov-switching model with endogenous transition probabilities. Copyright © 2005 John Wiley & Sons, Ltd.

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Significant deviations from covered interest parity were observed during the financial crisis of 2007–2009. This paper finds that before the failure of Lehman Brothers market-wide funding liquidity risk was the main determinant of these deviations measured by swap-implied US dollar (USD) interest rates for the euro, British pound, Hong Kong dollar, Japanese yen, Singapore dollar and Swiss Franc relative to US Libor rates. This evidence suggests that the deviations can be explained by the existence and nature of liquidity constraints. After the Lehman default, both counterparty risk and funding liquidity risk in the European economies were the significant determinants of the positive deviations found for these currencies, while the tightened liquidity condition in the USD was the main driving factor of the negative deviations in the Hong Kong, Japan and Singapore markets. The negative deviations reflect the fact that these markets became alternative dollar funding sources as borrowing in the European economies became more difficult. Federal Reserve Swap lines with other central banks that eased the liquidity pressure reduced the positive deviations in the European economies.

In common with privatisation issues around the world, those of UK utilities have earned very high returns on a continuing basis. This presents an asset pricing puzzle and has been used as a justification for the imposition of a "windfall" tax. This paper presents a framework for analysing the composition of these returns and for judging the extent to which they can be regarded as abnormal. It provides evidence that even the existence of abnormal returns depends crucially on the assumptions made with regard to their measurement. A general model that allows for time variation in investors' perceptions of risk reveals that the extent of the abnormal returns is much smaller than first thought, being present in only very few companies. In most cases, the observed high stock returns appear to be a reward for bearing risk and should not be regarded as abnormal. Copyright @ 2000 by John Wiley & Sons, Ltd. All rights reserved.

This paper estimates the readiness of the accession countries of Central and Eastern Europe for EMU or unilateral euroization using a fuzzy clustering algorithm. The variables to which the algorithm is applied are suggested alternately by the criteria in the Maastricht Treaty (nominal convergence) and by Optimum Currency Area theory (real convergence). The algorithm reveals that Estonia and Slovenia are the leaders in both nominal and real convergence, whereas the other countries from the 1998 accession wave have achieved substantial results only in real convergence. Moreover, Poland is excluded from the leading group in the most recent years due to its worsened economic performance. Copyright © 2003 John Wiley & Sons, Ltd.

The aim of this study is to estimate the credibility of monetary policy in four accession countries (the Czech Republic, Hungary, Poland and the Slovak Republic), based on the Markov regime-switching (MRS) framework. We utilize the theoretical proposition that in the conduct of monetary policy, there is uncertainty in terms of the type of central bank. We measure this uncertainty as a deviation of monetary policy from a target level. We utilize for the target level the differential between the interest rates of the four individual accession countries and a 'synthetic' interest rate of 11 EMU member countries. Copyright © 2005 John Wiley & Sons, Ltd.