New Economics Papers
on Financial Markets
Issue of 2005‒04‒03
72 papers chosen by
Erik Schloegl

  1. Determinants of Borrowing Limits on Credit Cards By Shubhasis Dey; Gene Mumy
  2. L’encadrement des sociétés de capital de risque : analyse et recommandations By Cécile Carpentier; Jean-Marc Suret
  3. Programme de recherche sur le rôle des gouvernements dans le financement des entreprises<BR>Initiatives gouvernementales en capital de risque : les leçons des expériences européennes By Cécile Carpentier; Jean-Marc Suret
  4. Capital Market Frictions, Business Cycle and Monetary Transmission By Olivier Pierrard
  5. Why do firms opt for Alternative-Format Financial Statements ? Some Evidence from France By DING, Yuan; JEANJEAN, Thomas; STOLOWY, Hervé
  6. The Asian Crisis Reconsidered By Takashi Shiraishi
  7. Relationship Banking in post Bubble Japan: Co-existence of soft-and hard budget constraint By Arikawa Yasuhiro; Miyajima Hideaki
  8. A Deviation Measurement for Coordinated Exchange Rate Policies in East Asia By Eiji Ogawa; Junko Shimizu
  9. An empirical examination of exchange-rate credibility determinants in the EMS By Francisco Ledesma-Rodríguez; Jorge Pérez-Rodríguez; Simón Sosvilla-Rivero
  10. Is the foreign capital leaving industrialized countries? The case of Spain By Carlos M. Fernández-Otheo; Rafael Myro
  11. Some critics to the contagion correlation test By Sarai Criado Nuevo
  12. Regímenes cambiarios de iure y de facto. El caso de la Peseta/Dólar, 1965-1998 By Francisco J. Ledesma-Rodríguez; Manuel Navarro-Ibáñez; Jorge V. Pérez-Rodríguez; Simón Sosvilla-Rivero
  13. What Happens After the Central Bank of Brazil Increases the Target Interbank Rate by 1%? By Rubens Penha Cysne
  14. Aggregate Savings When Individual Income Varies By Floden, Martin
  15. U.S. Financial Transmission Rights: Theory and Practice By Sun, Junjie
  16. Pension Incomes in the European Union: Policy Reform Strategies in Comparative Perspective By Daniela Mantovani; Fotis Papadopoulos; Holly Sutherland; Panos Tsakloglou
  17. US Monetary Police 1988-2004: An Empirical Analysis By Anders Møller Christensen; Heino Bohn Nielsen
  18. Static Replication and Model Risk: Razor's Edge or Trader's Hedge? By Morten Nalholm; Rolf Poulsen
  19. Closing International Real Business Cycle Models with Restricted Financial Markets By Martin Boileau; Michel Normandin
  20. Systemic Risk and Hedge Funds By Nicholas Chan; Mila Getmansky; Shane M. Haas; Andrew W. Lo
  21. Competition and Efficiency in Congested Markets By Daron Acemoglu; Asuman Ozdaglar
  22. Financing Cities By Robert Inman
  23. Attention, Demographics, and the Stock Market By Stefano DellaVigna; Joshua M. Pollet
  24. Pitfalls of a State-Dominated Financial System: The Case of China By Genevieve Boyreau-Debray; Shang-Jin Wei
  25. An Information Approach to International Currencies By Richard K. Lyons; Michael J. Moore
  26. The Tactical and Strategic Value of Commodity Futures By Claude B. Erb; Campbell R. Harvey
  27. Pharmaceutical Stock Reactions to Price Constraint Threats and Firm-Level R&D Spending By Joseph Golec; Shantaram Hegde; John Vernon
  28. Recent trends in the sources of finance for Japanese firms: has Japan become a 'high internal finance' country? By Kenichiro Suzuki; David Cobham
  29. "Institutional and Financial Determinants of Development: New Evidence from Advanced and Emerging Markets" By Juan Pineiro Chousa; Haider Ali Khan; Davit N. Melikyan; Artur Tamazian
  30. "Saving and Interest Rates in Japan: Why They Have Fallen and Why They Will Remain Low" By R. Anton Braun; Daisuke Ikeda; Douglas H. Joines
  31. "Bank Health and Investment: An Analysis of Unlisted Companies in Japan" By Shin-ichi Fukuda; Munehisa Kasuya; Jouchi Nakajima
  32. Price Discimination and Efficient Matching By Damiano, Ettore; Li, Hao
  33. Internet Auctions with Many Traders By Peters, Michael; Severinov, Sergei
  34. Labor-Use Efficiency in Indian Banking: A Branch Level Analysis By Abhiman Das; Subhash C. Ray; Ashok Nag
  35. Technical Efficiency and Stock Market Reaction to Horizontal Mergers By Yanna Wu; Subhash C. Ray
  36. Consumption Asymmetry and the Stock Market: Empirical Evidence By Nicholas Apergis; Stephen M. Miller
  37. The Value of Waiting: Foreign Direct Investment with Uncertainty and Imperfect Local Knowledge By Yongil Jeon; Taekwon Kim; Stephen M. Miller
  38. Exchange rate depreciation and exports: The case of Singapore revisited By WenShwo Fang; Stephen M. Miller
  39. Export Promotion through Exchange Rate Policy: Exchange Rate Depreciation or Stabilization? By WenShwo Fang; YiHao Lai; Stephen M. Miller
  40. Consumption asymmetry and the stock market: New evidence through a threshold adjustment model By Nicholas Apergis; Stephen M. Miller
  41. Does Exchange Rate Risk Affect Exports Asymmetrically? Asian Evidence By WenShwo Fang; YiHao Lai; Stephen M. Miller
  42. Buying Less, But Shopping More: Changes In Consumption Patterns During A Crisis By David McKenzie y Ernesto Schargrodsky
  43. A (New) Country Insurance Facility By Tito Cordella y Eduardo Levy Yeyati
  44. A Note on the Bias of using Futures Rates as a Proxy for the Instantaneous Forward Rate By Thuy-Duong To
  45. Yes, Wall Street, There Is a January Effect! Evidence from Laboratory Auctions By Lisa R. Anderson; Jeffrey R. Gerlach; Francis J. DiTraglia
  46. Do Vertical Mergers Facilitate Upstream Collusion? By Volker Nocke; Lucy White
  47. Dynamic analysis of bankruptcy and economic waves. By Irina Peaucelle
  48. Monetary Aggregation By William Barnett
  49. Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience By Tomáš Holub
  50. The CNB’s Policy Decisions – Are They Priced in by the Markets? By David Navrátil; Viktor Kotlán
  51. Stress Testing: A Review of key Concepts By Martin Čihák
  52. Designing Stress Tests for the Czech Banking System By Martin Čihák
  53. Predicting Bank CAMELS and S&P Ratings: The Case of the Czech Republic By Alexis Derviz; Jiří Podpiera
  54. EU Enlargement and Endogeneity of some OCA Criteria: Evidence from the CEECs By Ian Babetskii
  55. The Role of Banks in the Czech Monetary Policy Transmission Mechanism By Anca Pruteanu
  56. Credit Risk and Bank Lending in the Czech Republic By Narcisa Kadlčáková; Joerg Keplinger
  57. Market valuation and employee stock options By Zhang, Ge
  58. Heterogeneous beliefs and employee stock options By Jung, Wan; Zhang, Ge
  59. The value of interest rate stabilization polices when agents are learning By Duffy, John; Xiao, Wei
  60. Does futures exhibit maturity effect? New evidence from an extensive set of US and foreign futures contracts By Daal, Elton; Farhat, Joseph Basheer; Wei, Peihwang P.
  61. Quadratic term structure models with jumps in incomplete currency markets By Daal, Elton
  62. Volatility clustering, leverage effects, and jumps dynamics in emerging Asian equity markets By Daal, Elton; Naka, Atsuyuki; Yu, Jung-Suk
  63. Distributing excess cash: the role of specially designated dividends By Baker, H. Kent; Mukherjee, Tarun K.; Powell, Gary E.
  64. The impact of the dividend tax cut and managerial stock holdings on corporate dividend policy By Nam, Jouahn; Wang, Jun; Zhang, Ge
  65. The weekend trading profitability: evidence from international mutual funds By Mazumder, M. Imtiaz; Miller, Edward M.; Varela, Oscar Albert
  66. Strategic trading against retail investors with disposition effects By Nam, Jouahn; Wang, Jun; Zhang, Ge
  67. Aggregate vs Disaggregate Data Analysis — A Paradox in the Estimation of a Money Demand Function of Japan Under the Low Interest Rate Policy By Cheng Hsiao; Yan Shen; Hiroshi Fujiki
  68. Model Averaging and Value-at-Risk based Evaluation of Large Multi Asset Volatility Models for Risk Management By M. Hashem Pesaran; Paolo Zaffaroni
  69. Exploring the International Linkages of the Euro Area: A Global VAR Analysis By Stephane Dees; Filippo di Mauro; M. Hashem Pesaran; L. Vanessa Smith
  70. U.S. Real Exchange Rate Fluctuations and Relative Price Fluctuations By Caroline M. Betts; Timothy J. Kehoe
  71. Scope for Credit Risk Diversification By Samuel Hanson; M. Hashem Pesaran; Til Schuermann
  72. Monetary Policy Transparency:Too Good to be True? By Iris Biefang-Frisancho Mariscal; Peter Howells

  1. By: Shubhasis Dey; Gene Mumy
    Abstract: The difference between actual borrowings and borrowing limits alone generates information asymmetry in the credit card market. This information asymmetry can make the market incomplete and create ex post misallocations. Households that are denied credit could well turn out to be ex post less risky than some credit card holders who borrow large portions of their borrowing limits. Using data from the U.S. <em>Survey of Consumer Finances</em>, the authors find a positive relationship between borrower quality and borrowing limits, controlling for banks' selection of credit card holders and the endogeneity of interest rates. Their estimation reveals how interest rates have a negative influence on the optimal borrowing limits offered by banks.
    Keywords: Market structure and pricing; Econometric and statistical methods
    JEL: D4 D82 C3
    Date: 2005
  2. By: Cécile Carpentier; Jean-Marc Suret
    Abstract: To ease the financing of growing SMEs, governments found or indirectly fund venture capital companies. These companies act in a context of extreme information asymmetry and potentially exorbitant agency costs. The rigorous governance of these companies is thus pivotal to their performance. We analyze the financial reporting guidelines put in place for American SBICs by the Small Business Administration, along with the valuation guidelines issued by venture capital associations and institutions in several countries. SBICs are subject to rigorous uniform financial reporting and valuation standards, which likely partly explains their performance in recent years. We also describe the efforts of diverse institutions to develop venture capital valuation guidelines. The most rigorous methods entail filing the initial terms of the financial deal, which could allow more efficient control of the selection process of investments. The Quebec government would benefit from implementing more rigorous reporting and valuation guidelines. <P>Pour faciliter le financement des entreprises en croissance, les gouvernements mettent en place ou financent indirectement des sociétés de capital de risque. Celles-ci interviennent dans un contexte d’asymétrie informationnelle où les coûts d’agence sont potentiellement très élevés. L’encadrement strict de ces sociétés est donc une condition essentielle à leur performance. Nous analysons le cadre de reddition de comptes mis en place pour les Small Business Investment Companies (SBICs) par la Small Business Administration américaine, puis les normes d’évaluation des placements préconisés par les associations et organismes de capital de risque dans plusieurs pays. Les SBICs sont soumises à un cadre uniforme strict de reddition de comptes et d’évaluation, qui explique probablement en partie leur bonne performance dans les années récentes. Nous montrons également les efforts déployés par divers organismes pour développer un cadre d’évaluation des placements de capital de risque. Les méthodes les plus rigoureuses demanderaient l’archivage des conditions initiales du placement, ce qui contribuerait à un contrôle plus efficace du processus de sélection des investissements. Les initiatives québécoises gagneraient très certainement à disposer d’un cadre de reddition de comptes et d’évaluation plus strict que celui qui semble actuellement prévaloir.
    Keywords: public policy, venture capital, governance, reporting guidelines, valuation guidelines , politique publique, capital de risque, gouvernance, normes comptables, normes d’évaluation
    Date: 2005–03–01
  3. By: Cécile Carpentier; Jean-Marc Suret
    Abstract: Most countries have set up structures and programs for new business creation and financing. We analyze strategies implemented in France, Germany and United Kingdom, where the proportion of government funds in venture capital financing is significantly smaller than in the Quebec, yet the rate of creation and growth of tech start-ups is comparable. In these countries, intervention is based on R&D, transfer, incubation and start-up, in high technology industries exclusively. Except in France, universities are pivotal to new business creation. Internal or subordinated divisions of ministries are created to manage and evaluate governmental programs, define priorities and avoid financing non-crucial industries. Often of limited duration, government programs must abide by rigorous performance and accreditation criteria. Tax incentives are generally not associated with these initiatives. <P>La plupart des pays ont instauré des institutions et des mécanismes dédiés à la création de nouvelles entreprises et au financement de leur croissance. Nous analysons les stratégies mises en place par la France, l’Allemagne et le Royaume-Uni. Dans ces pays, la part de l’État dans le financement par capital de risque est significativement inférieure à celle du Québec sans que la performance en termes de création et de croissance d’entreprises technologiques ne semble inférieure. Ces pays ont privilégié une action ciblée, axée sur les stades de R&D, transfert, incubation et démarrage, clairement restreinte aux technologies. Les universités sont, à l’exception de la France, au centre de l’effort de création de nouveaux projets d’entreprises. Des structures internes ou directement subordonnées aux ministères sont mises en place pour gérer et évaluer les programmes, établir les priorités et éviter les dérapages vers des secteurs en demande de fonds mais non prioritaires. Les programmes, dont la durée de vie est souvent limitée, sont très largement soumis à des critères de performance et d’accréditation rigoureux. Les modes d’intervention autres que les déductions fiscales sont privilégiés.
    Keywords: small business, public policy, business creation, financing, start-ups, petite entreprise, politiques publiques, création d'entreprises, financement, Europe
    Date: 2005–03–01
  4. By: Olivier Pierrard
    Abstract: Empirical evidence shows that some firms may be capital constraintbecause of capital market imperfections. We therefore extend the business cycle models with frictions `a la Pissarides on the labour market by also introducing symmetric frictions on the capital market. We show that the capital market frictions (and their interactions with the labour market frictions) improve the statistical properties of the model and generate a financial accelerator.
    Keywords: capital market frictions; business cycle; monetary transmission
    JEL: E13 E24 E51
    Date: 2005–02
  5. By: DING, Yuan; JEANJEAN, Thomas; STOLOWY, Hervé
    Abstract: Historically, the format of financial statements has varied from one country to another. Recently, due to the attractiveness of their capital markets, the strength of their accounting professions and the influence of their institutional investors, Anglo-American countries have seen the impact of their accounting practices on other nations increase steadily, even influencing the actual format of financial statements. Given that French accounting regulations allow a certain degree of choice in consolidated balance sheet format (‘by nature’ or ‘by term’) and income statement format (‘by nature’ or ‘by function’), this study examines a sample of 199 large French listed firms in an attempt to understand why some of these firms do not use the traditional French formats (‘by nature’ for the balance sheet and ‘by nature” for the income statement), instead preferring Anglo-American practices (‘by term’ format for the balance sheet and ‘by function’ format for the income statement). We first analyze the balance sheet and income statement formats separately using a logit model, then combine the two and enrich the research design with a generalized ordered logit model and a multinomial logit regression. Our results confirm that the major driving factor behind the adoption of one or two alternative formats is the firm’s degree of internationalization, not only financial (auditor type, foreign listing and the decision to apply alternative accounting standards) but also commercial (company size and the internationalization of sales).
    Keywords: Disclosure; Determinants; Financial Statements; Alternative format; France; Logit; Generalized ordered logit; Multinomial logit
    JEL: M41
    Date: 2005–01–30
  6. By: Takashi Shiraishi
    Date: 2005–03
  7. By: Arikawa Yasuhiro; Miyajima Hideaki
    Abstract: The purpose of this paper is to provide an overview of the relationship banking in Japan in the 1990s. We show the increasing dependence on bank borrowing in spite of the deregulation of bond market in the mid 1990s in terms of the debt composition, and we confirm the loan from main-bank also increases among the firms with higher bank borrowing. Then, we examine the effects of these facts on borrowing firm behavior. By estimating the employment adjustment function, we present that main bank did not discipline effectively firms that were required the corporate restructuring, while it encouraged the restructuring of the firm with relatively better performance.
    Date: 2005–03
  8. By: Eiji Ogawa; Junko Shimizu
    Abstract: The monetary authorities in East Asian countries have been strengthening their regional monetary cooperation since the Asian Currency Crisis in 1997. In this paper, we propose a deviation measurement for coordinated exchange rate policies in East Asia to enhance the monetary authorities' surveillance process for their regional monetary cooperation. We estimate an AMU (Asian Monetary Unit) as a weighted average of East Asian currencies according to the method to calculate the ECU used under the EMS before introducing the euro into some EU countries. We consider four types of AMU, which are based on trade volume, nominal GDP, GDP measured at PPP, and international reserves. After choosing both the AMUs based on GDP measured at PPP weight and trade weight from a viewpoint of stability of the AMU value in terms of a currency basket composed of the US dollar and the euro, we calculate the deviation indicators from the benchmark rates for each of the East Asian currencies. We compare both nominal and real deviation indicators by taking into account inflation rate differentials. The real deviation indicator should be adequate for surveillance over effects of exchange rate policy on real economy while the nominal one can be frequently watched in real time.
    Date: 2005–03
  9. By: Francisco Ledesma-Rodríguez; Jorge Pérez-Rodríguez; Simón Sosvilla-Rivero
  10. By: Carlos M. Fernández-Otheo; Rafael Myro
  11. By: Sarai Criado Nuevo
  12. By: Francisco J. Ledesma-Rodríguez; Manuel Navarro-Ibáñez; Jorge V. Pérez-Rodríguez; Simón Sosvilla-Rivero
  13. By: Rubens Penha Cysne (EPGE/FGV)
    Date: 2005–03
  14. By: Floden, Martin (Dept. of Economics, Stockholm School of Economics)
    Abstract: This paper examines aggregate savings in a general equilibrium model where infinitely lived households face volatile (and possibly uncertain) income paths, hold a risk-free asset, and face a liquidity constraint. I first show that the equilibrium capital stock in an economy without uncertainty, but where individual income varies, can be larger than in an economy where each household's income is constant. When income is stochastic, the equilibrium capital stock is always larger than when income is constant. This additional capital accumulation has sometimes been interpreted as precautionary savings, but I demonstrate that it is mostly generated by permanent-income motives.
    Keywords: equilibrium interest rate; aggregate savings; precautionary saving; infinite horizon; general equilibrium
    JEL: D52 D91 E21
    Date: 2005–03–23
  15. By: Sun, Junjie
    Abstract: This paper reviews both theoretical and empirical studies of financial transmission rights (FTRs) in the major U.S. wholesale power markets. Although the current literature hold more negative views about FTRs, this paper presents a simple illustrative 2-stage model to study the competitive behaviors of electricity generators and load serving entities (LSEs) and analyzes the welfare effects of FTRs in the restructuring U.S. wholesale power market framework. The analysis focuses on a competitive two-node electricity network model where there is one generator and one LSE in each node with linear marginal cost and demand function, supervised by an independent system operator (ISO). In the first-stage of modelling, a no-rights benchmark model is developed to solve for the optimal quantity of power production and consumption and derive the locational marginal price for each node, which serve as the building blocks to solve for the optimal FTR hedge positions in the second-stage model. Once a stochastic parameter shock is introduced, the second-stage model shows that the acquisition of optimal FTRs by the risk averse generators and LSEs increases and in general strictly increases the social welfare compared with the case where there is no FTRs available. This result provides a counterexample to the somewhat negative views about FTRs held by other economists in the literature and provides some economic explanations to the fact that FTRs are widely adopted as a financial hedge instrument in the major U.S. wholesale power markets.
    Date: 2005–03–24
  16. By: Daniela Mantovani (University of Cambridge and Prometeia); Fotis Papadopoulos (Athens University of Economics and Business); Holly Sutherland (ISER, University of Essex); Panos Tsakloglou (Athens University of Economics and Business and IZA Bonn)
    Abstract: This paper considers the effects on current pensioner incomes of reforms designed to improve the long-term sustainability of public pension systems in the European Union. We use EUROMOD to simulate a set of common illustrative reforms for four countries selected on the basis of their diverse pension systems and patterns of poverty among the elderly: Denmark, Germany, Italy and the UK. The variations in fiscal and distributive effects on the one hand suggest that different paths for reform are necessary in order to achieve common objectives across countries, and on the other provide indications of the appropriate directions for reform in each case.
    Keywords: pensions, European Union, microsimulation
    JEL: C81 I30 H55
    Date: 2005–03
  17. By: Anders Møller Christensen (Danmarks Nationalbank); Heino Bohn Nielsen (Institute of Economics, University of Copenhagen)
    Abstract: Relationships between the Federal funds rate, unemployment, inflation, and the long-term government-bond rate are investigated with cointegration techniques. We find a stable long-term relationship between the Federal funds rate, unemployment, and the bond rate. This relationship is interpretable as a policy target because deviations are corrected primarily via the Federal funds rate. A traditional Taylor-type rule is clearly rejected by the data. Inflation does thus only influence the instrument indirectly via the bond rate, but we find that inflation is controllable with the Federal funds rate. The results are in accordance with recent developments in monetary theory stressing management of expectations as an important transmission channel.
    Keywords: cointegration; equilibrium correction; monetary policy; Taylor rule; Bond rate
    JEL: C32 E52
    Date: 2005–02
  18. By: Morten Nalholm (Department of Finance, Copenhagen Business School); Rolf Poulsen (Institute for Mathematical Sciences, University of Copenhagen)
    Abstract: We investigate how sensitive a variety of dynamic and static hedge strategies for barrier options are to model risk. We find that using plain vanilla options to hedge barrier options offers considerable improvements over usual ?-hedges. Further, we show that the hedge portfolios involving options are relatively more sensitive to model risk, the Devil is in the detail, but that the degree of misspecification sensitivity is quite robust across commonly used models.
    Date: 2005–03
  19. By: Martin Boileau; Michel Normandin
    Abstract: Several authors argue that international real business cycle (IRBC) models with incomplete financial markets offer a good explanation of the ranking of cross-country correlations. Unfortunately, this conclusion is suspect, because it is commonly based on an analysis of the near steady state dynamics using a linearized system of equations. The baseline IRBC model with incomplete financial markets does not possess a unique deterministic steady state and, as a result, its linear system of difference equations is not stationary. We show that the explanation of the ranking of cross-country correlations is robust to modifications that ensure a unique steady state and a stationary system of linear difference equations. We find, however, that the modifications affect the quantitative predictions regarding key macroeconomic variables.
    Keywords: Incomplete markets, stationarity, cross-country correlations, wealth effects
    JEL: F32 G15
    Date: 2005
  20. By: Nicholas Chan; Mila Getmansky; Shane M. Haas; Andrew W. Lo
    Abstract: Systemic risk is commonly used to describe the possibility of a series of correlated defaults among financial institutions---typically banks---that occur over a short period of time, often caused by a single major event. However, since the collapse of Long Term Capital Management in 1998, it has become clear that hedge funds are also involved in systemic risk exposures. The hedge-fund industry has a symbiotic relationship with the banking sector, and many banks now operate proprietary trading units that are organized much like hedge funds. As a result, the risk exposures of the hedge-fund industry may have a material impact on the banking sector, resulting in new sources of systemic risks. In this paper, we attempt to quantify the potential impact of hedge funds on systemic risk by developing a number of new risk measures for hedge funds and applying them to individual and aggregate hedge-fund returns data. These measures include: illiquidity risk exposure, nonlinear factor models for hedge-fund and banking-sector indexes, logistic regression analysis of hedge-fund liquidation probabilities, and aggregate measures of volatility and distress based on regime-switching models. Our preliminary findings suggest that the hedge-fund industry may be heading into a challenging period of lower expected returns, and that systemic risk is currently on the rise.
    JEL: G12
    Date: 2005–03
  21. By: Daron Acemoglu; Asuman Ozdaglar
    Abstract: We study the efficiency of oligopoly equilibria in congested markets. The motivating examples are the allocation of network flows in a communication network or of traffic in a transportation network. We show that increasing competition among oligopolists can reduce efficiency, measured as the difference between users' willingness to pay and delay costs. We characterize a tight bound of 5/6 on efficiency in pure strategy equilibria. This bound is tight even when the number of routes and oligopolists is arbitrarily large. We also study the efficiency properties of mixed strategy equilibria.
    JEL: D43 C62
    Date: 2005–03
  22. By: Robert Inman
    Abstract: The macro-economic and micro-economic evidences makes a persuasive case for cities as important centers for productive efficiency, innnovation, and economic growth. For cities to achieve their full economic potential, however, complementary public services are required. This paper reviews the arguments and the evidence for the efficient financing and governance of city public services. Against the criterion of efficiency, city services should be limited to those services valued by city residents; financing should assign residential taxes to residential services and business land taxes and fees to business services; and city governance should foster competition and choice.
    JEL: H11 H7 R38 R51
    Date: 2005–03
  23. By: Stefano DellaVigna; Joshua M. Pollet
    Abstract: Do investors pay enough attention to long-term fundamentals? We consider the case of demographic information. Cohort size fluctuations produce forecastable demand changes for age-sensitive sectors, such as toys, bicycles, beer, life insurance, and nursing homes. These demand changes are predictable once a specific cohort is born. We use lagged consumption and demographic data to forecast future consumption demand growth induced by changes in age structure. We find that demand forecasts predict profitability by industry. Moreover, forecasted demand changes 5 to 10 years in the future predict annual industry returns. One additional percentage point of annualized demand growth due to demographics predicts a 5 to 10 percentage point increase in annual abnormal industry stock returns. However, forecasted demand changes over shorter horizons do not predict stock returns. The predictability results are more substantial for industries with higher barriers to entry and with more pronounced age patterns in consumption. A trading strategy exploiting demographic information earns an annualized risk-adjusted return of 5 to 7 percent. We present a model of underreaction to information about the distant future that is consistent with the findings.
    JEL: G1 J1 D0
    Date: 2005–03
  24. By: Genevieve Boyreau-Debray; Shang-Jin Wei
    Abstract: State-owned financial institutions have been proposed as a way to address market failure, but the recent literature has also highlighted their pathological problems. This paper studies the case of China for pitfalls of a state-dominated financial system, including possible segmentation of the internal capital market due to local government interference and mis-allocation of capital. Even without formal legal prohibition to capital movement across regions, we find that capital mobility within China is low. Furthermore, to the extent some capital moves around the country, the government (as opposed to the private sector) tends to allocate capital systematically away from more productive regions toward less productive ones. In this context, a smaller role of the government in the financial sector might increase economic efficiency and the rate of economic growth.
    JEL: G1 F3
    Date: 2005–03
  25. By: Richard K. Lyons; Michael J. Moore
    Abstract: This paper addresses currency competition from an information perspective. Transactions in traditional models do not convey information, so transaction costs %u2013 the driver of competition outcomes %u2013 are driven by market size. In our model transactions do convey information (consistent with recent empirical findings). Several important departures arise. First, adding the information dimension resolves the traditional indeterminacy of currency trade patterns (by mitigating the concentrating force of market-size economies). Second, whether transactions are executed directly or through a vehicle actually affects prices (because these trading methods do not in general reveal the same information). Third, our model provides a new rationale for why some currency pairs never trade directly (information is not sufficiently symmetric to support trading). Fourth, our model formalizes the arbitrage process and shows that arbitrage transaction quantities and price levels are jointly determined. Empirically, the paper provides a first integrated analysis of transactions in a triangle of markets: ¥/$, $/ %u20AC, and ¥/ %u20AC. Data for the full triangle permits comparison of direct, indirect and arbitrage transactions, for each pair. The information model predicts that transactions should affect prices across markets (e.g., flow in the ¥/$ market should convey information relevant to $/ %u20AC and ¥/ %u20AC prices), which is borne out.
    JEL: F3 F4 G1
    Date: 2005–03
  26. By: Claude B. Erb; Campbell R. Harvey
    Abstract: Historically, commodity futures have had excess returns similar to those of equities. But what should we expect in the future? The usual risk factors are unable to explain the time-series variation in excess returns. In addition, our evidence suggests that commodity futures are an inconsistent, if not tenuous, hedge against unexpected inflation. Further, the historically high average returns to a commodity futures portfolio are largely driven by the choice of weighting schemes. Indeed, an equally weighted long-only portfolio of commodity futures returns has approximately a zero excess return over the past 25 years. Our portfolio analysis suggests that the a long-only strategic allocation to commodities as a general asset class is a bet on the future term structure of commodity prices, in general, and on specific portfolio weighting schemes, in particular. In contrast, we provide evidence that there are distinct benefits to an asset allocation overlay that tactically allocates using commodity futures exposures. We examine three trading strategies that use both momentum and the term structure of futures prices. We find that the tactical strategies provide higher average returns and lower risk than a long-only commodity futures exposure.
    JEL: G11 G12 G13 E44
    Date: 2005–03
  27. By: Joseph Golec; Shantaram Hegde; John Vernon
    Abstract: Political pressure in the United States is again building to constrain pharmaceutical prices either directly or through legalized reimportation of lower-priced pharmaceuticals from foreign countries. This study uses the Clinton Administration's Health Security Act (HSA) of 1993 as a natural experiment to show how threats of price constraints affect firm-level R&D spending. We link events surrounding the HSA to pharmaceutical company stock price changes and then examine the cross-sectional relation between the stock price changes and subsequent unexpected R&D spending changes. Results show that the HSA had significant negative effects on firm stock prices and R&D spending. Conservatively, the HSA reduced R&D spending by $1.6 billion, even though it never became law. If the HSA had passed, and had many small firms not raised capital just prior to the HSA, the R&D effects could have been much larger.
    JEL: G31 O32 L65 I1
    Date: 2005–03
  28. By: Kenichiro Suzuki; David Cobham
    Keywords: financial systems, corporate finance, bank-industry relationships, main bank, firm size, Japan.
    JEL: G1 G3
  29. By: Juan Pineiro Chousa (University of Santiago de Compostela); Haider Ali Khan (GSIS, University of Denver); Davit N. Melikyan (Institute of Management and Economic Reforms and AEPLAC); Artur Tamazian (University of Santiago de Compostela)
    Abstract: The paper tests <i>the democratization-development hypothesis</i>, namely that democratization has a positive impact on growth, economic development and changes in well-being. We employ a probit model to estimate the probabilistic indicator for democracy for a large sample of countries. Panel regressions are applied to explain the impact on growth of democratic political institutions, economic institutions and efficiency of financial management, along with other more "traditional" factors. The empirical findings support the hypothesis of the decisive role of democratic political and efficient economic institutions in stimulating economic growth. The main results also highlight the importance of effective allocation of financial resources. In addition to the growth regression results, it is argued, consistently with the capabilities approach to development by Sen, that many of the explanatory variables in the growth regression are positively related to development as capabilities enhancement. This is particularly true for democratic freedoms. Finally the problem of 'optimal' institutional development is discussed within the context of resource allocation, migration flows and political decision making.
    Date: 2005–03
  30. By: R. Anton Braun (Faculty of Economics, University of Tokyo); Daisuke Ikeda (Bank of Japan); Douglas H. Joines (Marshall School of Business, University of Southern California)
    Abstract: This paper quantifies the role of alternative shocks in accounting for the recent declines in Japanese saving rates and interest rates and provides some projections about their future course. We consider four distinct sources of variation in saving rates and real interest rates: changes in fertility rates, changes in survival rates, changes in technology and changes in uninsurable labor income risk. The emprical relevance of these factors is explored using a computable dynamic OLG model. We find that the combined effects of demographics and slower total factor productivity growth successfully explain both the levels and the magnitudes of the declines in the saving rate and the after-tax real interest rate during the 1990s. Model simulations indicate that the Japanese savings puzzle is over.
    Date: 2005–03
  31. By: Shin-ichi Fukuda (Faculty of Economics, University of Tokyo); Munehisa Kasuya (Research and Statistics Department, The Bank of Japan); Jouchi Nakajima (Graduate School of Economics, University of Tokyo)
    Abstract: To the extent that a borrower faces switching costs in a relationship with an individual bank, bank-specific financial health might affect a borrower's cost of funds. The costs would be particularly large for firms that have a close relationship with limited number of banks. The purpose of this paper is to investigate whether weakened financial conditions of banks reduced investment of small and medium firms in Japan. Estimating Tobin's Q investment functions, we examine the determinants of investment for unlisted Japanese companies in the late 1990s and the early 2000s. We find that several measures on bank-specific financial health have significantly large impacts on borrower's investment, even when observable characteristics relating to Tobin's Q, cash-flow, and leverage are controlled for. We also find that multiple banking relationships, which tend to have a negative impact on investment in general, may be beneficial in relieving a hold up problem when deteriorated bank health does matter.
    Date: 2005–03
  32. By: Damiano, Ettore; Li, Hao
    Abstract: This paper considers the problem of a monopoly matchmaker that uses a schedule of entrance fees to sort different types of agents on the two sides of a matching market into exclusive meeting places, where agents randomly form pairwise matches. We make the standard assumption that the match value function exhibits complementarities, so that matching types at equal percentiles maximizes total match value and is efficient. We provide necessary and sufficient conditions for the revenue-maximizing sorting to be efficient. These conditions require the match value function, modified to incorporate the incentive cost of eliciting private type information, to exhibit complementarities along the efficient path of matching types at equal percentiles.
    Date: 2005–03–21
  33. By: Peters, Michael; Severinov, Sergei
    Abstract: We study a multi-unit auction environment similar to eBay. Sellers, each with a single unit of a homogenous good, set reserve prices at their own independent second-price auctions. Each buyer has a private value for the good and wishes to acquire a single unit. Buyers can bid as often as they like and move between the sellers' auctions in a dynamic environment. We characterize a perfect Bayesian equilibrium for this decentralized trading mechanism in which, conditional on reserve prices, an efficient set of trades occurs at a uniform trading price. When the number of buyers and sellers is large but finite, the sellers set reserve prices equal to their true costs under a very mild distributional assumption, so ex-post efficiency is achieved. The buyers' strategies in this equilibrium are very simple and do not depend on their beliefs about the other buyers' valuations, or the number of buyers and sellers. They bid almost myopically. Their only `sophisticated' choice is where to bid when they are indifferent between several sellers.
    Date: 2005–03–30
  34. By: Abhiman Das (Reserve Bank of India); Subhash C. Ray (University of Connecticut); Ashok Nag (Reserve Bank of India)
    Abstract: This paper uses Data Envelopment Analysis to measure labor use efficiency of individual branches of a large public sector bank with several thousand branches across India. We find considerable variation in the average levels of efficiency across the four metropolitan regions considered in this study. In this context, we introduce the concept of area or spatial efficiency for each region relative to the nation as a whole. Our findings suggest that the policies, procedures, and incentives handed down from the corporate level cannot fully neutralize the influence of the local work culture in the different regions. Most of the potential reduction in labor cost appears to be coming from possible downsizing the clerical and subordinate staff. Our analysis identifies branches that operate at very low levels of efficiency and may be gainfully merged with other branches wherever possible.
    Keywords: Bank, Efficiency, Branch, Cost
    JEL: G21 G28 L11 L89 C33
    Date: 2005–03
  35. By: Yanna Wu (PricewaterhouseCooper LLP); Subhash C. Ray (University of Connecticut)
    Abstract: This study examines the relationship between stock market reaction to horizontal merger announcements and technical efficiency levels of the participating firms. The analysis is based on data pertaining to eighty mergers between firms in the U.S. manufacturing industry during the 1990s. We employ Data Envelopment Analysis (DEA) to measure technical efficiency, which capture the firms. competence to produce the maximum output given certain productive resources. Abnormal returns related to the merger announcements provide the investor.s re-evaluation on the future performance of the participating firms. In order to avoid the problem of nonnormality, heteroskedasticity in the regression analysis, bootstrap method is employed for estimations and inferences. We found that there is a significant relationship between technical efficiency and market response. The market apparently welcomes the merger as an arrangement to improve resource utilizations.
    JEL: G14 C61 C15
    Date: 2005–03
  36. By: Nicholas Apergis (University of Macedonia, Greece); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper examines whether U.S. stock-market wealth asymmetrically affects consumption. After identifying asymmetric behavior for consumption and stock market wealth, the results confirm that stock-market wealth asymmetrically affects real per capita consumption. Negative 'news' affects consumption more than positive 'news'.
    Keywords: Consumption; Stock market; Wealth effect; Asymmetry
    JEL: E21 E44
    Date: 2004–10
  37. By: Yongil Jeon (Central Michigan University); Taekwon Kim (Yonsei University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper examines the role of uncertainty and imperfect local knowledge in foreign direct investment. The main idea comes from the literature on investment under uncertainty, such as Pindyck (1991) and Dixit and Pindyck (1994). We empirically test .the value of waiting. with a dataset on foreign direct investment (FDI). Many factors (e.g., political and economic regulations) as well as uncertainty and the risks due to imperfect local knowledge, determine the attractiveness of FDI. The uncertainty and irreversibility of FDI links the time interval between permission and actual execution of such FDI with explanatory variables, including information on foreign (home) countries and domestic industries. Common factors, such as regulatory change and external shocks, may affect the uncertainty when foreign investors make irreversible FDI decisions. We derive testable hypotheses from models of investment under uncertainty to determine those possible factors that induce delays in FDI, using Korean data over 1962 to 2001.
    Keywords: Foreign Direct Investment, Irreversibility, Uncertainty, Imperfect information, Investment Delay
    JEL: F21 G31 O16
    Date: 2004–07
  38. By: WenShwo Fang (Feng Chia University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper revisits the weak relationship between exchange rate depreciation and exports for Singapore, using a bivariate GARCH-M model that simultaneously estimates time-varying risk. The evidence shows that depreciation does not significantly improve exports, but that exchange rate risk significantly impedes exports. In sum, Singaporean policy makers can better promote export growth by stabilizing the exchange rate rather than generating its depreciation.
    Keywords: depreciation, exchange rate risk, exports, bivariate GARCH-M model
    JEL: F14 F31
    Date: 2004–12
  39. By: WenShwo Fang (Feng Chia University); YiHao Lai (Deng Chia University); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: Exchange rate movements affect exports in two ways -- its depreciation and its variability (risk). A depreciation raises exports, but the associated exchange rate risk could offset that positive effect. The present paper investigates the net effect for eight Asian countries using a dynamic conditional correlation bivariate GARCH-M model that simultaneously estimates time varying correlation and exchange rate risk. Depreciation encourages exports, as expected, for most countries, but its contribution to export growth is weak. Exchange rate risk contributes to export growth in Malaysia and the Philippines, leading to positive net effects. Exchange rate risk generates a negative effect for six of the countries, resulting in a negative net effect in Indonesia, Japan, Singapore, Taiwan and a zero net effect in Korea and Thailand. Since the negative effect of exchange rate risk may offset, or even dominate, positive contributions from depreciation, policy makers need to reduce exchange rate fluctuation along with and possibly before efforts to depreciate the currency.
    Keywords: exports, exchange rate policy, net effect, DCC bivariate GARCH-M model
    JEL: F14 F31
    Date: 2005–03
  40. By: Nicholas Apergis (University of Macedonia, Greece); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper investigates whether stock market wealth affects real consumption asymmetrically through a threshold adjustment model. The empirical findings for the US show that wealth produces an asymmetric effect on real consumption, with negative 'news' affecting consumption less than positive 'news.' Thus, policy makers may want to focus more attention on preventing asset 'bubbles' than on responding to negative asset shocks.
    Keywords: Consumption; Stock market; Wealth effect; Asymmetry
    JEL: E21 E44
    Date: 2005–03
  41. By: WenShwo Fang (Feng Chia University); YiHao Lai (Feng Chia University); Stephen M. Miller (University of Connecticut and University of Nevada Las Vegas)
    Abstract: The effects of exchange rate risk have interested researchers, since the collapse of fixed exchange rates. Little consensus exists, however, regarding its effect on exports. Previous studies implicitly assume symmetry. This paper tests the hypothesis of asymmetric effects of exchange rate risk with a dynamic conditional correlation bivariate GARCH(1,1)-M model. The asymmetry means that exchange rate risk (volatility) affects exports differently during appreciations and depreciations of the exchange rate. The data include bilateral exports from eight Asian countries to the US. The empirical results show that real exchange rate risk significantly affects exports for all countries, negative or positive, in periods of depreciation or appreciation. For five of the eight countries, the effects of exchange risk are asymmetric. Thus, policy makers can consider the stability of the exchange rate in addition to its depreciation as a method of stimulating export growth.
    Keywords: depreciation, exchange rate risk, exports, bivariate GARCH-M model
    JEL: C32 F14 F31 F41
    Date: 2005–03
  42. By: David McKenzie y Ernesto Schargrodsky
    Abstract: Market research data are utilized to examine the use of changes in shopping behavior as a method of mitigating the effects of the 2002 Argentine economic crisis. Although the total quantity and real value of goods purchased fell during the crisis, consumers are found to be spending more days shopping. This increase in shopping frequency occurs through consumers purchasing lower-quality goods from a wider variety of shopping channels. This paper provides the first estimates of the magnitude of such effects during a recession, and suggests that this increase in shopping frequency can be an important coping mechanism for households. Shopping more often is shown to enable households to seek out lower prices and locate substitutes, allowing a given level of expenditure to buy more goods.
    Date: 2005
  43. By: Tito Cordella y Eduardo Levy Yeyati
    Abstract: To cope with the self-fulfilling liquidity runs that triggered many recent financial crises, we propose the creation of a country insurance facility. The facility, which we envisage as complementary to the existing multilateral lending facilities, would provide eligible countries with automatic access to a credit line at a predetermined interest rate. Eligibility criteria should be easily verifiable, focus on debt sustainability, and take into account the currency and maturity composition of the debt. Other critical design issues considered here include the size of the facility, its duration and charges, and the exit costs for a country that loses eligibility.
    Date: 2005
  44. By: Thuy-Duong To (School of Finance and Economics, University of Technology, Sydney)
    Abstract: The note shows that there is a non-negligible bias in using the futures rates as a proxy for the instantaneous forward rates in the estimation of forward rate models. It is therefore desirable to derive the evolution of observable rates, then use the distributional properties of this evolution to do the estimation. In a general case where these properties are hard to obtained, a filtering technique is required.
    Keywords: Heath-Jarrow-Morton; forward rate; futures; estimation bias
    JEL: C51 E43 G12 G13
    Date: 2004–12–01
  45. By: Lisa R. Anderson (Department of Economics, College of William and Mary); Jeffrey R. Gerlach (Department of Economics, College of William and Mary); Francis J. DiTraglia (Department of Economics, College of William and Mary)
    Abstract: In the first experimental test of the January effect, we find an economically large and statistically significant result in two very different auction environments. After controlling for variables that could influence subjectsÕ bids such as differences in private values, cumulative earnings, and learning effects, the prices in the January markets were systematically higher than those in December. The results suggest that psychological factors may contribute to the well-documented January effect in empirical stock market data, a conclusion that clearly violates the efficient markets hypothesis.
    Date: 2005–03–28
  46. By: Volker Nocke (Department of Economics, University of Pennsylvania); Lucy White (Harvard Business School)
    Abstract: We investigate the impact of vertical mergers on upstream firms' ability to sustain tacit collusion in a repeated game. We identify several effects and show that the net effect of vertical integration is to facilitate collusion. Most importantly, vertical mergers facilitate collusion through the operation of an outlets effect: cheating unintegrated firms can no longer profitably sell to the downstream affiliates of their integrated rivals. However, vertical integration also gives rise to an opposing punishment effect: it is typically more difficult to punish an integrated structure, so that integrated firms are able to make more profits in the punishment phase than unintegrated upstream firms. When downstream firms can condition their prices or quantities on upstream firms' contract offers, two additional effects arise, both of which further facilitate upstream collusion. First, an unintegrated upstream firm's deviation profits are reduced by the reaction effect which arises since the downstream unit of the integrated firm will now react aggressively to upstream deviations. Second, an integrated firm's deviation profit is reduced by the lack-of-commitment effect as it cannot commit to its own downstream price when deviating upstream.
    Keywords: vertical merger, collusion, vertical restraint, vertical integration, repeated game, penal code
    JEL: L13 L42 D43
    Date: 2005–03–08
  47. By: Irina Peaucelle
    Date: 2005
  48. By: William Barnett (Department of Economics, The University of Kansas)
    Abstract: This entry on monetary aggregation will appear under that title in The New Palgrave Dictionary of Economics, 2nd edition, edited by Steven Durlauf and Lawrence Blume. The entry provides an up-to-date overview of state-of-the-art research on monetary aggregation and index number theory, from its origins in 1980 to the current time. At the end of this dictionary entry, emphasis is placed on ongoing research on extensions to risk and to multilateral aggregation within multicountry areas, such as the euro area. Research on monetary aggregation theory has been especially successful in solving the 'puzzles' that have appeared in the monetary economics literature over the past 35 years.
    Keywords: monetary aggregation, Divisia index, money demand, monetary policy, dictionary, Divisia monetary aggregates
    JEL: E41 G12 C43 C22
    Date: 2005–03
  49. By: Tomáš Holub
    Abstract: This paper discusses the role of foreign exchange interventions in the inflation-targeting regime, focusing on the Czech experience since 1998. It proposes criteria for assessing whether the interventions are consistent with the inflation targeting. While the CNB’s interventions in mid- 1998 and in 2002 pass these criteria easily, the judgement might be more uncertain concerning the interventions in early-1998 and in 1999/2000. It is also stressed that the literature on managed floating usually ignores the difficulty in defining clear procedural rules for the interventions. This contrasts with the procedures guiding the interest rate decisions under the inflation targeting regime, which may occasionally create tensions in the policy regime, as demonstrated by the Czech experience, too. The interventions’ effectiveness in the Czech Republic is also discussed. It seems that sometimes they might have had an immediate impact lasting up to 2 or 3 months, but no strategy can be identified that would work in all episodes. Moreover, even many of the “successful” interventions were not able to prevent quite prolonged periods of exchange rate overvaluation in 1998 and in 2002. It is concluded that the signalling role of foreign exchange interventions is more important than their “market-equilibrating effect”, implying a rather unstable transmission between the central bank actions and the market reactions. Finally, the paper analyses the sterilisation costs, which are shown to have been quite substantial in the Czech Republic. It is argued that the financial sustainability of the interventions is quite important for their credibility and effectiveness.
    Keywords: Exchange rate, foreign exchange interventions, inflation targeting, sterilisation.
    JEL: E42 E44 E52 E58 E65 F31
  50. By: David Navrátil; Viktor Kotlán
    Abstract: This paper asks to what extent the market prices in the future monetary policy decisions of the Czech National Bank (CNB), how this policy predictability has evolved over time, and whether the change in the central bank’s forecasting methodology in mid-2002 had any impact. Using a sample up to mid-2004, the results are threefold. First, three-quarters of the CNB’s decisions were in line with medium-term money market expectations. Notwithstanding this relatively high predictability of CNB policy, the average mistake in the expectations was biased upwards: over the entire IT period the market has priced in a higher repo rate than has actually turned out to be the case. Second, our analysis shows that the period in which forecasts with an active monetary policy (unconditional forecasts) have been used is characterized by smaller “surprises” of the money market. On the one hand, this may be connected with a change in the CNB’s communication of the forecast, including releases of verbal comments on the interest rate trajectory that is consistent with the outlook. On the other hand, it may reflect a different economic environment in the second stage of IT in the Czech Republic. Third, we analyze whether there is convergence or divergence between the central bank’s forecast-consistent interest rate trajectory and market forward rates. We show that in most cases market rates converged toward the CNB’s interest rate trajectory after the publication of the forecast.
    Keywords: Financial market reaction, inflation targeting, monetary policy predictability, term structure of interest rates.
    JEL: E43 E44 E52
  51. By: Martin Čihák
    Abstract: The note is a review of the literature on the quantitative methods used to assess the vulnerabilities of financial systems to risks. In particular, the author focuses on the role of system-wide stress testing. He summarizes the recent developments in the literature, highlighting topics relevant for the Czech case. He presents the key concepts relating to systemwide stress tests, overviews the stress tests performed by central banks and international financial institutions, and discusses conceptual issues relating to modeling of individual risk factors.
    Keywords: Financial soundness, macroprudential analysis, stress tests.
    JEL: G21 G28 E44
  52. By: Martin Čihák
    Abstract: The note discusses key issues involved in designing a suitable set of stress tests for the Czech banking system. The aim of the note is to propose stress tests that could be used by the Czech National Bank on a regular basis to assess the soundness of domestic banks, both for purposes of macroprudential surveillance and for banking supervision. The author suggests that the exercise be broadly based on the stress tests conducted during the 2001 IMF-World Bank Financial Sector Assessment Program (FSAP) mission to the Czech Republic. He summarizes the FSAP stress tests, and proposes a number of extensions and modifications. The key recommendations are presented in a table that covers also data requirements and a suggested timeframe for implementation. The note includes results of a replication of the Czech FSAP stress tests for mid-2003 data.
    Keywords: Banking system, stress tests.
    JEL: G21 G28 E44
  53. By: Alexis Derviz; Jiří Podpiera
    Abstract: In this paper we investigate the determinants of the movements in the long-term Standard & Poors and CAMELS bank ratings in the Czech Republic during the period when the three biggest banks, representing approximately 60% of the Czech banking sector’s total assets, were privatized (i.e., the time span 1998–2001). The same list of explanatory variables corresponding to the CAMELS rating inputs employed by the Czech National Bank’s banking sector regulators was examined for both ratings in order to select significant predictors among them. We employed an ordered response logit model to analyze the monthly long-run S&P rating and a panel data framework for the analysis of the quarterly CAMELS rating. The predictors for which we found significant explanatory power are: Capital Adequacy, Credit Spread, the ratio of Total Loans to Total Assets, and the Total Asset Value at Risk. Models based on these predictors exhibited a predictive accuracy of 70%. Additionally, we found that the verified variables satisfactorily predict the S&P rating one month ahead.
    Keywords: Bank rating, CAMELS, ordered logit model, panel data analysis.
    JEL: C53 E58 G21 G33
  54. By: Ian Babetskii
    Abstract: There are two opposite points of view on the link between economic integration and business cycle synchronization. De Grauwe (1997) classifies these competing views as “The European Commission View” and “The Krugman View”. According to the European Commission (1990), closer integration leads to less frequent asymmetric shocks and to more synchronized business cycles between countries. On the other hand, for Krugman (1993) closer integration implies higher specialization and, thus, higher risks of idiosyncratic shocks. Drawing on the evidence from a group of transition countries which have experienced a notable increase in trade openness and economic integration with the European Union during the past decade, this paper tries to determine whose argument is supported by the data. This is done by confronting estimated time-varying coefficients of supply and demand shock asymmetry with indicators of trade intensity and exchange rates. We find that (i) an increase in trade intensity leads to higher symmetry of demand shocks; the effect of integration on supply shock asymmetry varies from country to country; (ii) a decrease in exchange rate volatility has a positive effect on demand shock convergence. The results for demand shocks can be interpreted in favor of “The European Commission View”, also known as the endogeneity argument by Frankel and Rose (1998) in the OCA criteria discussion, according to which trade links reduce asymmetries between countries. Overall, our results support Kenen’s (2001) argument that the impact of trade integration on shock asymmetry depends on the type of shock.
    Keywords: EU enlargement, business cycle, trade, OCA (optimal currency area)
    JEL: E32 F30 F42
  55. By: Anca Pruteanu
    Abstract: With this work, we aim to enrich the knowledge about the monetary policy transmission mechanism in the Czech Republic with empirical evidence on the impact of monetary policy on bank lending. Using a panel of quarterly time series for Czech commercial banks for the period 1996–2001, we study the overall effect of monetary policy changes on the growth rate of loans and the characteristics of the supply of loans. The characterization of the credit market’s supply side allows us to make inferences on the operativeness of the credit channel (the bank lending channel and the broad credit channel) of the monetary transmission mechanism. We find that changes in monetary policy alter the growth rate of loans with considerably stronger magnitude in the period 1999–2001 than in the period 1996–1998. From the analysis intended to capture the characteristics of the supply of loans, we conclude that the lending channel was operative in the period 1996–1998: we find cross-sectional differences in the lending reactions to monetary policy shocks due to degree of capitalization and liquidity. For the subsequent period 1999– 2001, the results also show distributive effects of monetary policy due to bank size and a bank’s proportion of classified loans. In the context of steadily decreasing interest rates, this bolsters the supposition of credit rationing and hence that of an operative broad credit channel. At the same time, we find evidence of linear relationships between bank characteristics and the growth rate of loans, and again these relationships change between the two time periods. This bodes well with the changes in the structure and attitude towards lending of the Czech commercial banks.
    Keywords: Bank lending channel, broad credit channel, credit rationing, monetary transmission mechanism.
    JEL: E52 E51 E58 G21
  56. By: Narcisa Kadlčáková; Joerg Keplinger
    Abstract: This project undertakes an empirical analysis in credit risk modeling using a data sample representative of bank lending to the Czech corporate sector. A rating system is constructed using a proprietary database (Creditreform) that provides a solvency index for a large number of Czech firms. Several methods for the calibration and validation of a rating system are described and tested in practice. On the basis of a representative portfolio for Czech industries, systemic predictions of regulatory and economic capital are obtained and compared. The methodologies formulated by the latest Consultative Document of the NBCA (April 2003) and by the Credit Metrics and CreditRisk+ models are applied. The main contributions of this project can be briefly summarized as follows: (a) it shows in an applied manner that input data problems in credit risk modeling can be overcome, (b) it sheds light on regulatory issues that are gaining increasing relevance, and (c) it outlines the most important features of two credit risk models.
    Keywords: Credit Risk, Economic Capital, Exchange Rate Exposure, Rating System.
    JEL: G21 G28 G23
  57. By: Zhang, Ge
    Abstract: This paper investigates a market-valuation-based hypothesis for employee stock options (ESOs). It examines how market valuation has affected the decision to grant ESOs, the amount of options granted, and the distribution of options among executives and rankand- file employees. I find strong empirical evidence that firms with high market valuation and high probability of future overvaluation are more likely to adopt ESOs and grant more options to their employees. Furthermore, when top executives perceive that the current market valuation is high, they grant a smaller portion of options to themselves relative to rank-and-file employees. All these results are consistent with the market-valuation rationale for ESOs, which argues that firms use ESOs as a method to sell overvalued equity.
    Keywords: Market valuation, Stock options
    Date: 2004–01–27
  58. By: Jung, Wan; Zhang, Ge
    Abstract: This paper uses a market valuation model to explore why firms grant employee stock options. When insider managers and outside investors have different opinions about the future prospects of the firm, employee stock options can be used to capture future investor overvaluation and to save employee compensation costs. Options can enhance the stock value for existing shareholders if the difference in opinion is highly volatile. The equilibrium option grant is positively correlated with both the perception error of investors, and the volatility of this error, as well as the correlation between investors 19 error and firm fundamental value. The model provides implications on the cross-sectional differences in option grants, and these implications can be examined empirically. 1 Introduction An employee stock option is an agreement between a firm and its employees under which the employees can buy a specified number of shares of stock at a specified price. Over the past decade, the use of employee stock options has been rising.
    Keywords: Stock options, Market valuation
    Date: 2003–10–15
  59. By: Duffy, John; Xiao, Wei
    Abstract: We examine the expectational stability (E—stability) of rational expectations equilibrium under optimal interest rate rules in the context of the standard, “New Keynesian” model of the monetary transmission mechanism. We focus on the case where the monetary authority adds interest rate stabilization to its other objectives of inflation and output stabilization. We consider both the case where the monetary authority lacks a commitment technology and as well as the case of full commitment. We show that for both cases, optimal interest rate rules yield rational expectations equilibria that are E-stable for a wide range of empirically plausible parameter values. This finding stands in contrast to the findings of Evans and Honkapohja (2002, 2003ab) for optimal monetary policy rules in environments where interest rate stabilization is not part of the central bank’s objective function.
    Keywords: Expectational stability (E-stability), Rational expectations equilibrium, Monetary transmission mechanism
    Date: 2004–06
  60. By: Daal, Elton; Farhat, Joseph Basheer; Wei, Peihwang P.
    Abstract: In a seminal article, Samuelson (1965) proposes the maturity effect that volatility of futures prices should increase as futures contract approaches maturity. This study provides new evidence on the maturity effect by examining a more extensive set of futures contracts than previous studies and analyzing each contract separately. Using 6805 futures contracts drawn from 61 commodities, including some data from non-US markets, we find that the maturity effect is absent in the majority of contracts. In addition, the maturity effect tends to be stronger in agricultural and energy commodities than in financial futures. We also examine the hypothesis in Bessembinder, Coughenour, Seguin, and Smoller (1996), which states that negative covariance between the spot price and net carry cost causes the maturity effect in futures. Our results provide very weak evidence in favor of this hypothesis.
    Keywords: Maturity effect, Futures prices volatility, Futures markets
    JEL: C32 G12 G13 Q14
    Date: 2004
  61. By: Daal, Elton
    Abstract: We propose a multi-currency quadratic term structure model that allows for several sources of market incompleteness. A new feature of the model is the jump-quadratic dynamics of the exchange rates that simultaneously generate greater flexibility in the time-varying risk premium and excessive currency volatility. Our model empirically outperforms the complete market quadratic and affine multi-currency diffusion models. It accounts for the forward premium anomaly with reasonable market price of risks. The market incompleteness consists of idiosyncratic diffusion-like innovations and jump discontinuities. We find that the jumps dominate the variations in the currency returns and produce most of the excessive currency volatility.
    Keywords: Quadratic term structure, Incomplete markets, Jumps, Excess volatility
    JEL: F31 E43 D52 C14
    Date: 2004–09–29
  62. By: Daal, Elton; Naka, Atsuyuki; Yu, Jung-Suk
    Abstract: This paper proposes a mixed GARCH-Jump model that is tailored to the specific circumstances arising in emerging equity markets. Our model accommodates lagged currency returns as a local information variable in the autoregressive jump intensity function, incorporates jumps in the returns and volatility, and allows volatility to respond asymmetrically to both normal innovations and jump shocks. The model captures the distinguishing features of the Asian index returns and significantly improves the fit for those markets that were affected by the 1997 Asian crisis. Our proposed model yields higher levels of conditional kurtosis and superior forecasts of the expected arrival rate of jumps.
    Keywords: Jumps, Volatility, Leverage effects, Emerging markets, Asia, Equity markets
    Date: 2004–09–30
  63. By: Baker, H. Kent; Mukherjee, Tarun K.; Powell, Gary E.
    Abstract: This study explores why firms distribute excess cash as specially designated dividends (SDDs) instead of using regular dividends or repurchasing shares. We survey top managers of NASDAQ, AMEX, and NYSE firms issuing at least one SDD between 1994 and 2001. The results show that firms tend to pay SDDs when they experience strong earnings and cash flows and want to increase at least temporarily the yield to shareholders. Having strong earnings and cash flows also provide an impetus for regular dividend increases, but paying regular dividends is part of a firm’s standard dividend policy. The primary motives for repurchasing shares are to take advantage of perceived market undervaluation of the firm’s shares and to improve performance measures, especially. Overall, the results lend support to the signaling explanation for the disbursement of excess funds, but not the free cash flow or wealth transfer explanations.
    Keywords: Dividends, Payout policy, Specially designated dividends, Share repurchases
    JEL: G35
    Date: 2004–10–19
  64. By: Nam, Jouahn; Wang, Jun; Zhang, Ge
    Abstract: We examine the impact of the May 2003 dividend tax cut and managerial stock holdings on corporate dividend initiation decision. We find that managers who hold sizable stakes in their companies are more likely to initiate dividends following this tax cut. This positive relation is stronger for firms with higher growth opportunities. These results are consistent with the hypothesis that managers initiate dividends to maximize their own wealth. Moreover, the market reacts negatively (most positively) to dividend initiation announcements by firms with higher (lower) growth opportunities and higher (lower) managerial share holdings.
    Keywords: Dividend tax cut, Managerial stock holdings, Dividend payout
    JEL: G30 G35
    Date: 2004
  65. By: Mazumder, M. Imtiaz; Miller, Edward M.; Varela, Oscar Albert
    Abstract: The weekend effect is described as the tendency for Monday security returns to be low (or negative) compared to other days of the week. The weekend effect may not be exploited by trading individual stocks because of transactions costs. However, the institutional characteristics of the US-based international open-end mutual funds may allow investors to exploit the weekend effect because mutual funds lack much of the transactions costs associated with individual stocks. This paper extends the study of Compton and Kunkel (1999), Varela (2002), and Miller, Prather and Mazumder (2003) by examining the weekend predictability and profitable trading opportunities for international mutual funds. The rationale behind the weekend predictability and profitability of international funds lies on the fact that the Net Asset Values (NAVs) of international funds are computed from stale prices of the underlying assets of these funds. The sample of international funds is divided into two sub-samples and the initial sub-sample is used to test the weekend effect and develop trading strategies. Returns of trading strategies are then evaluated out-of-sample and compared with the returns of a buy-and-hold strategy. Empirical findings suggest that smart investors may earn higher risk-adjusted returns by following daily dynamic trading strategies. Results also document that trading strategies based on the weekend effect produce higher risk-adjusted returns. Finally market timing models are also tested for trading strategy returns and Treynor-Mazuy and Henriksson-Merton timing measures are positive and statistically significant. Moreover, the trading rules of this study may be useful in future if fair value pricing or other institutional regularities eliminate any profitable trading opportunity based on the US market signals.
    Keywords: Mutual funds, Weekend effect, Trading rule, Market efficiency
    JEL: G12 G14
    Date: 2005–01
  66. By: Nam, Jouahn; Wang, Jun; Zhang, Ge
    Abstract: In this paper, we study a model incorporating the retail trader’s reluctance to sell into losses. We show that in this setup the informed trader always buys the asset when he receives a favorable signal. However, when the informed trader receives an unfavorable signal, he may not always sell the asset if the signal is moderately bad and the retail trader is reluctant to realize losses. Hence the good news travels faster than the bad news and the asset price exhibits steady climbs with sharp and sudden drops.
    Keywords: Disposition effect, Retail investors, Strategic trading
    JEL: G10
    Date: 2004
  67. By: Cheng Hsiao; Yan Shen; Hiroshi Fujiki
    Abstract: We use Japanese aggregate and disaggregate money demand data to show that conflicting inferences can arise. The aggregate data appears to support the contention that there was no stable money demand function. The disaggregate data shows that there was a stable money demand function. Neither was there any indication of the presence of a liquidity trap. Possible sources of discrepancy are explored and the diametrically opposite results between the aggregate and disaggregate analysis are attributed to the neglected heterogeneity among micro units. We provide necessary and sufficient conditions for the existence of cointegrating relations among aggregate variables when heterogeneous cointegration relations among micro units exist. We also conduct simulation analysis to show that when such conditions are violated, it is possible to observe stable micro relations, but unit root phenomenon among macro variables. Moreover, the prediction of aggregate outcomes, using aggregate data is less accurate than the prediction based on micro equations and policy evaluation based on aggregate data ignoring heterogeneity in micro units can be grossly misleading.
    Date: 2004–02
  68. By: M. Hashem Pesaran; Paolo Zaffaroni
    Abstract: This paper considers the problem of model uncertainty in the case of multi-asset volatility models and discusses the use of model averaging techniques as a way of dealing with the risk of inadvertently using false models in portfolio management. In particular, it is shown that under certain conditions portfolio returns based on an average model will be more fat-tailed than if based on an individual underlying model with the same average volatility. Evaluation of volatility models is also considered and a simple Value-at-Risk (VaR) diagnostic test is proposed for individual as well as 'average' models and its exact and asymptotic properties are established. The model averaging idea and the VaR diagnostic tests are illustrated by an application to portfolios of daily returns based on twenty two of Standard & Poor's 500 industry group indices over the period January 2, 1995 to October 13, 2003, inclusive.
    Keywords: Model Averaging, Value-at-Risk, Decision Based Evaluations
    JEL: C32 C52 C53 G11
    Date: 2004–10
  69. By: Stephane Dees; Filippo di Mauro; M. Hashem Pesaran; L. Vanessa Smith
    Abstract: This paper presents a global model linking individual country vector error-correcting models in which the domestic variables are related to the country-specific variables as an approximate solution to a global common factor model. This global VAR is estimated for 26 countries, the euro area being treated as a single economy. This paper proposes two important extensions of previous research (see Pesaran, Schuermann and Weiner, 2004). First, it provides a theoretical framework where the GVAR is derived as an approximation to a global unobserved common factor model. Also using average pair-wise cross-section error correlations, the GVAR approach is shown to be quite effective in dealing with the common factor interdependencies and international comovements of business cycles. Second, in addition to generalised impulse response functions, we propose an identification scheme to derive structural impulse responses. We focus on identification of shocks to the US economy, particularly the monetary policy shocks, and consider the time profiles of their effects on the euro area. To this end we include the US model as the first country model and consider alternative orderings of the US variables. Further to the US monetary policy shock, we also consider oil price, US equity and US real output shocks.
    Keywords: Global VAR (GVAR), Global interdependencies, global macroeconomic modeling, impulse responses
    JEL: C32 E17 F47
    Date: 2004–12
  70. By: Caroline M. Betts; Timothy J. Kehoe
    Abstract: This paper studies the relation between the United States’ bilateral real exchange rate and the associated bilateral relative price of nontraded goods for five of its most important trade relationships. Traditional theory attributes fluctuations in real exchange rates to changes in the relative price of nontraded goods. We find that this relation depends crucially on the choice of price series used to measure relative prices and on the choice of trade partner. The relation is stronger when we measure relative prices using producer prices rather than consumer prices. The relation is stronger the more important is the trade relationship between the United States and a trade partner. Even in cases where there is a strong relation between the real exchange rate and the relative price of nontraded goods, however, a large fraction of real exchange rate fluctuations is due to deviations from the law of one price for traded goods.
    Keywords: Risk management, correlated defaults, credit loss distributions, heterogeneity, diversification
    JEL: C33 G13 G21
    Date: 2005–03
  71. By: Samuel Hanson; M. Hashem Pesaran; Til Schuermann
    Abstract: This paper considers a simple model of credit risk and derives the limit distribution of losses under different assumptions regarding the structure of systematic risk and the nature of exposure or firm heterogeneity. We derive fat-tailed correlated loss distributions arising from Gaussian (i.e. non-fat-tailed) risk factors and explore the potential for (and limit of) risk diversification. Where possible the results are generalized to non-Gaussian distributions. The theoretical results indicate that if the firm parameters are heterogeneous but come from a common distribution, for suffciently large portfolios there is no scope for further risk reduction through active portfolio management. However, if the firm parameters come from different distributions, say for different sectors or countries, then further risk reduction is possible, even asymptotically, by changing the portfolio weights. In either case, neglecting parameter heterogeneity can lead to underestimation of expected losses. But, once expected losses are controlled for, neglecting parameter heterogeneity can lead to overestimation of risk, whether measured by unexpected loss or value-at-risk. We examine the impact of sectoral and geographic diversification on credit losses empirically using returns for firms in the U.S. and Japan across seven sectors and find that ignoring this heterogeneity results in far riskier credit portfolios. Risk, is reduced significantly when parameter heterogeneity is properly taken into account.
    Keywords: Risk management, correlated defaults, credit loss distributions, heterogeneity, diversification
    JEL: C33 G13 G21
    Date: 2005–02
  72. By: Iris Biefang-Frisancho Mariscal (School of Economics, University of the West of England); Peter Howells (School of Economics, University of the West of England)
    Abstract: In the last fifteen years or so the conduct of monetary policy in developed economies has converged in a number of ways which include an increasing emphasis on ‘openness’ and ‘transparency’ in policy-making. There is a widespread belief that transparency in the conduct of UK monetary policy has increased substantially since, and because of, the introduction of inflation targeting and associated institutional reforms in 1992. A large measure of this belief is based upon studies which reveal the increased ability of money market agents to anticipate accurately the change in official rates. In this paper, we have updated one of those studies and show that the findings are largely unaffected by events of the last five years. More interestingly, perhaps, we have floated the possibility that this improved anticipation may be the result of developments other than institutional reforms. For example, it is notable that the Bank of England has made fewer and smaller interest changes since 1992. It is also widely believed (and the behaviour of many macro variables suggests this) that economies have generally become more stable since 1992. If this is true, then macroeconomic forecasts in general should have improved and the increased anticipation would be, partly at least, due to this rather than institutional changes. We test both theses hypotheses with negative results.
    JEL: E58
    Date: 2004–05

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