New Economics Papers
on Financial Markets
Issue of 2005‒10‒29
forty papers chosen by

  1. Knowledge, Technology Adoption and Financial Innovation By Ana Fernandes
  2. The Emerging Market Crisis and Stock Market Linkages: Further Evidence By Jian Yang; Cheng Hsiao; Qi Li; Zijun Wang
  3. Credit Derivatives: Capital Requirements and Strategic Contracting By Antonio Nicolo'; Loriana Pelizzon
  4. Does Anonymity Matter in Electronic Limit Order Markets? By Thierry Foucault; Sophie Moinas; Erik Theissen
  5. Bank finance versus bond finance: what explains the differences between US and Europe? By Fiorella De Fiore; Harald Uhlig
  6. Time-varying Beta Risk of Pan-European Industry Portfolios: A Comparison of Alternative Modeling Techniques By Sascha Mergner; Jan Bulla
  7. Uncovered Interest Rate Parity and the Expectations Hypothesis of the Term Structure: Empirical Results for the U.S. and Europe By Ralf Brüggemann; Helmut Lütkepohl
  8. Spreads Soberanos: ¿Diferencian los Inversionistas Internacionales entre Economías Emergentes? By Valentín Délano; Felipe Jaque
  9. Robust Lessons about Practical Early Warning Systems By Beckmann, Daniela; Menkhoff, Lukas; Sawischlewski, Katja
  10. Has Exchange Rate Pass-Through Really Declined in Canada? By Hafedh Bouakez; Nooman Rebei
  11. Banking Regulation and Financial Accelerators: A One-Period Model with Unlimited Liability By Wolfgang Bühler; Christian Koziol
  12. Banks without Parachutes - Competitive Effects of Government Bail-out Policies By Hendrik Hakenes; Isabel Schnabel
  13. On the equality of Real Interest Rates across borders in Integrated Capital Markets By Patrick Minford; David Peel
  14. Evaluating the German Bank Merger Wave By Michael Koetter
  15. Currency Manipulation versus Current Account Manipulation By Junning Cai
  16. Asset Price Dynamics in a Financial Market with Heterogeneous Trading Strategies and Time Delays By Alessandro Sansone; Giuseppe Garofalo
  17. Collateral and Risk Sharing in Group Lending: Evidence from an Urban Microcredit Program By Kugler, Maurice; Oppes, Rossella
  18. Herding and Contrarian Behavior in Financial Markets - An Internet Experiment By Mathias Drehmann; Jörg Oechssler; Andreas Roider
  19. Bargaining and Sustainability: The Argentine Debt Swap of 2005 By Dhillon, Amrita; García-Fronti, Javier; Ghosal, Sayantan; Miller, Marcus
  20. A Test of the Strategic Effect of Basel II Operational Risk Requirements on Banks By Carolyn Currie
  21. What Drives ECB Monetary Policy? By Clemens J.M. Kool
  22. Does Partnering Pay Off? - Stock Market Reactions to Inter-Firm Collaboration Announcements in Germany By Carolin Häussler
  23. Competing for Criminal Money By Greg Rawlings; Brigitte Unger
  24. Risk-return preferences in the pension domain: are people able to choose? By Maarten C.J. van Rooij; Clemens J.M. Kool; Henriette M. Prast
  25. Credit Rationing and Firms in Oligopoly By Tong, Jian
  26. The Feasibility of a Fixed Exchange Rate Regime for New EU-members: Evidence from Real Exchange Rates By Bertrand Candelon; Clemens Kool; Katharina Raabe; Tom van Veen
  27. The determinants of merger waves By Klaus Gugler; Dennis C. Mueller; B. Burcin Yurtoglu
  28. Financial Institutions and the Wealth of Nations: Tales of Development By Tong, Jian; Xu, Chenggang
  29. Costs of Financial Instability, Household-Sector Balance Sheets and Consumption By Ray Barrell; Olga Pomerantz; E.Philip Davis
  30. Exchange Rate Pass-Through to Domestic Prices in Pakistan By Zulfiqar Hyder; Sardar Shah
  31. Evaluating Brazilian Stock Mutual Funds with Stochastic Frontiers By Andre Santos; Joao Tusi; Newton Da Costa Jr; Sergio Da Silva
  32. Bid Rigging. An Analysis of Corruption in Auctions By Yvan Lengwiler; Elmar Wolfstetter
  33. Transparency of Monetary Policy: Theory and Practice By Petra M. Geraats
  34. Modeling the FIBOR/EURIBOR Swap Term Structure: An Empirical Approach By Oliver Blaskowitz; Helmut Herwartz; Gonzalo de Cadenas Santiago
  37. Capital Controls: An Evaluation By Nicolas Magud; Carmen M. Reinhart
  38. Value-at-Risk Calculations with Time Varying Copulae By Enzo Giacomini; Wolfgang Härdle
  39. Financial Liberalisation, Consumption and Wealth Effects in 7 OECD Countries By Ray Barrell; E.Philip Davis
  40. External Debt and Exchange Rate Overshooting: The Case of Selected East Asian Countries By Victor Pontines; Reza Siregar

  1. By: Ana Fernandes
    Abstract: Why are new financial instruments created? This paper proposes the view that financial development arises as a response to the contractual needs of emerging technologies. Exogenous technological progress generates a demand for new financial instruments in order to share risk or overcome private information, for example. A model of the dynamics of technology adoption and the evolution of financial instruments that support such adoption is presented. Early adoption may be required for financial markets to learn the technology; once learned, financial innovation boosts adoption further. Financial learning emerges as a source of technological diffusion. The analysis identifies a causality link from technology to growth which is nonetheless consistent with empirical findings of a positive effect of current financial development on future growth
    Keywords: Technology adoption; financial innovation; learning
    JEL: G20 N20 O30
    Date: 2005–06
  2. By: Jian Yang; Cheng Hsiao; Qi Li; Zijun Wang
    Abstract: This study examines the long-run price relationship and the dynamic price transmission among the U.S., Germany, and four major Eastern European emerging stock markets, with particular attention to the impact of the 1998 Russian financial crisis. The results show that both the long-run price relationship and the dynamic price transmission were strengthened among these markets after the crisis. The influence of Germany became noticeable on all the Eastern European markets only after the crisis but not before the crisis. We also conduct a rolling generalized VAR analysis to confirm the robustness of the main findings.
    Keywords: market linkages, emerging stock markets, generalized impulse response analysis, generalized forecast error variance decomposition, rolling VAR analysis
    JEL: G15 C32
    Date: 2005–07
  3. By: Antonio Nicolo' (University of Padua); Loriana Pelizzon (University of Venice)
    Abstract: In this paper we investigate the problem of a bank, which, due to the presence of capital requirements, needs to issue credit derivatives. Because of asymmetric information in the loan and credit risk transfer markets, banks face an adverse selection problem, sharpened by the fact that credit derivative contracts are not publicly observable. We show that high-quality banks can use CDO contracts to signal their own type, even when credit derivatives are private contracts. Also a menu of contracts with a first-to-default basket and a credit default swap conditioned to the default of the first asset, can be used as a signalling device. Moreover, this last menu of contracts generates larger profits for high-quality banks than the CDO contract if the cost of capital and the loan interest rates are su¢ ciently high.
    JEL: G21 D82
    Date: 2005–10
  4. By: Thierry Foucault (HEC, School of Management, Paris (GREGHEC and CEPR)); Sophie Moinas (Doctorat HEC); Erik Theissen (Bonn University, Germany)
    Abstract: We develop a model of limit order trading in which some traders have better information on future price volatility. As limit orders have option-like features, this information is valuable for limit order traders. We solve for informed and uninformed limit order traders' bidding strategies in equilibrium when limit order traders' IDs are concealed and when they are visible. In either design, a large (resp. small) spread signals that informed limit order traders expect volatility to be high (resp. low). However the quality of this signal and market liquidity are different in each market design. We test these predictions using a natural experiment. As of April 23, 2001, the limit order book for stocks listed on Euronext Paris became anonymous. For our sample stocks, we find that following this change, the average quoted and effective spreads declined significantly. Consistent with our model, we also find that the size of the spread is a predictor of future price volatility and that the strength of the association between the spread and volatility is weaker after the switch to anonymity.
    Keywords: Market Microstructure, Limit Order Trading, Anonymity, Transparency, Liquidity, Volatility Forecasts
    JEL: G10 G14 G24
    Date: 2004–05
  5. By: Fiorella De Fiore; Harald Uhlig
    Abstract: We present a dynamic general equilibrium model with agency costs, where heterogeneous firms choose among two alternative instruments of external finance-corporate bonds and bank loans. We characterize the financing choice of firms and the endogenous financial structure of the economy. The calibrated model is used to address questions such as: What explains differences in the financial structure of the US and the euro area? What are the implications of these differences for allocations? We find that a higher share of bank finance in the euro area relative to the US is due to lower availability of public information about firms' credit worthiness and to higher effciency of banks in acquiring this information. We also quantify the effect of differences in the financial structure on per-capita GDP.
    Keywords: Financial structure, agency costs, heterogeneity
    JEL: E20 E44 C68
    Date: 2005–08
  6. By: Sascha Mergner (AMB Generali Asset Managers); Jan Bulla (Georg-August-University, Goettingen)
    Abstract: This paper investigates the time-varying behavior of systematic risk for eighteen pan-European sectors. Using weekly data over the period 1987- 2005, four different modeling techniques in addition to the standard constant coefficient model are employed: a bivariate t-GARCH(1,1) model, two Kalman filter based approaches, a bivariate stochastic volatility model estimated via the efficient Monte Carlo likelihood technique as well as two Markov switching models. A comparison of the different models' ex-ante forecast performances indicates that the random walk process in connection with the Kalman filter is the preferred model to describe and forecast the time-varying behavior of sector betas in a European context. Remarkably, the Markov switching models yield a worse out-of-sample performance than standard OLS.
    Keywords: Markov switching; Kalman filter; stochastic volatility; efficient Monte Carlo likelihood; bivariate t-GARCH; European industry portfolios; time-varying beta risk
    JEL: C22 C32 G10 G12 G15
    Date: 2005–10–26
  7. By: Ralf Brüggemann; Helmut Lütkepohl
    Abstract: A system of U.S. and euro area short- and long-term interest rates is analyzed. According to the expectations hypothesis of the term structure the interest rate spreads should be stationary and according to the uncovered interest rate parity the difference between the U.S. and euro area longterm interest rates should also be stationary. If all four interest rates are integrated of order one, one would expect to find three linearly independent cointegration relations in the system of four interest rate series. Combining German and European Monetary Union data to obtain the euro area interest rate series we find indeed the theoretically expected three cointegration relations, in contrast to previous studies based on different data sets.
    Keywords: Expectations hypothesis of the term structure, uncovered interest rate parity, unit roots, cointegration analysis
    JEL: C32
    Date: 2005–04
  8. By: Valentín Délano; Felipe Jaque
    Abstract: This paper examines the global investors’ behavior related to emerging markets assets, controlling by credit rating. Hence, a particular interest is set on reviewing whether these global agents do differentiate between investment grade and non-investment grade emerging economies once they face shocks to international financial markets. It is interesting to explore how these investors look at Chile in comparison to other emerging economies both ranked in a similar credit rating notch and neighbor ones. Thus, this study aim at analyzing the main hypotheses raised on investment differentiation by credit rating and inter-regional contagion based upon the performance of the sovereign spread volatility of emerging markets economies. The main results support the hypothesis that a clear differentiation from global investors about emerging markets cannot be observed during tranquil periods. However, a higher preference can be observed for better credit rating assets under periods of turbulence in the international financial markets.
    Date: 2005–09
  9. By: Beckmann, Daniela; Menkhoff, Lukas; Sawischlewski, Katja
    Abstract: Early warning systems (EWSs) are subject to restrictions that apply to exchange rates in general: fundamentals matter but their influence is small and unstable. Despite this limitation four major lessons emerge: First, EWSs have robust forecasting power and thus help policy-makers to prevent crises. Second, policy-makers must decide about some EWSs elements, such as the sensitivity of the forecasts. Third, EWSs performance is increased by taking a logit model, shorter samples and a regional approach. Fourth, the finding of contagion may motivate policy to shield its economy against inefficient international financial markets.
    Keywords: early warning system, currency crises, emerging markets
    JEL: F33 F31
    Date: 2005–10
  10. By: Hafedh Bouakez; Nooman Rebei
    Abstract: Several empirical studies suggest that exchange rate pass-through has declined in recent years in industrialized countries. Results for Canada also indicate that, in the 1990s, import and consumer prices became less responsive to exchange rate movements. These findings are based on reducedform regressions that are typically motivated by partial-equilibrium models of pricing. Bouakez and Rebei instead use a structural, general-equilibrium approach to test the premise that exchange rate pass-through has decreased in Canada. Their approach consists in estimating a dynamic stochastic general-equilibrium model for Canada over two subsamples, which cover the periods before and after the Bank's adoption of inflation targeting. The authors then use impulse-response analysis to assess the stability of exchange rate pass-through across the two subsamples. Their results indicate that pass-through to Canadian import prices has been rather stable, while passthrough to Canadian consumer prices has declined in recent years. Counterfactual experiments reveal that the change in monetary policy regime is largely responsible for this decline.
    Keywords: Business fluctuations and cycles; Economic models; Exchange rates; Inflation and prices; International topics
    JEL: F3 F4
    Date: 2005
  11. By: Wolfgang Bühler (Chair of Finance, University of Mannheim); Christian Koziol (Chair of Finance, University of Mannheim)
    Abstract: In this paper, we analyze the consequences of bank regulation on the size of the real sector. In particular, we address the question whether exogenous shocks on the return-risk characteristics of the technology and on the equity of the real sector are intensified or damped by a value-at-risk constraint on the credit portfolio of a bank. We consider a one-period model with three risk-averse agents, an investor, a bank, and a firm. The size of the markets for deposits and loans, their prices and the size of the real sector are endogenous. We find that stricter regulation results in higher loan rates, lower deposit rates, and lower activity in the real sector. A negative shock on the return-risk position or on the risk buffer of the real sector reduces the activities in the economy. Surprisingly, the sensitivity of the real sector's activities on negative shocks is smaller for a regulated financial sector than for a non-regulated one. Therefore, in our economy, imperfections in the financial sector do not result in procyclical or acceleration effects.
    Date: 2004–06
  12. By: Hendrik Hakenes (MPI for Research on Collective Goods, Kurt-Schumacher-Str. 10, 53113 Bonn, Germany); Isabel Schnabel (MPI for Research on Collective Goods, Kurt-Schumacher-Str. 10, D-53113 Bonn, Germany)
    Abstract: The explicit or implicit protection of banks through government bail-out policies is a universal phenomenon. We analyze the competitive effects of such policies in two models with different degrees of transparency in the banking sector. Our main result is that the bail-out policy unambiguously leads to higher risk-taking at those banks that do not enjoy a bail-out guarantee. The reason is that the prospect of a bail-out induces the rotected bank to expand, thereby intensifying competition in the deposit market and depressing other banks' margins. In contrast, the effects on the protected bank's risk taking and on welfare depend on the transparency of the banking sector.
    Keywords: Government bail-out, banking competition, transparency, opacity, “too big to fail", financial stability
    JEL: G21 G28 L11
    Date: 2004–06
  13. By: Patrick Minford (Cardiff Business School); David Peel
    Abstract: The purpose in this letter is first to review briefly the empirical results on the relationship between real interest rates and real exchange rates; this empirical literature provides little support for the hypothesis of Roll that expected real interest rates are equal in general. Our second aim is to discuss the theoretical conditions that have to be met for his hypothesis to hold.
    Keywords: Real interest rates; Real Exchange rates; Roll
    JEL: F31 C22 C51
    Date: 2005
  14. By: Michael Koetter
    Abstract: German banks experienced a merger wave throughout the 1990's. However, the success of bank mergers remains a continuous matter of debate. In this paper we suggest a taxonomy as how to evaluate post-merger performance on the basis of cost efficiency (CE). We categorise mergers a success that fulfill simultaneously two criteria. First, merged institutes must exhibit CE levels above the average of non-merging banks. Second, banks must exhibit CE changes between merger and evaluation year above efficiency changes of non-merging banks. We employ this taxonomy to characterise (successful) mergers in terms of various key-performance and structural indicators and investigate the implications for four prominent policy issues particular to German banking. Our main conclusions are threefold. First, roughly every second merger is a success. Second, the margin of success is narrow, as the CE difference amounts to approximately 1 percentage point. Third, it takes around seven years after a transaction until maximum mean CE differentials materialise.
    Keywords: Bank mergers, cost efficiency.
    Date: 2005–03
  15. By: Junning Cai (University of Hawaii at Manoa)
    Abstract: It is said that a country’s currency peg can become currency manipulation representing protracted government intervention in the foreign exchange market that gives it unfair competitive advantage in international trade yet prevents effective balance of payments in its trade partners. Regarding this widespread fallacy, this paper explains why currency peg is not currency manipulation even when it keeps a country’s currency undervalued. We clarify that 1) government is inherently a major player in the financial market and hence “no protracted intervention” is a meaningless guideline for designating currency manipulation; 2) exchange rate flexibility is neither a sufficient nor a necessary condition for fixing current account imbalance and hence currency peg would not prevent effective current account adjustments; and 3) as far as causing “unfair” trade advantage is concerned, currency peg is less guilty than the attempt to prevent or fix current account imbalance; and obligating a country to adjust its currency to accommodate its trade partners’ current account management would unfairly impair this country’s trade advantage.
    Keywords: currency manipulation; current account; exchange rate; RMB controversies
    JEL: E52 F31 F32
    Date: 2005–10–24
  16. By: Alessandro Sansone (Department of Economic Sciences; University of Rome “La Sapienza” & School of Finance & Economics; University of Technology, Sydney); Giuseppe Garofalo (Department of Managerial, Technological & Quantitative Studies; University of Viterbo “Tuscia” & Department of Public Economics; University of Rome “La Sapienza”)
    Abstract: In this paper we present a continuous time dynamical model of heterogeneous agents interacting in a financial market where transactions are cleared by a market maker. The market is composed of fundamentalist, trend following and contrarian agents who process information from the market with different time delays. Each class of investors is characterized by path dependent risk aversion. We also allow for the possibility of evolutionary switching between trend following and contrarian strategies. We find that the system shows periodic, quasi-periodic and chaotic dynamics as well as synchronization between technical traders. Furthermore, the model is able to generate time series of returns that exhibit statistical properties similar to those of the S&P500 index, which is characterized by excess kurtosis, volatility clustering and long memory.
    Keywords: Dynamic asset pricing; Heterogeneous agents; Complex dynamics; Strange attractors; Chaos; Intermittency; Stock market dynamics; Synchronization
    JEL: G11 G12 G14
    Date: 2005–10–24
  17. By: Kugler, Maurice; Oppes, Rossella
    Abstract: Empirical research on group lending is extensive, but without allowance for collateral to mitigate strategic default. Indeed, lack of credit access has motivated microcredit in rural areas of developing countries, where agents with collateral are very rare. As rural communities have tight-knit hierarchical structures information about borrowers is accessible and enforcement of social sanctions makes collateral superfluous. First, we illustrate in a model how collateral mitigates group default. Second, we study a group lending program in Cotonou, the largest city in Benin with 1.1 million inhabitants. Results show diversification within groups facilitating risk pooling but also increasing expected default costs for safe borrowers. Risky borrowers offset group-default negative spillovers default with collateral, and facilitate credit access to safe borrowers. We find joint liability to be a mechanism for risk sharing in a setting where poor households lack resources for collateral and insurance markets are missing.
    Keywords: Group lending, mutual cosigners, collateral, risk sharing, strategic default, bailout costs. JEL Codes: O12, O17, G20, D82
    Date: 2005–04–01
  18. By: Mathias Drehmann (Bank of England); Jörg Oechssler (Department of Economics, University of Bonn, Germany); Andreas Roider (Department of Economics, University of Bonn, Germany)
    Abstract: We report results of an internet experiment designed to test the theory of informational cascades in financial markets (Avery and Zemsky, AER, 1998). More than 6400 subjects, including a subsample of 267 consultants from an international consulting firm, participated in the experiment. As predicted by theory, we find that the presence of a flexible market price prevents herding. However, the presence of contrarian behavior, which can (partly) be rationalized via error models, distorts prices, and even after 20 decisions convergence to the fundamental value is rare. We also report some interesting differences with respect to subjects' fields of study. Reassuringly, the behavior of the consultants turns out to be not significantly different from the remaining subjects.
    Keywords: informational cascades, herding, contrarians, experiment, internet
    JEL: C92 D8 G1
    Date: 2004–06
  19. By: Dhillon, Amrita; García-Fronti, Javier; Ghosal, Sayantan; Miller, Marcus
    Abstract: When Argentine sovereign default in December 2001 led to a collapse of the peso, the burden of dollar debt became demonstrably unsustainable. But it was not clear what restructuring was feasible, nor when. Eventually, in 2005 after a delay of more than three years, a supermajority of creditors accepted a swap implying a recovery rate of around 37 cents in the dollar. In this paper a bargaining approach is used to explain both the settlement and the delay. We conclude that the agreed swap broadly corresponds to a bargaining outcome where the Argentine government had 'first mover' advantage, and that a substantial delay occurred as negotiators seeking a sustainable settlement waited for economic recovery. Factors not explicit in the formal framework are also considered - heterogeneity of creditors, for example, and the role of third parties in promoting 'good faith' bargaining.
    Keywords: bargaining; debt restructuring; efficiency delay; sustainability
    JEL: C7 F3 F33 F34 K4
    Date: 2005–09
  20. By: Carolyn Currie (School of Finance and Economics, University of Technology, Sydney)
    Abstract: Most problematic of the Basel II capital adequacy requirements is the subset of Pillar I, requiring provision for operational risk (OR) as distinct from credit and market risk. Previous tests of the strategic effect of this new regulation from three prior Quality Impact Studies (QIS) conducted in G10 countries under the guidance of the Bank for International Settlements, have concluded that OR requirements poses difficulties of definition, implementation, and strategic planning. Anticipated strategic effects include dramatic changes to product development, investment and asset mix, as well as the necessity to rapidly develop new risk rating models and techniques, together with vastly expanded internal and external audit compliance routines. Unlike QIS1, 2 and 3, QIS4 focuses on operational risk, but still has drawbacks. This paper discusses its approach, in view of the ongoing difficulties that banks are experiencing with operational risk, particularly in the construction of a database. It concludes by listing the unanswered questions that have not even been addressed in four studies of the strategic impact of Basel II?s OR requirements. It also suggests that many smaller banks and emerging nations may not be able to use the sophisticated approaches and hence will suffer a competitive disadvantage. Hence in view of drawbacks in the simpler approaches such as lack of correlation of operational risk and revenue, other indicators such as the standard deviation of efficiency measures are suggested.
    Keywords: operational risk; Basel II
    JEL: E42 E44 E58
    Date: 2005–09–01
  21. By: Clemens J.M. Kool
    Abstract: In this paper I have analyzed ECB interest rate setting in the first 5 years of its existence. Contrary to popular belief and continuous ECB statements, the ECB has not acted has as an obsessed inflation fighter. By any measure, output considerations do play a significant role in the ECB's policy rule. If anything, the ECB has been on the loose side, especially since 2001, when taking economic development in the euro area as a whole as the starting point. Actual interest rates have been consistent with German (and to a lesser extent French) preferences, however. It suggests the ECB puts a dominant weight on German economic developments. Small peripheral countries receive too low weight rather than too high. In case the ECB actually focuses on euro area wide developments, its looseness is comparable to that of the Fed. In case ECB policy actually is geared towards Germany's preferences ­ or perhaps the average German-French preferences -- the ECB has been much closer to a standard Taylor-rule interest rate setting than the Fed. In that scenario, the Fed indeed has been much more aggressive in the lowering of its interest rates in the face of adverse economic shocks.
    Date: 2005–03
  22. By: Carolin Häussler (Institute for Innovation Research, Technology Management, and Entrepreneurship, University of Munich, Kaulbachstr. 45, D-80539 Munich, Germany)
    Abstract: The dramatic increase in interorganizational partnering in the last two decades raises questions for scholars and managers regarding the value impact of inter-firm collaborations. Using event study methodology, this paper tests whether stock market reactions differ when a collaboration formation or termination is announced. In addition, the study provides an in-depth analysis of potential determinants of stock market reactions to collaboration formation announcements. The sample consists of 1037 announcements in German stock markets from 1997 to 2002. The results show that an unexpected termination announcement decreases firm valuation, and a formation announcement increases firm valuation. Further, certain collaborations are more favorable than others, depending on firm industry, age, size, collaboration constellations, and equity versus non-equity investment in partner firm. The results open avenues for further research on partnering strategies.
    Keywords: Firm valuation, inter-firm collaboration, expectations, stock market reactions
    JEL: G14 L22 D23
    Date: 2004–12
  23. By: Greg Rawlings; Brigitte Unger
    Abstract: To compete for criminal money by means of low bank secrecy seems a tempting strategy for countries in order to attract additional funds. We show in a model that this "Seychelles-strategy" can increase national output, in particular if a country takes a (Stackelberg ) leadership in the competition game. If all countries try to do the same, there will be a race to the bottom and a supranational authority like the FATF (Financial Action Task Force) must intervene. However, there are also some intrinsic barriers to the "Seychelles-strategy". Among others, criminal capital might crowd out legal capital and money laundering might increase crime. Our findings suggest that countries have created niches for laundering. Small countries can free ride for a while, but eventually will face external sanctions and internal crime problems.
    Date: 2005–06
  24. By: Maarten C.J. van Rooij; Clemens J.M. Kool; Henriette M. Prast
    Abstract: In this paper we investigate pension preferences and the effect of individual freedom of choice on risk taking in the context of pension arrangements based on a representative survey of about 1000 Dutch citizens. The attitude towards pension schemes and portfolio choices is explained by individual characteristics. Our main conclusions are the following. Risk aversion is domain dependent and highest in the pension domain. The vast majority of respondents is in favour of compulsory saving for retirement and favours a defined benefit pension system. If offered a combined defined benefit/defined contribution system, the majority of the respondents would like to have a guaranteed pension income of 70% or more of their net labour income. Self-assessed risk tolerance and financial expertise are important explanatory variables of pension system attitude. Respondents are on average conservative in their investment policy. If given investor autonomy, they are willing to change the composition of their retirement savings portfolio in response to their personal financial situation, general economic conditions, and expectations of financial markets. Respondents may be inconsistent in their preferences. Especially respondents who have chosen a relatively safe portfolio (less stock, more bonds) appear to prefer the retirement income streams of the median investment portfolio to their own portfolio choice. Finally, the average respondent considers himself financially unsophisticated, but is not very eager to take control of retirement savings investment when offered the possibility to increase expertise.
    Keywords: behavioural finance, risk tolerance, pension preferences, defined contribution schemes, freedom of choice, portfolio investment
    JEL: D12 D80 G11 J26
    Date: 2004–12
  25. By: Tong, Jian
    Abstract: This paper develops a theory of the firm, and equilibrium credit rationing mechanisms in oligopoly with R&D-product market competition. Credit rationing arises from a hold-up problem between wealth-constrained entrepreneurs and external investors. Underinvestment occurs if entrepreneurial wealth constraint is binding, even though the equilibrium corporate governance structure addresses the hold-up problem optimally. In a symmetric equilibrium outcome all firms face equitable credit-size rationing. In contrast the asymmetric equilibrium outcome sees some firms (the 'preys') denied external credits entirely while the others (the 'predators') receiving more favorable finances, which turns out to increase market concentration and overall R&D investments. Key words: credit rationing, oligopoly, hold-up, corporate governance, theory of the firm, market structure, predation
    Date: 2005–06–01
  26. By: Bertrand Candelon; Clemens Kool; Katharina Raabe; Tom van Veen
    Abstract: In this paper, we estimate fundamental bilateral real exchange rates for a group of eight accession countries using a panel-cointegration approach for the period 19932003. We document a significant positive link between productivity levels and the corresponding real exchange rate levels. Future rises in productivity cannot be excluded on the basis of either our own analysis or the literature as a whole. Consequently, inflation pressure and real exchange rate appreciation in the accession countries probably remain a fact of life in the near future. The extent to which this is a problem for a fixed nominal exchange rate regime is hard to determine. Price dynamics in the accession countries are still quite flexible to accommodate substantial real exchange rate movements even when the nominal exchange rate is rather fixed; moreover, that price adjustment is mostly an internal process for the accession countries. Overall we conclude that a fixed exchange rate regime for each of the accession countries would be feasible in itself, despite possible future real exchange rate appreciations due to either the BalassaSamuelson effect or demand shifts. We find current misalignments to be small, robust and generally in line with the literature. This implies current exchange rate levels provide a reasonable indication of the level at which a parity exchange rate could be set.
    Keywords: real exchange rate, misalignments, Balassa-Samuelson, panel cointegration
    Date: 2005–03
  27. By: Klaus Gugler; Dennis C. Mueller; B. Burcin Yurtoglu
    Abstract: One of the most conspicuous features of mergers is that they come in waves, and that these waves are correlated with increases in share prices and price/earnings ratios. We test four hypotheses that have been advanced to explain merger waves: the industry shocks, q-, overvaluation and managerial discretion hypotheses. The first two are neoclassical in that they assume that managers maximize profits, mergers create wealth, and the capital market is efficient. The last two, behavioral hypotheses relax these assumptions in different ways. We test the four hypotheses by estimating models of the amounts of assets acquired by firms, models that identify the characteristics of targets, and estimates of the returns to acquirers' shareholders. Although some support is found for each of the four hypotheses, most of the evidence favors the two behavioral hypotheses.
    Date: 2005–03
  28. By: Tong, Jian; Xu, Chenggang
    Abstract: Abstract: Interactions between economic development and financial development are studied by looking at the roles of financial institutions in selecting R&D projects (including for both imitation and innovation). Financial development is regarded as the evolution of the financing regimes. The effectiveness of R&D selection mechanisms depends on the institutions and the development stages of an economy. At higher development stages a financing regime with ex post selection capacity is more effective for innovation. However, this regime requires more decentralized decision-making, which in turn depend on contract enforcement. A financing regime with more centralized decision-making is less affected by contract enforcement but has no ex post selection capacity. Depending on the legal institutions, economies in equilibrium choose regimes that lead to different steady-state development levels. The financing regime of an economy also affects development dynamics through a ‘convergence effect’ and a ‘growth inertia effect’. A backward economy with a financing regime with centralized decision-making may catch up rapidly when the convergence effect and the growth inertia effect are in the same direction. However, this regime leads to large development cycles at later development stages. Empirical implications are discussed.
    Date: 2003–12–01
  29. By: Ray Barrell; Olga Pomerantz; E.Philip Davis
    Abstract: The literature on costs of financial instability tends to focus on fiscal costs and the impact on GDP of banking crises. In this paper we analyse the effect of a banking or currency crisis on consumption. We show that consumption plays an important role in the macroeconomic adjustment following a financial crisis. Furthermore, the effect of a crisis is aggravated by high leverage, notably as shown by the effect of a high debt-income ratio, despite the benefits of financial liberalisation in easing liquidity constraints. It is also greater in a small open economy than in the G-7. Meanwhile, falling house prices are shown to be part of the transmission process of financial instability, and high nominal interest rates are an indicator of sharp declines in consumption. A simulation for a banking crisis underlines the important role of monetary and fiscal policy in easing the impact of a financial crisis on consumption and other expenditure components. Viewed in the light of growing gearing, or leverage, in recent years, the results imply that a banking crisis taking place now could have a greater incidence than in the past, especially if macroeconomic policy is unable to respond, as for a small country in EMU.
    Date: 2004–07
  30. By: Zulfiqar Hyder (State Bank of Pakistan); Sardar Shah (State Bank of Pakistan)
    Abstract: This paper assesses the extent to which the movements in exchange rate affect domestic wholesale and consumer prices in Pakistan by analyzing data from January 1988 to September 2003. The empirical model is a recursive VAR, suggested by McCarthy (2000), incorporating a distribution chain of pricing. Impulse response function and variance decomposition are used to measure the exchange rate pass-through to domestic prices. The major findings of this paper are: (1) the exchange rate movements have only a moderate effect on domestic prices, i.e., exchange rate pass-through is low; (2) the exchange rate pass-through is more stronger in wholesale price index (WPI) relative to consumers price index (CPI); (3) the impact of pass-through on domestic prices spreads over 12 months, however, the effect is mostly felt in the first four months; (4) the exchange rate pass-through to consumer prices have further weakened after the free float of Rupee/Dollar parity in July 2000; (5) within the WPI commodity groups, the exchange rate pass- through is stronger in ‘Fuel & Lighting’ and ‘Manufactures’ groups while in the case of CPI, pass-through is more pronounced in ‘Transport & Communication’ and ‘Fuel & Lighting’ group. Furthermore, the exchange rate pass-through to domestic prices is much stronger in higher inflationary environment during Jan-88 to Dec-97 relative to lower inflationary environment down the road.
    Keywords: Exchange Rate Pass-through, Domestic Prices, Impulse Response Function, Variance Decomposition
    JEL: E
    Date: 2005–10–22
  31. By: Andre Santos (Department of Economics, Federal University of Santa Catarina); Joao Tusi (Department of Economics, Federal University of Santa Catarina); Newton Da Costa Jr (Department of Economics, Federal University of Santa Catarina); Sergio Da Silva (Department of Economics, Federal University of Santa Catarina)
    JEL: M
    Date: 2005–10–26
  32. By: Yvan Lengwiler (University of Basel, Department of Economics (WWZ), Petersgraben 51, CH-4003 Basel, Switzerland); Elmar Wolfstetter (Institut für Wirtschaftstheorie I, Humboldt Universität zu Berlin, Spandauer Str. 1, D-10099 Berlin, Germany)
    Abstract: In many auctions, the auctioneer is an agent of the seller. This invites corruption. We propose a model of corruption in which the auctioneer orchestrates bid rigging by inviting a bidder to either lower or raise his bid, whichever is more profitable. We characterize equilibrium bidding in first- and second-price auctions, show how corruption distorts the allocation, and why both the auctioneer and bidders may have a vested interest in maintaining corruption. Bid rigging is initiated by the auctioneer after bids have been submitted in order to minimize illegal contact and to realize the maximum gain from corruption.
    Keywords: auctions, procurement, corruption, right of first refusal, numerical
    JEL: D44
    Date: 2005–05
  33. By: Petra M. Geraats
    Abstract: Transparency has become one of the main features of monetary policymaking during the last decade. This paper establishes some stylized facts. In addition, it provides a systematic overview of the practice of monetary policy transparency around the world. It shows much diversity in information disclosure, even for central banks with the same monetary policy framework, including inflation targeting. Nevertheless, the paper finds significant differences in transparency across monetary policy frameworks. The empirical findings are explained using key insights distilled from the theoretical literature. Thus, this paper aims to bridge the gap between the theory and practice of monetary policy transparency.
    Keywords: : Transparency, monetary policy, central bank communication
    JEL: E58 D82
    Date: 2005–10
  34. By: Oliver Blaskowitz; Helmut Herwartz; Gonzalo de Cadenas Santiago
    Abstract: In this study we forecast the term structure of FIBOR/EURIBOR swap rates by means of recursive vector autoregressive (VAR) models. In advance, a principal components analysis (PCA) is adopted to reduce the dimensionality of the term structure. To evaluate ex–ante forecasting performance for particular short, medium and long term rates and for the level, slope and curvature of the swap term structure, we rely on measures of both statistical and economic performance. Whereas the statistical performance is investigated by means of the Henrikkson–Merton statistic, the economic performance is assessed in terms of cash flows implied by alternative trading strategies. Arguing in favor of local homogeneity of term structure dynamics, we propose a data driven, adaptive model selection strategy to ’predict the best forecasting model’ out of a set of 100 alternative implementations of the PCA/VAR model. This approach is shown to outperform forecasting schemes relying on global homogeneity of the term structure.
    Keywords: Principal components, Factor Analysis, Ex–ante forecasting, EURIBOR swap rates, Term structure, Trading strategies
    JEL: C32 C53 E43 G29
    Date: 2005–04
  35. By: Jorge Higinio Maldonado
    Abstract: Increased access to education will be key in any efforts to improve the quality of rural life and the welfare of the next generation in developing countries. Microfinance programshave been among components of strategies for poverty alleviation that have attempted to address this challenge. This essay uses data from three different surveys of households of clients of microfinance Organizations (MFOs) in Bolivia to examine several channels through which microfinance may exert an influence on Education outcomes. Five channels are identified, designated as income, risk-management, child-labor demand, gender, and information effects. Based on an econometric specification that explains schooling decisions at the household level, regression models are used to examine determinants of education achievements and to make inferences about the potential influence of microfinance, through these channels, on those achievements. The results challenge usual assumptions in microfinance programs. In particular, for some ranges of household income and some types of borrowers, access to loans has conflicting effects on school enrollment. On the one hand, loans increase the demand for education as a result of income, risk-management, gender, and information effects. On the other hand, credit-constrained households that cultivate land or operate labor-intensive microenterprises discover new demands for child labor, either for farming, working in the microenterprise, or taking care of siblings while the mothers operate the new or expanded business. Significant program and policy consequences are derived from these paradoxical results.
    Keywords: microfinance
    JEL: C25
    Date: 2005–08–10
  36. By: Jorge Higinio Maldonado
    Abstract: Increased access to education will be key in any efforts to improve the quality of rural life and the welfare of the next generation in developing countries. Microfinance programshave been among components of strategies for poverty alleviation that have attempted to address this challenge. This essay uses data from three different surveys of households of clients of microfinance Organizations (MFOs) in Bolivia to examine several channels through which microfinance may exert an influence on Education outcomes. Five channels are identified, designated as income, risk-management, child-labor demand, gender, and information effects. Based on an econometric specification that explains schooling decisions at the household level, regression models are used to examine determinants of education achievements and to make inferences about the potential influence of microfinance, through these channels, on those achievements. The results challenge usual assumptions in microfinance programs. In particular, for some ranges of household income and some types of borrowers, access to loans has conflicting effects on school enrollment. On the one hand, loans increase the demand for education as a result of income, risk-management, gender, and information effects. On the other hand, credit-constrained households that cultivate land or operate labor-intensive microenterprises discover new demands for child labor, either for farming, working in the microenterprise, or taking care of siblings while the mothers operate the new or expanded business. Significant program and policy consequences are derived from these paradoxical results.
    Keywords: microfinance
    JEL: C25
    Date: 2005–08–10
  37. By: Nicolas Magud (University of Oregon Economics Department); Carmen M. Reinhart (University of Maryland and NBER)
    Abstract: The literature on capital controls has (at least) four very serious apples-to-oranges problems: (i) There is no unified theoretical framework to analyze the macroeconomic consequences of controls; (ii) there is significant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple definitions of what constitutes a “success” and (iv) the empirical studies lack a common methodology—furthermore these are significantly “overweighted” by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by: being very explicit about what measures are construed as capital controls. Also, given that success is measured so differently across studies, we sought to “standardize” the results of over 30 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Effectiveness Index (CCE Index), and Weighted Capital Control Effectiveness Index (WCCE Index). The difference between them lies only in that the WCCE controls for the differentiated degree of methodological rigor applied to draw conclusions in each of the considered papers. Inasmuch as possible, we bring to bear the experiences of less well known episodes than those of Chile and Malaysia.
    Date: 2005–06–01
  38. By: Enzo Giacomini; Wolfgang Härdle
    Abstract: Value-at-Risk (VaR) of a portfolio is determined by the multivariate distribution of the risk factors increments. This distribution can be modelled through copulae, where the copulae parameters are not necessarily constant over time. For an exchange rate portfolio, copulae with time varying parameters are estimated and the VaR simulated accordingly. Backtesting underlines the improved performance of time varying copulae.
    Keywords: Value-at-Risk,VaR, portfolio, copulae
    JEL: C14
    Date: 2005–02
  39. By: Ray Barrell; E.Philip Davis
    Abstract: We estimate the impact of financial liberalisation on consumption in 7 major industrial countries, and find a marked shift in behaviour, notably a decline in short run income elasticities and a rise in short run wealth and interest rate elasticities. A corollary is that consumption equations estimated over both pre- and post-liberalisation regimes may be misleading, and either a form of testing as presented here or a shortening of the sample period may be appropriate for accurate forecasting and simulation.
    Date: 2004–05
  40. By: Victor Pontines (University of Adelaide); Reza Siregar (University of Adelaide)
    Abstract: The accumulations of foreign debts had indeed been at a rapid phase, particularly during the last few years leading to the outbreak of the 1997 financial crises in the four most severely effected economies, namely Indonesia, the Philippines, Thailand and Korea. Interestingly, during the same period, the rates of overshooting of these East Asian currencies have also been found to increase considerably. The objective of this paper is to evaluate whether the rapid accumulation of external debts, especially since 1994, has contributed to the overshooting of the East Asian countries’ currencies starting late 1997.
    Keywords: External Debt, East Asian Countries, Exchange Rate and Overshooting
    JEL: F3 F4
    Date: 2005–10–21

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.