This paper solves a model consisting of two monetary economies with incomplete markets, in which agents are subject to borrowing constraints. The paper investigates if such a framework is able to account for the volatility and the size of the foreign exchange risk premium. The model succeeds in increasing substantially the volatility of the risk premium to about 30% of that in the data. However, this more volatile risk premium does not translate into sufficiently large predictable excess returns. It thus appears unlikely that excess returns from currency speculation can be uniquely explained by a time-varying risk premium in an incomplete-markets economy with exogenous borrowing constraints.
This paper evaluates how the global financial crisis emanating from the U.S. was transmitted to emerging markets. Our focus is on the extent that the crisis caused external market pressures (EMP), and whether the absorption of the shock was mainly through exchange rate depreciation or the loss of international reserves. Controlling for variety of factors associated with EMP, we find clear evidence that emerging markets with higher total foreign liabilities, including short- and long-term debt, equities, FDI and derivative products—had greater exposure and were much more vulnerable to the financial crisis. Countries with large balance sheet exposure -- high external portfolio liabilities exceeding international reserves—absorbed the global shock by allowing greater exchange rate depreciation and comparatively less reserve loss. Despite the remarkable buildup of international reserves by emerging markets during the period prior to the financial crisis, countries relied primarily on exchange rate depreciation rather than reserve loss to absorb most of the exchange market pressure shock. This could reflect a deliberate choice (“fear of reserve loss” or competitive depreciations) or market actions that caused very rapid exchange rate adjustment, especially in emerging markets with open capital markets, overwhelming policy actions.
This paper provides a broad analysis of the effect of the current financial crisis on global equity markets and their major components. We also examine the magnitude of the crisis in terms of value destruction in comparison to other market crashes. In brief, upon looking at return performance across an array of regions, countries, and sectors, broad market averages are down approximately 40% on their end of 2006 levels. While deterioration started in most markets in early to mid 2008, the crisis period of mid-September to the end of October 2008 is responsible for the lion's share of the collapse with just about all indices falling 30–40% in this short period. Financial sectors have taken a bigger hit than non-financials over the period, though they both suffered similarly during the peak of the crisis. Due to larger rises in 2007 the emerging markets drop more in 2008 than developed markets but in large part end up at the same level as the other markets. The global nature of the crisis is also apparent from the high correlations between markets and investment styles that further increased during the crisis. As a result, diversification provided little help to investors when needed most as markets dropped in tandem.
This paper synthesizes studies analyzing the effects of capital account liberalization on industry growth while controlling for financial crises, domestic financial development and the strength of institutions. We find evidence that financial openness has positive effects on the growth of financially dependent industries, although these growth-enhancing effects evaporate during financial crises. Further analysis indicates that the positive effects of capital account liberalization are limited to countries with relatively well-developed financial systems, good accounting standards, strong creditor rights and rule of law. It suggests that countries must reach a certain threshold in terms of institutional and economic development before they can expect to benefit from capital account liberalization.
The share market boom in the 1990s is often linked to the acceleration in labour and total factor productivities over the same period. This paper explores the argument that labour and total factor productivities are inaccurate measures of firm's earnings, which underlie equity valuations, and that capital productivity is a better measure of earnings. Using 80 years of data for 11 OECD countries, it is shown empirically that the link of capital productivity to share returns is indeed stronger than that of labour productivity and TFP.
I estimate a three-equation model of savings, investment and growth on pooled time-series data for 14 Asian developing countries to explore terms-of-trade dynamic effects on the current account. A terms-of-trade deterioration lowers aggregate saving and raises investment in the current year. It also exerts a positive lagged effect on investment due to the unanticipated, temporary nature of the terms-of-trade change. The current account oscillates before returning gradually to its steady-state level. The model explains 65 per cent of the variance in the sample countries' current accounts over the period 1962–1983.
This article studies the monetary transfers system that was created by the short-term inland bill of exchange markets. For decades this system was the most practical way of channeling the growing volume of transfers which were taking place as a consequence of the growth of the Spanish economy. This analysis argues that, between 1775 and 1885, the markets involved in this activity became progressively more efficient, due largely to the multilateralization of the payment system. This situation lasted longer in Spain than in the rest of Europe since Spanish banking was, initially, slower to develop. Using univariate and multivariate GARCH models, it was possible to conclude that the inland bill of exchange markets constituted an essential monetary instrument, and one that faithfully reflects the integration of monetary markets in Spain.
Do international trade and finance flow together? In a variety of theoretical models, trade and finance can be shown to have the potential to be substitutes or complements, so the matter must be resolved empirically. We study trade and financial flows from the United Kingdom from 1870 to 1913 and the United States in the interwar years. These were the two major capital exporters and key financial centers in each era. We find that trade and finance were robustly correlated for each case. We consider simultaneity issues. We also discuss evidence from the British Empire which casts doubt on the idea that trade is a punishment device in the event of a default.
This article is an excerpt from a monograph, Monetary Trends in the United States and the United Kingdom: Their Relation to Income, Prices, and Interest Rates, 1867–1975, that the University of Chicago Press has scheduled for publication in July 1982. Earlier in the monograph, we estimate a single demand curve for money for the United States and the United Kingdom, and also show that velocity in the two countries had parallel movements and that the rates of change of velocity were nearly identical in the two countries for most of the century we cover. Similar behavior of velocity in the two countries requires in addition to a largely common demand curve similar behavior of the variables affecting the demand for money. Chapter 7 from which this excerpt is taken begins by examining the interrelations between velocity in the two countries. The excerpt though self-contained is clearly incomplete.
This paper investigates the effectiveness of the monetary authority's borrowing policies in resolving exchange rate cises. It shows why obtaining loans or lines of credit in foreign currency may avoid, at least temporarily, the devaluation of a fixed rate, and discusses the problem of the optimal size of the loan and/or the line of credit. The analysis focuses on a particular episode of foreign exchange rate pressure, during the troubled years between 1894 to 1896. The results suggest that the borrowing policy followed by the US Treasury in those years was effective in avoiding the collapse of the United States ' gold standard, and that the amount of the borrowing undertaken by the Treasury might have been optimal.
The aim of this paper is to develop an aggregate stability index for the Romanian financial system, which is meant to enhance the set of analysis used by authorities to assess the financial system stability. The index takes into consideration indicators related to financial system development, vulnerability, soundness and also indicators which characterise the international economic climate. Another purpose of our study is to forecast the financial stability level, using a stochastic simulation model. The outcome of the study shows an improvement of the Romanian financial system stability during the period 1999-2007. The constructed aggregate index captures the financial turbulences periods like 1998-1999 Romanian banking crisis and 2007 subprime crisis. The forecasted values of the index show a deterioration of financial stability in 2009, influenced by the estimated decline of the financial and economic activity.
The paper reviews the long-term relationship between world money and international prices, using new indices of internationally traded good prices: an aggregate index of manufactures, fuels and non-fuel primary commodities, and a partial index covering only non-fuel commodities. It verifies such relationship using both regression analysis and direct-indirect Granger causality tests. The relationship between money and international prices is strong, significant and quite stable over time. The elasticity is close to unity for all international prices and less than unity for commodity prices. The direction of causality is found to be from money to price, not vice versa.
The Phillips-Hansen fully modified Wald test is used to analyze whether or not the forward rate is an unbiased predictor of the future spot rate for the 1920s. Daily data for five exchange rates (German mark, Belgium franc, French franc, Italian lira and US dollar versus the British pound) are examined. The results suggest that the forward unbiasedness hypothesis can be rejected in three (Beligium franc, French franc and German mark) out of the five currencies. This result may be due to the presence of a risk premium for the Belgian and French francs and to market failure in the case of the German mark. The results also indicate that, with the exception of the German mark, the forward and future spot exchange rates are cointegrated.
This paper presents empirical evidence which supports the purchasing power parity (PPP) hypothesis for three bilateral exchange rates involving the Greek drachma during the 1920s, using the technique of cointegration of economic time series. The results are obtained for a period of high money supply growth and a high and variable rate of inflation which gave rise to large differentials in price movements between Greece and the other countries. The speed at which long-run PPP was reached following a shock was 50 per cent per month confirming the results of other studies of PPP over the 1920s, and explaining the supportive evidence for long-run PPP even though data over a short period were used. (JEL F31)
This paper studies how financial markets in the US and Mainland China affected equity, money and foreign exchange markets in Hong Kong on daily basis during the current financial crisis, and how these financial linkages have changed compared with the experience in 2001. In the equity markets, the influence of the Mainland on Hong Kong has increased substantially in the current financial crisis, but it is still less important than that of the US. In the money market, correlation between HIBOR and LIBOR has picked up from the low levels observed during the tranquil period before the crisis, to almost the same level of correlation as observed during the IT bubble burst. In the foreign exchange market, the daily movements of the Hong Kong dollar/US dollar exchange rate have been rather small and mainly influenced by the short-term interest rates. Fund flows in different directions might have neutralised the impact of other markets on the foreign exchange market. A broad interpretation of these findings is that Hong Kong financial markets appear to be more aligned with the US markets in turbulent times, but relatively more integrated with the Mainland markets during the tranquil periods.
This paper examines some of the characteristics of the foreign exchange market in the 1920s floating period. Nominal returns appear to exhibit properties consistent with asset prices on modern more well-organized financial markets; i.e. they appear to be well described by martingales and possess persistent time dependent heteroscedasticity. In order to deal with the extreme kurtosis in the exchange rate series we use robust inferential methods to test for volatility spillovers and shocks that might effect subsequent mean returns. Apart from some particularly abnormal ‘bear squeeze’ episodes the markets appear remarkably efficient.
This study shows empirically that the political costs of sovereign default can differ considerably for domestic and external debt. The analysis uses new evidence from Danish and Swedish bond markets around World War II, a time when markets went from being fully integrated to fully segmented overnight. By linking the exogenous wartime shocks to changes in default costs on domestic and external debt, it is found that these costs explain a significant part of the variation in the sovereign yield spread across markets. The results suggest that governments can choose strategically on which debt, the domestic or the external, to default on, and that this decision hinges on the relative size of the political default costs.
This paper analyzes the transmission of aggregate shocks between the USA and three major European economies-the UK, France, and Germany -under fixed and flexible exchange rate regimes, using time series techniques. Short-run linkages are investigated in the context of vector autoregression models, while long-run relations are analyzed by testing for cointegration. Empirical findings indicate that flexible exchange rates have not, in general, completely insulated domestic economies from foreign shocks and that the degree of insulation and interdependence, across exchange rate regimes and over the long and short runs, differs substantially across the European countries.
We study the correlation of monthly excess returns for seven major countries over the period 1960-90. We find that the international covariance and correlation matrices are unstable over time. A multivariate GARCH(1,1) model with constant conditional correlation helps to capture some of the evolution in the conditional covariance structure. However tests of specific deviations lead to a rejection of the hypothesis of a constant conditional correlation. An explicit modelling of the conditional correlation indicates an increase of the international correlation between markets over the past thirty years. We also find that the correlation rises in periods of high volatility. There is some preliminary evidence that economic variables such as the dividend yield and interest rates contain information about future volatility and correlation that is not contained in past returns alone.
The paper examines the transmission of inflation in Canada during 1962–1980 using an empirical methodology which is very flexible in determining the direction of casuality and the shape of distributed lag effects. The paper finds that US monetary growth exerted an important effect on Canadian inflation during both fixed and flexible exchange-rate periods. The evidence also shows that Canadian monetary growth has remained linked to US monetary growth under the present flexible exchange-rate regime.
This paper estimates a simple consumption-smoothing model of the French current account, and examines its capacity to predict recent developments in France`s external performance. The model views the current account as a buffer through which private agents can smooth consumption over time in response to temporary disturbances to output, investment, and government expenditure. The empirical results indicate that the model performs well overall, and predicts correctly the sharp turnaround in France`s external accounts observed in the past three years--a feature of the data that conventional models of trade flows, based on income and relative price variables, appear unable to explain.
This paper analyzes the switch in monetary control procedures by the Bank of Japan toward a so-called ‘money-focused’ monetary policy in the mid-1970s. The extent to which monetary control under the new regime has been limited by an exchange rate objective is examined. Through estimation of an explicit Bank of Japan (BoJ) reaction function, we find evidence that the BoJ operating instrument has been systematically manipulated with a view to maintain short-term money control but that this objective has often been dominated by an attempt to moderate yen– dollar exchange rate fluctuations.
This paper examines domestically held government debt, financial indexation, inflation, and intertemporal solvency in Brazil. An error-correction model is used to examine the temporal causality of expenditures, taxation and real indexation. Evidence shows that, for the 1986–1991 period, reductions in real indexation followed increases in government spending. Such reductions, while generally associated with anti-inflation plans, served as implicit defaults. The policy was largely unrelated to foreign factors. Of course, such a policy cannot be sustained in the long run. Accordingly, Brazil recently ended backward looking financial indexation.
We study the regime dependence of the money-prices relationship, focusing on Argentina's experience over the last 30 years. Using descriptive and cointegration analysis we find that proportionality holds for the high inflation period but weakens once inflation lowers. Money velocity correlates positively with money growth under high inflation, while this relation reverts under low inflation. VAR analysis allows to identify the key role of inflation expectations in driving the short-run dynamics of the money growth-inflation relationship under high inflation. Although this relationship weakens under low inflation, money continues to play a role in explaining inflation dynamics in Argentina.
The purpose of this paper is to provide empirical answers to questions related to the propagation of shocks in a high-inflation economy. Do one-time shocks give rise to long-term persistence of inflation? Do foreign trade shocks trigger a process that, through indexation and monetary accomodation, results in long-term changes in inflation? Within the context of a specific hypothesis, influential both in policy discussions and in economic analyses, the paper addresses these issues using Israeli data and vector-autoregression techniques. The evidence does not support the hypothesis from the ‘inertia approach’ that one-time nominal shocks have a persistent effect on the inflation rate, or the hypothesis that long-term changes in inflation are triggered by autonomous fluctuations in the trade deficit.
This article applies a speculative attack model to Argentina during its pre-announced exchange-rate system from January 1, 1979 to June 30, 1981. The model attempts to verify a rule whereby if domestic credit growth exceeds the rate of currency depreciation, two things occur: First, the domestic price of non-traded goods rises relative to the price of traded goods. Second, foreign reserves decline until a point when a sudden speculative attack depletes remaining reserves, causes a precipitous fall in the relative price of non-tradables, and forces the country onto a floating exchange-rate regime. In some important respects, the model captures the Argentinian experience, yet in other respects if fails to do so.
From October 1979 to February 1985, forward rates systematically underpredicted the strength of the US dollar. In this paper we argue that the explanation of this phenomenon is the existence of a peso problem. We identify two peso problem periods. The first one is related to the change in monetary regime in October 1979 and to the private sector doubts about the Federal Reserve commitment to lower money growth and inflation. The second peso problem period is related to the private sector anticipation of the dollar's depriciation beginning in March 1985.
Deutsche mark and yen futures options over 1984–1992 and 1986–1992, respectively, are examined for deviations from the lognormal assumption underlying standard option pricing models. Two methods are used: an atheoretic ‘skewness premium,’ and daily estimates of moments using a model for pricing American foreign currency futures options under systematic exchange rate jump risk. Substantial variation over time is found in all moments, including implicit skewness and kurtosis. The implicit abnormalities predict future abnormalities in log-differenced $/DM futures prices, but not $/yen. The ‘peso problem’ implications do not explain standard rejections of uncovered interest parity.
This paper implements a robust statistical approach to regression with non-stationary time series. The methods were recently developed in other work and are briefly exposited here. They allow us to perform regressions in levels with non-stationary time series data, they accommodate data distributions with heavy tails and they permit serial dependence and temporal heterogeneity of unknown form in the equation errors. With these features the methods are well suited to applications with frequently sampled exchange rate data, which generally display all of these empirical characteristics. Our application here is to daily data on spot and forward exchange rates between the Australian and US dollars over the period 1984–1991, following the deregulation of the Australian foreign exchange market. We find big differences between the robust and the non-robust regression outcomes and in the associated statistical tests of the hypothesis that the forward rate is an unbiased predictor of the future spot rate. The robust tests reject the unbiasedness hypothesis but still give the forward rate an important role as a predictor of the future spot rate.
Since the Debt Crisis in 1982, the secondary market for developing country bank loans has rapidly become a key element in the debt strategies. Based on the present value model of secondary market price, this paper tests joint hypotheses of the market's efficiency and the various expectation models. As far as actively traded debt is concerned, we find that the prices indicate the market efficiency. Large and negative differences between expected returns for new and old credit during 1987–90 imply the effects of bank regulations and the failure to establish seniority for new money. The results of this paper show that, only after 1993, an expected rate of return for new money increased significantly, and thus, new private lending extended substantially.
This paper documents differences in the performance of bank and nonbank initial public offerings (IPOs) in Mexico during 1987-1993. We measure performance relative to the Mexican stock market index. Banks experience much larger initial underpricing than nonbanks due in part to a hot issue market in 1987. In the aftermarket, excess returns for banks, industrials, and services are not significant. Excess aftermarket returns for brokerage houses are significantly negative. We also find that underpricing of the privatized IPOs diminishes over time, supporting the argument that the Mexican government offered discounts on IPOs issued early in the privatization program.
This paper studies volatility, risk premia and the persistence of volatility in six emerging stock markets before and after the 1987 stock market crash. The empirical investigation is conducted by means of the GARCH in the mean model (GARCH-M) and monthly data from Argentina, Greece, India, Mexico, Thailand, and Zimbabwe between January of 1976 and August of 1994. Results indicate changes in the ARCH parameter, risk premia and persistence of volatility before and after the 1987 crash. But these noted changes are not uniform and depend upon the individual markets. Factors other than the 1987 crash may also be responsible for the changes.
This paper uses two different estimation approaches to demonstrate that equity markets in South East Asia have shown signs of converging during the 1990s. According to the Haldane and Hall (Economic Journal101, 436–443, 1991) method of measuring convergence, a subset of Asian markets had converged by mid-1997. This process appears to have been abruptly halted and somewhat reversed by the recent financial crisis. We find that in general, there are two common trends present in the eight Asian equity market indices modeled here, and also two trends when the US market is additionally included in a Johansen VAR.
We use simultaneous equation estimation techniques to analyze decisions made by 35 US banks with respect to credit extended domestically and to credit extended within 16 foreign countries, 1988–1994. Our results indicate that foreign credit extension by US banks follows the commercial expansion of US businesses abroad and is greater in countries with expanding economies. They are inconsistent with the notion that banks trade off credit activities undertaken domestically and abroad.
Post-1990 Chinese monetary policy is modeled with an augmented McCallum-type rule that takes into account the People's Bank of China's emphasis on targeting the rate of money supply growth. People's Bank policy appears responsive to the gap between target and actual nominal GDP as well as to external pressures. Additional cointegration analysis yields estimates of the gap between estimated money demand and actual money supply that appear to track the inflationary trends evident over our sample period. Chinese inflation and monetary policy outcomes seem reasonably captured using a standard monetary approach without the need to appeal to China-specific “structural” factors.
Bond flows to Less Developed Countries (LDCs) proved more resilient than expected to the rising US interest rates during 1994, raising hopes that the current episode of private capital flows to LDCs may not end in a widespread crisis as its predecessors in the 1920s and 1970s did. Global bond issuance, a significant determinant of the flows that recovered quickly from the first interest-rate rise in February 1994, explains this resilience. It can also help the flows withstand future cyclical interest rate rises, as long as the ongoing process of international portfolio diversification continues fueling it.
This paper contributes empirically to our understanding of informed traders. It analyzes traders' characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders' trades which--simultaneously--use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.
In this paper we investigate purchasing power parity (PPP) in a panel with 17 countries for the period 1972 through 1996. The novel feature of our panel methodology is that results are invariant to the choice of a benchmark on numeraire currency. In the panel we allow individual country effects in the relation between prices and exchange rates. In this way we can identify the currency pairs for which PPP holds or does not hold. We conclude that there is substantive evidence for PPP, although not to the same extent for every currency. Evidence in favor of PPP is strongest for many exchange rates relative to the Dmark, and weakest for the Japanese yen. For this currency a trend-like variable, like productivity growth, is missing.
Money, inflation and output are tested for stationarity, and found to be integrated of order one. We apply the Johansen procedure for cointegration to test for the rank of the matrix of cointegration relations (one), to test for the weak exogeneity of output (accepted), inflation (rejected) and money (rejected). We interpret the unique cointegrating relationship as an extended Cagan money demand function. We then estimate error correction mechanisms, which explain the short-run movements of real money and inflation. The evidence suggests that in the period considered, including the sub-sample between the liberalization shocks, inflation was largely a monetary phenomenon.
We analyze the effectiveness of intervention in the European Monetary System by using data on the DEM-intervention activity of six European central banks, covering the period from August 1993 to April 1998. To allow for regime-specific intervention effects, we estimate Markov Switching Autoregressive Conditional Heteroscedasticity models. We find that interventions have only limited effects on the conditional means and variances.