nep-fmk New Economics Papers
on Financial Markets
Issue of 2005‒11‒05
47 papers chosen by
Carolina Valiente
London South Bank University

  1. International Capital Flows, Returns and World Financial Integration By Martin D. D. Evans; Viktoria Hnatkovska
  2. Financial Supervision Fragmentation and Central Bank Independence: The Two Sides of the Same Coin? By Andreas Freytag; Donato Masciandaro
  3. Institutional Investors and Stock Market Volatility By Xavier Gabaix; Parameswaran Gopikrishnan; Vasiliki Plerou; H. Eugene Stanley
  4. The IMF in a world of private capital markets By Barry Eichengreen; Kenneth Kletzer; Ashoka Mody
  5. Interest Rate Risk and the Forward Premium Anomaly in Foreign Exchange Markets By Shu Wu
  6. "Is Money Neutral in the Long Run?" By Burton Abrams; Russell Settle
  7. Large investors: implications for equilibrium asset returns, shock absorption, and liquidity By Matthew Pritsker
  8. Strategic bank monitoring and firms’ debt structure By Eirik Gaard Kristiansen
  10. On the predictability of common risk factors in the US and UK interest rate swap markets: Evidence from non-linear and linear models. By Ilias Lekkos; Costas Milas; Theodore Panagiotidis
  11. Forecasting Volatility of Turkish Markets: A Comparison of Thin and Thick Models By Ekrem Kilic
  12. Too big to fail after all these years By Donald P. Morgan; Kevin J. Stiroh
  13. Foreign Exchange Controls, Fiscal and Monetary Policy, and the Black Market Premium By Mohsen Fardmanesh; Seymour Douglas
  14. Central Banks as Agents of Economic Development By Gerald Epstein
  16. Arbitrage pricing theory By Gur Huberman; Zhenyu Wang
  17. Why is the U.S. Treasury contemplating becoming a lender of last resort for Treasury securities? By Kenneth D. Garbade; John E. Kambhu
  19. The economic effects of violent conflict: evidence from asset market reactions By Massimo Guidolin; Eliana La Ferrara
  20. Exchange rate pass-through to import prices in the Euro area By Jose Manuel Campa; Linda S. Goldberg; Jose M. Gonzalez-Minguez
  21. Speculation and Survival in Financial Markets By Eugen Kovac
  22. How Important are Financial Frictions in the U.S. and Euro Area? By Queijo, Virginia
  23. Risk, uncertainty, and asset prices By Geert Bekaert; Eric Engstrom; Yuhang Xing
  24. The Political Economy of Fixed Exchange Rates: A Survival Analysis By Ralph Setzer
  25. Exchange Market Pressure, Monetary Policy, and Economic Growth: Argentina in 1993 - 2004 By Clara Garcia; PNuria Malet
  26. Financial crises and total factor productivity By Felipe Meza; Erwan Quintin
  28. Collateral, credit history, and the financial decelerator By Ronel Elul
  30. Amplification and Asymmetry in Crashes and Frenzies By Han N. Ozsoylev
  31. Macro Factors in Bond Risk Premia By Sydeny C. Ludvigson; Serena Ng
  32. The laws, regulations, and industry practices that protect consumers who use electronic payment systems: policy considerations By Mark Furletti
  33. Price, Trade Size, and Information Revelation in Multi-Period Securities Markets By Han N. Ozsoylev; Shino Takayama
  34. A Decision Rule Based on the Conditional Value at Risk By Werner Jammernegg; Peter Kischka
  35. LONG RUN AND CYCLICAL DYNAMICS IN THE US STOCK MARKET By Guglielmo Maria Caporale; Luis A. Gil-Alana
  36. Turning Workers into Savers? Incentives, Liquidity, and Choice in 401(k) Plan Design By Olivia S. Mitchell; Stephen P. Utkus; Tongxuan (Stella) Yang
  37. Price discovery in a market under stress: the U.S. Treasury market in fall 1998 By Craig H. Furfine; Eli M. Remolona
  38. Explicit characterization of the super-replication strategy in financial markets with partial transaction costs By Imen Bentahar; Bruno Bouchard
  39. Limited Enforceable International Loans, International Risk Sharing and Trade By Almuth Scholl
  40. Monetary and Exchange Rate Policy Coordination in ASEAN 1 By William H. Branson; Conor N. Healy
  41. Do nonfinancial firms use interest rate derivatives to hedge? By Daniel Covitz; Steven A. Sharpe
  42. The duration of fixed exchange rate regimes By Sébastien Wälti;
  43. Should You Take a Lump-Sum or Annuitize? Results from Swiss Pension Funds By Monika Bütler; Federica Teppa
  44. The Value Relevance of Financial Accounting Information in a Transitional Economy: The Case of the Czech Republic By Hellström, Katerina
  45. The Foresight Bias in Monte-Carlo Pricing of Options with Early By Christian Fries
  46. Special purpose vehicles and securitization By Gary Gorton; Nicholas S. Souleles
  47. Ownership Structure, Control and Firm Performance: The Effects of Vote Differentiated Shares By Bjuggren, Per-Olof; Eklund, Johan; Wiberg, Daniel

  1. By: Martin D. D. Evans; Viktoria Hnatkovska
    Abstract: International capital flows have increased dramatically since the 1980s, with much of the increase being due to trade in equity and debt markets. Such developments are often attributed to the increased integration of world financial markets. We present a model that allows us to examine how greater integration in world financial markets affects the behavior of international capital flows and financial returns. Our model predicts that international capital flows are large (in absolute value) and very volatile during the early stages of financial integration when international asset trading is concentrated in bonds. As integration progresses and households gain access to world equity markets, the size and volatility of international bond flows fall dramatically but continue to exceed the size and volatility of international equity flows. This is the natural outcome of greater risk sharing facilitated by increased integration. We find that the equilibrium flows in bonds and stocks are larger than their empirical counterparts, and are largely driven by variations in equity risk premia. The paper also makes a methodological contribution to the literature on dynamic general equilibrium asset-pricing. We implement a new technique for solving a dynamic general equilibrium model with production, portfolio choice and incomplete markets.
    JEL: D52 F36 G11
    Date: 2005–10
  2. By: Andreas Freytag (University of Jena, Faculty of Economics); Donato Masciandaro (Paolo Baffi Centre, Bocconi University, Milan, and Department of Economics, Mathematics and Statistics, University of Lecce)
    Abstract: This paper analyses how the central banks role in the monetary institutional setting can affect the unification process of the overall financial supervision architecture. Using indicators of monetary commitment and central bank independence, we claim that these legal proxies show an inverse link with financial supervision unification. Therefore, the trade off still holds between the supervisory and the central bank involvement per se, however, monetary commitment and independence do also matter. In this respect, in an institutional setting characterized by a central bank deeply and successfully involved in supervision, or legally independent, a multi-authority model is likely to occur.
    Keywords: Financial Supervision, Single Authority, Central Bank Independence, Monetary Commitment
    JEL: E58 G20 G28
    Date: 2005–11–01
  3. By: Xavier Gabaix; Parameswaran Gopikrishnan; Vasiliki Plerou; H. Eugene Stanley
    Abstract: We present a theory of excess stock market volatility, in which market movements are due to trades by very large institutional investors in relatively illiquid markets. Such trades generate significant spikes in returns and volume, even in the absence of important news about fundamentals. We derive the optimal trading behavior of these investors, which allows us to provide a unified explanation for apparently disconnected empirical regularities in returns, trading volume and investor size.
    JEL: G1 G12
    Date: 2005–11
  4. By: Barry Eichengreen; Kenneth Kletzer; Ashoka Mody
    Abstract: The IMF attempts to stabilize private capital flows to emerging markets by providing public monitoring and emergency finance. In analyzing its role we contrast cases where banks and bondholders do the lending. Banks have a natural advantage in monitoring and creditor coordination, while bonds have superior risk sharing characteristics. Consistent with this assumption, banks reduce spreads as they obtain more information through repeat transactions with borrowers. By comparison, repeat borrowing has little influence in bond markets, where publicly-available information dominates. But spreads on bonds are lower when they are issued in conjunction with IMF-supported programs, as if the existence of a program conveyed positive information to bondholders. The influence of IMF monitoring in bond markets is especially pronounced for countries vulnerable to liquidity crises.
    Keywords: Capital market ; Developing countries ; International Monetary Fund
    Date: 2005
  5. By: Shu Wu (Department of Economics, The University of Kansas)
    Abstract: This paper shows that even adjusted for the time-varying risk premiums implied by the yield curves across countries, uncovered interest parity is still strongly rejected by the data. Moreover, factors that predict the excess bond returns are found not significant at all in predicting the foreign exchange returns. These results reject the joint restrictions on the exchange rate and interest rates imposed by dynamic term structure models, suggesting that foreign exchange markets and bond markets may not be fully integrated and we have to look beyond interest rate risk in order to understand the exchange rate anomaly.
    Keywords: forward premium puzzle, the term structure of interest rates
    JEL: F31 G12
    Date: 2005–10
  6. By: Burton Abrams (Department of Economics,University of Delaware); Russell Settle (Department of Economics,University of Delaware)
    Abstract: The traditional neoclassical open-economy flexible exchange rate model is expanded to include a “credit channel” by incorporating a bank loan market. The new “credit view” model provides substantially different predictions concerning the neutrality of money and the types of autonomous shocks that might affect the real exchange rate.
    Keywords: Credit Channel, Monetary policy, Fixed Exchange Rates, Money Neutrality
    JEL: F41 E51
    Date: 2005
  7. By: Matthew Pritsker
    Abstract: The growing share of financial assets that are held and managed by large institutional investors whose desired trades move asset prices is at odds with the traditional competitive assumption that investors are small and take prices as given. This paper relaxes the traditional price-taking assumption and instead presents a dynamic multiple asset model of imperfect competition in asset markets among large investors who differ in their risk aversion. The model is used to study asset price dynamics during an LTCM-like scenario in which market rumors of distressed asset sales are followed at a later date by the sales themselves. Using the model, it is shown that large investors front-run distressed sales; asset prices overshoot their long-run fundamentals; and asset pricing models experience temporary breakdown. During the period of model breakdown assets equilibrium returns are explained by the market portfolio and by transient liquidity factors.
    Date: 2005
  8. By: Eirik Gaard Kristiansen (Norwegian School of Economics and Business Administration and Norges Bank (Central Bank of Norway))
    Abstract: Firms choose debt structure and competing banks choose monitoring intensity. Monitoring improves credit allocation, but creates informational lock-in effects in bank-borrower relationships. In a competitive credit market, banks dissipate anticipated profit from serving locked-in borrowers subsequently revealed to the bank as good to attract new borrowers with unknown credit quality. Consequently, banks’ lending strategies result in cross-subsidies from good to bad borrowers. We investigate how firms’ choice of debt structure interacts with the cross-subsidies inherent in banks’ lending strategies. The analysis sheds light on how dynamic bank competition determines monitoring intensity, seniority, and maturity structure in bank dependent industries.
    Keywords: Corporate debt structure, bank lending, lock-in effects
    JEL: D82 G32 G21 L14
    Date: 2005–10–28
  9. By: Philip Arestis; Guglielmo Maria Caporale; Andrea Cipollini; Nicola Spagnolo
    Abstract: In this paper we examine whether during the 1997 East Asian crisis there was any contagion from the four largest economies in the region (Thailand, Indonesia, Korea and Malaysia) to a number of developed countries (Japan, UK, Germany and France).Following Forbes and Rigobon (2002), we test for contagion as a significant positive shift in the correlation between asset returns, taking into account heteroscedasticity and endogeneity bias. Furthermore, we improve on earlier empirical studies by carrying out a full sample test of the stability of the system that relies on more plausible (over)identifying restrictions. The estimation results provide some evidence of contagion, in particular from Japan (the major international lender in the region), which drastically cut its credit lines to the other Asian countries in 1997.
    Date: 2005–04
  10. By: Ilias Lekkos (Eurobank Ergasias); Costas Milas (Keele University); Theodore Panagiotidis (Loughborough University)
    Abstract: This paper explores the ability of common risk factors to predict the dynamics of US and UK interest rate swap spreads within a linear and a non-linear framework. We reject linearity for the US and UK swap spreads in favour of a regime-switching smooth transition vector autoregressive (STVAR) model, where the switching between regimes is controlled by the slope of the US term structure of interest rates. The first regime is characterised by a "flat" term structure of US interest rates, while the alternative is characterised by an "upward" sloping US term structure. We compare the ability of the STVAR model to predict swap spreads with that of a non-linear nearest-neighbours model as well as that of linear AR and VAR models. We find some evidence that the nearest-neighbours and STVAR models predict better than the linear AR and VAR models. However, the evidence is not overwhelming as it is sensitive to swap spread maturity. We also find that within the non-linear class of models, the nearest-neighbours model predicts better than the STVAR model US swap spreads in periods of increasing risk conditions and UK swap spreads in periods of decreasing risk conditions.
    Keywords: Interest rate swap spreads, term structure of interest rates, regime switching, smooth transition models, nearest-neighbours, forecasting.
    JEL: C51 C52 C53 E43
    Date: 2005–09
  11. By: Ekrem Kilic (Marmara University)
    Abstract: Volatility of financial markets is an important topic for academics, policy makers and market participants. In this study first I summarized several specifications for the conditional variance and also define some methods for combination of these specifications. Then assuming that the squared returns are the benchmark estimate for actual volatility of the day, I compare all of the models with respect to how much efficient they are to mimic the realized volatility. At the same time I used a VaR approach to compare these forecasts. With the help of these analyses I examine if combination of the forecast could outperform the single models.
    Keywords: volatility, arch, garch, combination, VaR
    JEL: C1 C2 C3 C4 C5 C8
    Date: 2005–10–29
  12. By: Donald P. Morgan; Kevin J. Stiroh
    Abstract: The naming of eleven banks as "too big to fail (TBTF)" in 1984 led bond raters to raise their ratings on new bond issues of TBTF banks about a notch relative to those of other, unnamed banks. The relationship between bond spreads and ratings for the TBTF banks tended to flatten after that event, suggesting that investors were even more optimistic than raters about the probability of support for those banks. The spread-rating relationship in the 1990s remained flatter for TBTF banks (or their descendants) even after the passage of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), suggesting that investors still see those banks as TBTF. Until investors are disabused of such beliefs, investor discipline of big banks will be less than complete.
    Keywords: Bank management ; Bank failures ; Corporate bond
    Date: 2005
  13. By: Mohsen Fardmanesh; Seymour Douglas
    Abstract: This paper examines the relationship between the official and parallel exchange rates, in three Caribbean countries, Guyana, Jamaica and Trinidad, during the 1985-1993 period using cointegration, Granger causality, and reduced form methods. The official and parallel rates are cointegrated in all three countries, but with significant average disparity between them in Guyana and Trinidad, which unlike Jamaica applied infrequent and large adjustments to their official rates. The causation is bi-directional in the case of Jamaica and uni-directional, with changes in the official rate Granger causing changes in the parallel rate, in the cases of Guyana and Trinidad, reflecting the difference in their official exchange rate policies. Our reduced form estimates indicate that exchange controls, expansionary fiscal and monetary policy, and changes of government mostly have the expected positive effect on the black market premium. After past values of the premium, exchange controls exert the strongest impact on the premium.
    Keywords: Foreign Exchange Controls, Black Market Exchange Rate, Black Market Premium, Cointegration, Granger Causality
    JEL: F31
    Date: 2003–12
  14. By: Gerald Epstein
    Abstract: In the last two decades, there has been a global sea change in the theory and practice of central banking. The currently dominant “best practice” approach to central banking consists of the following: (1) central bank independence (2) a focus on inflation fighting (including adopting formal “inflation targeting”) and (3) the use of indirect methods of monetary policy (i.e., short-term interest rates as opposed to direct methods such as credit ceilings). This paper argues that this neo-liberal approach to central banking is highly idiosyncratic in that, as a package, it is dramatically different from the historically dominant theory and practice of central banking, not only in the developing world, but, notably, in the now developed countries themselves. Throughout the early and recent history of central banking in the U.S., England, Europe, and elsewhere, financing governments, managing exchange rates, and supporting economic sectors by using “direct methods” of intervention have been among the most important tasks of central banking and, indeed, in many cases, were among the reasons for their existence. The neoliberal central bank policy package, then, is drastically out of step with the history and dominant practice of central banking throughout most of its history.
    Date: 2005
  15. By: Guglielmo Maria Caporale; Luis A. Gil-Alana
    Abstract: In this article we estimate the order of integration of the volatility process of several exchange rates and stock returns using fractionally integrated semiparametric techniques,namely a local Whittle semiparametric estimator. The results suggest that all series can be well described in terms of I(d) statistical models, with values of d higher than 0, indicating long-memory behaviour.
    Date: 2005–06
  16. By: Gur Huberman; Zhenyu Wang
    Abstract: Focusing on capital asset returns governed by a factor structure, the Arbitrage Pricing Theory (APT) is a one-period model, in which preclusion of arbitrage over static portfolios of these assets leads to a linear relation between the expected return and its covariance with the factors. The APT, however, does not preclude arbitrage over dynamic portfolios. Consequently, applying the model to evaluate managed portfolios is contradictory to the no-arbitrage spirit of the model. An empirical test of the APT entails a procedure to identify features of the underlying factor structure rather than merely a collection of mean-variance efficient factor portfolios that satisfies the linear relation.
    Keywords: Arbitrage - Econometric models ; Stock - Prices ; Portfolio management
    Date: 2005
  17. By: Kenneth D. Garbade; John E. Kambhu
    Abstract: The U.S. Treasury announced in August 2005 that it is exploring whether to provide a backstop securities lending facility for U.S. Treasury securities. This paper examines the conceptual basis for such a facility by analogizing the market for borrowing and lending Treasury securities with the market for borrowing and lending money prior to the founding of the Federal Reserve System in 1914. An inelastic supply of currency in the nineteenth century led to periodic suspensions of convertibility of bank deposits; Congress authorized a system of Federal Reserve Banks to address the problem. A similarly inelastic supply of Treasury securities has led to several recent episodes of chronic settlement fails. A backstop lending facility would mitigate the fails problem by allowing the Treasury to act as a lender of last resort of Treasury securities during periods of unusual market stress.
    Keywords: Government securities
    Date: 2005
  18. By: E Philip Davis
    Abstract: In recent years, a growing number of Emerging Market Economies, as well as most advanced countries, have witnessed growth of pension funds as institutional investors. This has often occurred in the wake of pension reform shifting retirement income provision from pay-as-you-go to funding. The ongoing ageing of the population and financing difficulties of pay-as-you-go systems suggests that such reforms will become yet more common in the future. Accordingly, it is important to analyse the impact of institutional investment on the economy. In this context, our aim is to address the role of pension funds as institutional investors in financial development, and the wider effects of such financial development on economic performance. We note inter alia some of the ways in which the behaviour and impact of institutional investors might differ in emerging market economies from advanced countries as well as policy issues.
    Date: 2005–09
  19. By: Massimo Guidolin; Eliana La Ferrara
    Abstract: This paper studies the effects of conflict onset on asset markets applying the event study methodology. We consider a sample of 112 conflicts during the period 1974-2004 and find that a sizeable fraction of them had a significant impact on stock market indices and on major commodity prices. Furthermore, our results suggest that we are more likely to see investor reactions in response to conflicts that occur in highly polarized settings, possibly because the expected duration and intensity of the conflict is higher.
    Keywords: Stock exchanges ; Prices
    Date: 2005
  20. By: Jose Manuel Campa; Linda S. Goldberg; Jose M. Gonzalez-Minguez
    Abstract: This paper presents an empirical analysis of transmission rates from exchange rate movements to import prices, across countries and product categories, in the euro area over the last fifteen years. Our results show that the transmission of exchange rate changes to import prices in the short run is high, although incomplete, and that it differs across industries and countries; in the long run, exchange rate pass-through is higher and close to 1. We do not find compelling evidence that the introduction of the euro caused a structural change in exchange rate pass-through. Although some estimated point elasticities have declined, structural breaks in exchange rate pass-through into import prices are evident only in a limited sample of manufacturing industries. And since the euro was introduced, industries producing differentiated goods have been more likely to experience reduced rates of exchange rate pass-through to import prices. Exchange rate changes continue to lead to large changes in import prices across euro-area countries.
    Keywords: Imports - Prices ; Foreign exchange rates ; Euro ; Industries
    Date: 2005
  21. By: Eugen Kovac
    Abstract: The paper analyzes a finite time economy with a single risky asset which pays a one-shot payoff (dividend). The payoff is random and its distribution is not known a priori. Agents observe public signals (random draws from the same distribution) and update their beliefs about the payoff. They trade in order to reshuffle their portfolios according to new beliefs. Agents may use various updating rules and are considered to be of two types: sophisticated who are aware of their future beliefs and prices, and naive who are not. Drawing on the methodology by Sandroni (2000), it is shown that among sophisticated agents, those with less accurate beliefs are driven out, in the sense that their wealth becomes arbitrarily small when the number of signals is sufficiently large. On the other hand, it is shown that this statement may not hold in economies with naive agents only, where even agents with inaccurate beliefs may survive.
    Keywords: Market selection, wealth accumulation, speculation, learning, sophisticated agents, naive agents.
    JEL: D83 D84 G11
    Date: 2005–09
  22. By: Queijo, Virginia (Institute for International Economic Studies, Stockholm University)
    Abstract: This paper aims to evaluate the importance of frictions in credit markets for business cycles in the U.S. and the Euro area. For this purpose, I modify the DSGE financial accelerator model developed by Bernanke, Gertler and Gilchrist (1999) and estimate it using Bayesian methods. The model is augmented with frictions such as price indexation to past inflation, sticky wages, consumption habits and variable capital utilization. My results indicate that financial frictions are relevant in both areas. Using the Bayes factor as criterion, the data favors the model with financial frictions both in the U.S. and the Euro area in five different specifications of the model. Moreover, the size of the financial frictions is larger in the Euro area.
    Keywords: DSGE models; Bayesian estimation; financial accelerator
    JEL: C11 C15 E32 E40 E50 G10
    Date: 2005–08–01
  23. By: Geert Bekaert; Eric Engstrom; Yuhang Xing
    Abstract: We identify the relative importance of changes in the conditional variance of fundamentals (which we call "uncertainty") and changes in risk aversion ("risk" for short) in the determination of the term structure, equity prices, and risk premiums. Theoretically, we introduce persistent time-varying uncertainty about the fundamentals in an external habit model. The model matches the dynamics of dividend and consumption growth, including their volatility dynamics and many salient asset market phenomena. While the variation in dividend yields and the equity risk premium is primarily driven by risk, uncertainty plays a large role in the term structure and is the driver of counter-cyclical volatility of asset returns.
    Date: 2005
  24. By: Ralph Setzer
    Date: 2005
  25. By: Clara Garcia; PNuria Malet
    Abstract: The pressure in the exchange market against a particular currency has been frequently measured as the sum of the loss of international reserves plus the loss of nominal value of that currency. This paper follows the tradition of investigating the interactions between such measure of exchange market pressure (EMP) and monetary policy; but it also questions the usual omission of output growth in the empirical investigations of the interrelations between EMP, domestic credit, and interest rates. The focus of this work is Argentina between 1993 and 2004. As in previous studies, we found some evidence of a positive and double-direction relationship between EMP and domestic credit. But output growth also played a role in the determination of EMP, even more than domestic credit or interest rates. Also, there is some evidence that EMP affected growth negatively.
    Date: 2005
  26. By: Felipe Meza; Erwan Quintin
    Abstract: Total factor productivity (TFP) falls markedly during financial crises, as we document with recent evidence from Mexico and Asia. These falls are unusual in magnitude and present a difficult challenge for the standard small open economy neoclassical model. We show in the case of Mexico’s 1994-95 crisis that the model predicts that inputs and output should have fallen much more than they did. Using models with endogenous factor utilization, we find that capital utilization and labor hoarding can account for a large fraction of the TFP fall during the crisis. However, these models also predict that output should fall significantly more than in the data. Given the behavior of TFP, the biggest challenge may not be explaining why output falls so much following financial crises, but rather why it falls so little.
    Keywords: Financial crises - Mexico
    Date: 2005
  27. By: Ray Barrell; E Philip Davis
    Abstract: Equity prices are major sources of shocks to the world economy and channels for propagation of these shocks. We seek to calibrate macroeconomic effects of falls in share prices and assess appropriate policy responses, using the National Institute Global Econometric Model NiGEM. Based on estimated relationships, falls in US equity prices have significant impacts on global activity; potential for liquidity traps suggest a need for complementary monetary and fiscal policy easing. However, fiscal easing boosts long-term real interest rates and hence moderates one of the automatic shock absorbers provided by the market mechanism.
    Date: 2005–06
  28. By: Ronel Elul
    Abstract: The author develops a simple model in which nancial imperfections can serve to stabilize aggregate uctuations and not merely aggravate them as in much of the previous literature; the author terms this a nancial decelerator. In the model agents borrow to purchase housing and secure their loans with this long-lived asset. There are two nancial imperfections in this model. First, agents are unable to commit to repay their loans — that is, they can strategically default. This limits the amount that lenders are willing to offer. In addition, however, lenders are also imperfectly informed as to a borrower’s propensity to default; that is, there is adverse selection. The latter imperfection implies that default may actually occur in equilibrium, unlike in much of the previous literature. For relatively high house prices the commitment problem ensures that the equilibrium is typically characterized by a standard nancial accelerator; that is, the borrowing constraints which prevent default become tighter as falling prices reduce the wealth with which agents can collateralize future loans, thereby exacerbating aggregate uctuations. However, Elul shows that when prices are very low, agents will default, which serves as a stabilizing force; he terms this a nancial decelerator.
    Date: 2005
    Abstract: We evaluate changes in international spillovers of equity price shocks with EMU by estimating BEKK-GARCH models over 1993-98 and 1999-2004. Results are consistent with EMU market integration via sectoral allocation, but not autonomy from the external influence of the US.
    Date: 2005–10
  30. By: Han N. Ozsoylev
    Abstract: We often observe disproportionate reactions to tangible information in large stock price movements. Moreover these movements feature an asymmetry: the number of crashes is more than that of frenzies in the S&P 500 index. This paper offers an explanation for these two characteristics of large movements in which hedging (portfolio insurance) causes amplified price reactions to news and liquidity shocks as well as an asymmetry biased towards crashes. Risk aversion of traders is shown to be essential for the asymmetry of price movements. Also, we show that differential information enhances both amplification and asymmetry delivered by hedging.
    JEL: G11 G12
    Date: 2005
  31. By: Sydeny C. Ludvigson; Serena Ng
    Abstract: Empirical evidence suggests that excess bond returns are forecastable by financial indicators such as forward spreads and yield spreads, a violation of the expectations hypothesis based on constant risk premia. But existing evidence does not tie the forecastable variation in excess bond returns to underlying macroeconomic fundamentals, as would be expected if the forecastability were attributable to time variation in risk premia. We use the methodology of dynamic factor analysis for large datasets to investigate possible empirical linkages between forecastable variation in excess bond returns and macroeconomic fundamentals. We find that several common factors estimated from a large dataset on U.S. economic activity have important forecasting power for future excess returns on U.S. government bonds. Following Cochrane and Piazzesi (2005), we also construct single predictor state variables by forming linear combinations of either five or six estimated common factors. The single state variables forecast excess bond returns at maturities from two to five years, and do so virtually as well as an unrestricted regression model that includes each common factor as a separate predictor variable. The linear combinations we form are driven by both "real" and "inflation" macro factors, in addition to financial factors, and contain important information about one year ahead excess bond returns that is not captured by forward spreads, yield spreads, or the principal components of the yield covariance matrix.
    JEL: G10 G12 E0 E4
    Date: 2005–10
  32. By: Mark Furletti
    Abstract: This is the third in a series of three papers that examines the laws, regulations, and voluntary industry practices that may aid consumers who contest an electronic transaction because of error, fraud, or merchant dispute. The first two papers describe the complex web of protections available to users of four popular electronic payment mechanisms: credit cards, debit cards, prepaid cards, and ACH e-checks. This third paper considers how protections related to fraud, error, and disputes affect market participants. The paper concludes that (i) the current protection mechanisms make it more difficult to encourage the adoption of fraud-reduction schemes, (ii) the current protections represent a significant cost to banks, merchants, processors, and consumers, and (iii) the present federal system of protection, while encouraging innovation and thoughtful regulation, leads to consumer confusion.
    Keywords: Payment systems ; Fraud ; Consumer protection
    Date: 2005
  33. By: Han N. Ozsoylev; Shino Takayama
    Abstract: We study price formation in securities markets, using the sequential trade framework of Glosten and Milgrom. This paper makes one basic methodological advance over previous research on sequential securities trading: we allow traders to choose from n trade sizes in a multi-period market, where n can be arbitrarily large. We examine how trade size multiplicity affects the intertemporal dynamics of trading strategies, bid-ask spreads, and information revelation. We show that price impact, as a function of trade size, is increasing and exhibits (discrete) concavity.
    JEL: D82 G12
    Date: 2005
  34. By: Werner Jammernegg (Vienna University of Economics and Business Administration, Department of Information Systems and Operations); Peter Kischka (University of Jena, Faculty of Economics)
    Abstract: We introduce a decision rule where the risk dimension is measured by the conditional value of risk. We characterize the risk attitudes implied by the decision rule in a way similar to the well known mean variance framework. We show that the rule is consistent with Yaaris dual theory for all risk attitudes. Finally a reformulation of the decision rule is presented which is based on two conditional expected values.
    Date: 2005–09–08
  35. By: Guglielmo Maria Caporale; Luis A. Gil-Alana
    Abstract: This paper examines the long-run dynamics and the cyclical structure of the US stock market using fractional integration techniques. We implement a version of the tests of Robinson (1994a), which enables one to consider unit roots with possibly fractional orders of integration both at the zero (long-run) and the cyclical frequencies. We examine the following series: inflation, real risk-free rate, real stock returns, equity premium and price/dividend ratio,annually from 1871 to 1993. When focusing exclusively on the long-run or zero frequency, the estimated order of integration varies considerably, but nonstationarity is found only for the price/dividend ratio. When the cyclical component is also taken into account, the series appear to be stationary but to exhibit long memory with respect to both components in almost all cases. The exception is the price/dividend ratio, whose order of integration is higher than 0.5 but smaller than 1 for the long-run frequency, and is between 0 and 0.5 for the cyclical component. Also, mean reversion occurs in all cases. Finally, we use six different criteria to compare the forecasting performance of the fractional (at both zero and cyclical frequencies) models with others based on fractional and integer differentiation only at the zero frequency. The results show that the former outperform the others in a number of cases.
    Date: 2005–06
  36. By: Olivia S. Mitchell; Stephen P. Utkus; Tongxuan (Stella) Yang
    Abstract: We develop a comprehensive model of 401(k) pension design that reflects the complex tax, savings, liquidity and investment incentives of such plans. Using a new dataset on some 500 plans covering nearly 740,000 workers, we show that employer matching contributions have only a modest impact on eliciting additional retirement saving. In the typical 401(k) plan, only 10 percent of non-highly-compensated workers are induced to save more by match incentives; and 30 percent fail to join their plan at all, despite the fact that the company-proffered match would grant them a real return premium of 1-5% above market rates if they contributed. Such indifference to retirement saving incentives cannot be attributed to liquidity or investment constraints. These results underscore the need for alternative approaches beyond matching contributions, if retirement saving is to become broader-based.
    JEL: J26 J32 G23
    Date: 2005–10
  37. By: Craig H. Furfine; Eli M. Remolona
    Abstract: We analyze how price discovery in the inter- dealer market for U.S. Treasury securities differs between stressful times and normal periods. Using tick-by-tick data on inter-dealer transactions in the on-the- run two-year, five-year and 10-year Treasury notes, we find that the impact of trades on prices tends to become significantly stronger on stressful days. This effect remains after accounting for the faster trading, wider spreads, and shallower depth observed on stressful days.
    Date: 2005
  38. By: Imen Bentahar; Bruno Bouchard
    Abstract: We consider a continuous time multivariate financial market with proportional transaction costs and study the problem of finding the minimal initial capital needed to hedge, without risk, European-type contingent claims. The model is similar to the one considered in Bouchard and Touzi (2000) except that some of the assets can be exchanged freely, i.e. without paying transaction costs. This is the so-called non-effcient friction case. To our knowledge, this is the first time that such a model is considered in a continuous time setting. In this context, we generalize the result of the above paper and prove that the super-replication price is given by the cost of the cheapest hedging strategy in which the number of non-freely exchangeable assets is kept constant over time.
    Keywords: Transaction costs, hedging options, viscosity solutions
    JEL: G12 G13 C6
    Date: 2005–10
  39. By: Almuth Scholl
    Abstract: This paper analyzes the impact of limited enforceable international loans on international risk sharing and trade fluctuations in a two-country two-good endowment economy. Our specification of the punishment threat allows the exclusion from trade to last only finitely many periods and distinguishes between financial autarky and full autarky. Quantitative results show that limited enforceability substantially alters cross-country consumption correlations and the dynamics of net exports. In contrast to existing studies, risk sharing is low for large elasticities of substitution between the domestic and foreign goods. However, it remains challenging to explain the high volatility of the terms of trade empirically observed.
    JEL: E32 D52 F34 F41
    Date: 2002–06
  40. By: William H. Branson; Conor N. Healy
    Abstract: This paper develops the basis for monetary and exchange rate coordination in Asia as part of a package of monetary integration that could support growth and poverty reduction. This could be achieved directly through coordinated exchange rate stabilization, and indirectly through the implications of this for reserve pooling and investment in an Asian development fund (ADF) and through development of the Asian bond market (ABM). Macro policy coordination could be viewed as a necessary condition for further development of both reserve pooling via the Chiang Mai Initiative (CMI) and of the ABM. The paper analyzes the trade structure of ASEAN and China in terms of both geographic sources of imports and markets for exports, and of the commodity structure of trade. The similarities of the geographic and commodity trade structures across the region are consistent with adoption of a common currency basket for stabilization, and with an argument for monetary integration across the region along the lines of Mundell (1961) on optimum currency areas. The paper constructs currency baskets and real effective exchange rates (REERs) for the countries in the region. Since their trade patterns are quite similar and their policies are already implicitly coordinated, their REERs tend to move together. This means that ASEAN and China are already moving toward integration in practical effect. Explicit movement toward coordination could support surveillance and reserve-sharing under the CMI, and release reserves to be invested in an ADF.
    JEL: F33 F41 G15
    Date: 2005–10
  41. By: Daniel Covitz; Steven A. Sharpe
    Abstract: We compile and analyze detailed information on the debt structure and interest rate derivative positions of nonfinancial firms in 2000 and 2002. We find that differences in debt structure across firms and time tend to be counterbalanced by difference in derivative positions. In particular, among derivative users, smaller firms tend to have relatively more interest rate exposure from liabilities than larger firms and tend to use derivatives that offset these exposures. Larger firms also tend to limit their interest rate exposures, but they do so through their choice of debt structure rather than with derivatives. On the other hand, we find that a large fraction of the change in derivative positions over time cannot be explained by changes in debt structure. Finally, we find no evidence that nonfinancial firms hedge interest rate exposures from their operating assets, but do not see this as supporting the hypothesis that firms use derivatives to speculate.
    Date: 2005
  42. By: Sébastien Wälti; (Department of Economics, Trinity College Dublin; )
    Abstract: This paper studies the survival of fixed exchange rate regimes. The probability of an exit from a fixed exchange rate regime depends on the time spent within this regime. In such a context durations models are appropriate, in particular because of the possible non-monotonic pattern of duration dependence. Non-parametric estimates show that the pattern of duration dependence exhibits non-monotonic behaviour and that it differs across types of economies. This behaviour persists when we control for time-varying covariates in a proportional hazard specification. We conclude that how long a regime has lasted will affect the probability that it will end, in a non-monotonic fashion.
    JEL: F30 F31 F41
    Date: 2005–08
  43. By: Monika Bütler; Federica Teppa
    Abstract: We use a unique dataset on individual retirement decisions in Swiss pension funds to analyze the choice between an annuity and a lump sum at retirement. Our analysis suggests the existence of an "acquiescence bias", meaning that a majority of retirees chooses the standard option offered by the pensions fund or suggested by common practice. Small levels of accumulated pension capital are much more likely to be withdrawn as a lump sum, suggesting a potential moral hazard behavior or a magnitude effect. We hardly find evidence for adverse selection effects in the data. Single men, for example, whose money's worth of an annuity is considerably below the corresponding value of married men, are not more likely to choose the capital option.
    JEL: D91 H55 J26
    Date: 2005–10
  44. By: Hellström, Katerina (Dept. of Business Administration, Stockholm School of Economics)
    Abstract: The paper investigates the value relevance of accounting information in the Czech Republic in 1994-2001. Value relevance is understood as the ability of financial statement information to capture or summarise information that affects share values and empirically tested as a statistical association between market values and accounting values. The first objective is to evaluate the value relevance of accounting information in the Czech Republic in comparison to accounting information in a well-developed market economy. The second objective is to investigate whether the value relevance of accounting information has increased over time in the Czech Republic, as an indictor of improvements in the accounting regulation and practice. Sweden is chosen as a benchmark country for the comparison. The results show that the value relevance of accounting information indeed is lower in the Czech Republic than in Sweden. The results, however, indicate an improvement in the quality of the Czech financial accounting information during the research period
    Keywords: value relevance; financial accounting information; transitional economy; international accounting
    Date: 2005–10–11
  45. By: Christian Fries
    Abstract: In this paper we investigate the so called foresight bias that may appear in the Monte-Carlo pricing of Bermudan and compound options if the exercise criteria is calculated by the same Monte-Carlo simulation as the exercise values. The standard approach to remove the foresight bias is to use two independent Monte-Carlo simulations: One simulation is used to estimate the exercise criteria (as a function of some state variable), the other is used to calculate the exercise price based on this exercise criteria. We shall call this the numerical removal of the foresight bias. In this paper we give an exact definition of the foresight bias in closed form and show how to apply an analytical correction for the foresight bias. Monte Carlo price for different levels of aggregation. Starting with a single Monte Carlo simulation with 2048000 paths we price the same option with two, four, eight, etc. smaller simulations and average the prices. Foresight bias becomes a strong effect when aggregating prices from many small (2000-5000 paths) simulations. Our corrections improve the prices even if a very small number of paths (200) is used. Our numerical results show that this analytical removal of the foresight bias gives similar results as the standard numerical removal of the foresight bias. The analytical correction allows for a simpler coding and faster pricing, compared to a numerical removal of the foresight bias. Our analysis may also be used as an indication of when to neglect the foresight bias removal altogether. While this is sometimes possible, neglecting foresight bias will break the possibility of parallelization of Monte-Carlo simulation and may be inadequate for Bermudan options with many exercise dates (for which the foresight bias may become a Bermudan option on the Monte-Carlo error) or for portfolios of Bermudan options (for which the foresight bias grows faster than the Monte-Carlo error).
    Keywords: Monte Carlo, Bermudan, Early Exercise, Regression, Least Square Approximation of Conditional Expectation, Longstaff-Schwartz, Perfect Foresight, Foresight Bias
    JEL: C15 G13
    Date: 2005–11–03
  46. By: Gary Gorton; Nicholas S. Souleles
    Abstract: This paper analyzes securitization and more generally “special purpose vehicles” (SPVs), which are now pervasive in corporate finance. The first part of the paper provides an overview of the institutional features of SPVs and securitization. The second part provides a model to analyze the motivations for using SPVs and the conditions under which SPVs are sustainable. The authors argue that a key source of value to using SPVs is that they help reduce bankruptcy costs. Off-balance sheet financing involves transferring assets to SPVs, which reduces the amount of assets that are subject to bankruptcy costs, since SPVs are carefully designed to avoid bankruptcy. Off-balance sheet financing is most advantageous for sponsoring firms that are risky or face large bankruptcy costs. SPVs become sustainable in a repeated SPV game, because firms can implicitly “commit” to subsidize or “bail out” their SPVs when the SPV would otherwise not honor its debt commitments, despite legal and accounting restrictions to the contrary. The third part of the paper tests two key implications of the model using unique data on credit card securitizations. First, riskier firms should securitize more, ceteris paribus. Second, since investors know that SPV sponsors can bail out their SPVs if there is a need, in pricing the debt of the SPV investors will care about the risk of the sponsor defaulting, above and beyond the risk of the SPVs assets. The authors find evidence consistent with these implications
    Keywords: Asset-backed financing
    Date: 2005
  47. By: Bjuggren, Per-Olof (Jönköping International Business School); Eklund, Johan (Jönköping International Business School); Wiberg, Daniel (Jönköping International Business School)
    Abstract: This paper contributes to the literature on ownership, control and performance by exploring these relationships for Swedish listed companies (1997-2002). We find that firms, on average, are making inferior investment decisions and that the use of dual-class shares have a negative effect on performance. According to our results concentration of ownership has a negative impact on investment performance and firm value when control instruments that separate votes from capital share are used. Marginal q is used as a measure of economic performance. It was presented in an article by Mueller and Reardon in 1993 and has recently been used in empirical studies of ownership and performance by among others Gugler and Yurtoglu (2003). Frequently Tobin’s q is used in studies of this type, but Tobin’s q has a number of disadvantages which can be circumvented by employing a marginal q. This study adds to earlier studies by investigating how the separation of vote and capital shares’ creates a wedge between the incentives and the ability to pursue value maximization. The relationships between the performance measure and different ownership characteristics like ownership concentration and foreign ownership are also investigated.
    Keywords: marginal q; ownership structure; firm performance; investments; dual-class shares
    JEL: C23 D21 G30 K22 L20
    Date: 2005–10–27

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