New Economics Papers
on Financial Markets
Issue of 2006‒01‒24
117 papers chosen by

  1. Regulation of Banking Groups By Thomas Harr; Thomas Rønde
  2. The timing of central bank communication By Michael Ehrmann; Marcel Fratzscher
  3. The Interaction between Technical Currency Trading and Exchange Rate Fluctuations By Stephan Schulmeister
  4. The Day of the Week Effect Patterns on Stock Market Return and Volatility: Evidence for the Athens Stock Exchange By Dimitris Kenourgios; Aristeidis Samitas; Spyros Papathanasiou
  5. Driving factors behind O/N interbank interest rates – the Hungarian experiences By Szilárd Erhart
  6. Bank interest rate pass-through in the euro area: a cross country comparison By Christoffer Kok Sorensen; Thomas Werner
  7. The Political Economy of Financial Fragility By Erik Feijen; Enrico Perotti
  8. Bubbles and self-fulfilling crises. By Edouard Challe; Xavier Ragot
  9. Un modello dei conti economici per il sistema bancario italiano By Luca Casolaro; Leonardo Gambacorta
  10. Do mergers improve information? Evidence from the loan market By Fabio Panetta; Fabiano Schivardi; Matthew Shum
  11. Too-Big-To-Fail: Bank Failure and Banking Policy in Jamaica By Daley, J; Matthews, Kent; Whitfield, K
  12. Risk Diversification by European Financial Conglomerates By Jan Frederik Slijkerman; Dirk Schoenmaker; Casper de Vries
  13. CEE Banking Sector Co-Movement: Contagion or Interdependence? By Terhi Jokipii; Brian Lucey
  14. The Impact of Monetary Union on EU-15 Sovereign Debt Yield Spreads By Marta Gómez-Puig
  15. How the Eurosystem’s Treatment of Collateral in its Open Market Operations Weakens Fiscal Discipline in the Eurozone (and what to do about it) By Buiter, Willem H; Sibert, Anne
  16. Money, Interest Rate and Stock Prices: New Evidence from Singapore and The United States By Wong Keung-Wing; Habibullah Khan; Jun Du
  17. Competitiveness and Market Contestability of Major UK Banks By Matthews, Kent; Murinde, Victor; Zhao, Tianshu
  18. Macroeconomics Uncertainty and Banks' Lending Decisions: The Case of Italy By Mario Quagliariello
  19. The Impact of Central Bank FX Interventions on Currency Components By Michel Beine; Charles S. Bos; Sebastian Laurent
  20. Towards European monetary integration - the evolution of currency risk premium as a measure for monetary convergence prior to the implementation of currency unions By Fernando González; Simo Launonen
  21. Establishing Credibility: Evolving Perceptions of the European Central Bank By Linda S. Goldberg; Michael W. Klein
  22. Evolution of trade patterns in the new EU member states By Alberto Franco Pozzolo
  23. The Political Economy of Corporate Control By Enrico Perotti; Ernst-Ludwig von Thadden
  24. Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Roll–over By Galina Hale;
  25. Market Efficiency Today By M. Hashem Pesaran
  26. Financial structure and the transmission of monetary shocks: preliminary evidence for the Czech Republic, Hungary and Poland By Alessio Anzuini; Aviram Levy
  27. The Impact of Boards with Financial Expertise on Corporate Policies By A. Burak Guner; Ulrike Malmendier; Geoffrey Tate
  28. Links between the Indian, U.S. and Chinese Stock Markets By Heng Chen; Bento J. Lobo; Wing-Keung Wong
  29. Bi-Polar Disorder: Exchange Rate Regimes, Economic Crises and the IMF By Graham Bird; Dane Rowlands
  30. Forecasting ECB monetary policy - accuracy is (still) a matter of geography By Helge Berger; Michael Ehrmann; Marcel Fratzscher
  31. Which Past Returns Affect Trading Volume? By Glaser, Markus; Weber, Martin
  32. Does SIZE Matter? Liquidity Provision by the Nasdaq Anonymous Trading Facility By Bruce Mizrach
  33. New Variance Ratio Tests to Identify Random Walk from the General Mean Reversion Model By Kin Lam; May Chun Mei Wong; Wing-Keung Wong
  34. Banking on "Green Money:" Are Environmental Financial Responsibility Rules Fulfilling Their Promise? By Boyd, James
  35. International Capital Flows and U.S. Interest Rates By Francis E. Warnock; Veronica C. Warnock
  36. Is time ripe for a currency union in emerging East Asia? The role of monetary stabilisation By Marcelo Sánchez
  37. Credit chains and the propagation of financial distress By Frederic Boissay
  38. Are emerging market currency crises predictable? A test By Tuomas A. Peltonen
  39. A better way to account for fiat money at the Central Bank By Thomas Colignatus
  40. Real versus financial frictions to capital investment By Nihal Bayraktar; Plutarchos Sakellaris; Philip Vermeulen
  41. Investors’ Misreaction to Unexpected Earnings: Evidence of Simultaneous Overreaction and Underreaction By Kaestner, Michael
  42. What Can Rational Investors Do About Excessive Volatility and Sentiment Fluctuations? By Dumas, Bernard J; Kurshev, Alexander; Uppal, Raman
  43. Big Elephants in Small Ponds: Do Large Traders Make Financial Markets More Aggressive? By Christina E. Bannier
  45. Competitive equilibrium with asymmetric information : the arbitrage characterization. By Lionel de Boisdeffre
  46. Option Pricing by Students and Professional Traders: A Behavioural Investigation By KLAUS ABBINK; BETTINA ROCKENBACH
  47. Attila Csajbók - András Rezessy : Hungary's euro zone entry date: what do the markets think and what if they change their minds? By Attila Csajbók; András Rezessy
  48. Financial Globalization, Corporate Governance, and Eastern Europe By Rene M. Stulz
  49. 'Large' vs. 'Small' Players: A Closer Look at the Dynamics of Speculative Attacks By Bjönnes, Geir H.; Holden, Steinar; Rime, Dagfinn; Solheim, Haakon O.Aa.
  50. A Wavelet Analysis of MENA Stock Markets By Marco Gallegati
  51. Environmental policy and speculation on markets for emission permits By Paolo, COLLA; Marc, GERMAIN; Vincent, VAN STEENBERGHE
  52. Household debt sustainability - What explains household non-performing loans? An empirical analysis By Laura Rinaldi; Alicia Sanchis-Arellano
  53. Some Empirical Observations on the Forward Exchange Rate Anomaly By Derek Bond; Michael J. Harrison; Niall Hession; Edward J. O'Brien
  54. Methodology and Implementation of Value-at-Risk Measures in Emerging Fixed-Income Markets with Infrequent Trading. By Gonzalo Cortazar; Alejandro Bernales; Diether Beuermann
  55. Estimating the immediate impact of monetary policy shocks on the exchange rate and other asset prices in Hungary By András Rezessy
  56. AMU Deviation Indicator for Coordinated Exchange Rate Policies in East Asia and its Relation with Effective Exchange Rates By Eiji Ogawa; Junko Shimizu
  57. Anomalous Price Behavior Following Earnings Surprises: Does Representativeness Cause Overreaction? By Kaestner, Michael
  58. The Determinants of Multinational Banking during the First Globalization, 1870-1914 By Stefano Battilossi
  59. Does Financial Integration Spur Economic Growth? New Evidence from the First Era of Financial Globalization By Moritz Schularick; Thomas M. Steger
  60. Asset Price Dynamics When Traders Care About Reputation By Dasgupta, Amil; Prat, Andrea
  61. Uniform Price Auction and Fixed Price Offerings in IPO: An Experimental Comparison By Ping Zhang
  62. Why Don't Lenders Finance High-Return Technological Change in Developing-Country Agriculture? By Blackman, Allen
  63. Long-Term Stewardship of Contaminated Sites: Trust Funds as Mechanisms for Financing and Oversight By Probst, Katherine; Bauer, Carl
  64. Macroeconomic Derivatives: An Initial Analysis of Market-Based Macro Forecasts, Uncertainty, and Risk By Refet Gurkaynak; Justin Wolfers
  65. Il pilastro privato del sistema previdenziale. Il caso del Regno Unito By Francesco Spadafora
  66. Why a Sub-Debt Policy Must Be Mandatory ? - A Pro Domo Apology - By Adrian Pop
  67. Does wealth affect consumption? Evidence for Italy By Monica Paiella
  68. Hope springs eternal… French bondholders and the Soviet Repudiation (1915-1919) By John Landon-Lane; Kim Oosterlinck
  69. Stock market returns and economic activity: evidence from wavelet analysis By Marco Gallegati
  70. Stock Markets Turmoil: Worldwide Effects of Middle East Conflicts By Viviana Fernandez
  71. How Noisy Should a Noisy Signal be: A Model of Bank Runs By Geethanjali Selvaretnam
  72. Stock Market Predictability in the MENA: Evidence from New Variance Ratio Tests and Technical Trade Analysis By Thomas Lagoarde Segot; Brian M Lucey
  73. Should It Be Curtains for Some of the IMF’s Lending Windows? By Graham Bird; Dane Rowlands
  74. Financial Market Integration in East Asia: Regional or Global? By Jongkyou Jeon; Yonghyup Oh; Doo Yong Yang
  76. La Value-at-Risk: Modèles de la VaR, simulations en Visual Basic (Excel) et autres mesures récentes du risque de marché By Francois-Éric Racicot; Raymond Théoret
  77. Assessing debt sustainability in emerging market economies using stochastic simulation methods By Karam, Philippe; Hostland, Dou g
  78. Estimating expectations of shocks using option prices By Antonio Di Cesare
  79. The Social Cost of Foreign Exchange Reserves By Dani Rodrik
  80. Does Prospect Theory Explain the Disposition Effect? By Thorsten Hens; Martin Vlcek
  81. Exchange Rate Smoothing in Hungary By Péter Karádi
  82. On Overborrowing By Martin Uribe
  83. The Dynamic Behavior of the Real Exchange Rate in Sticky Price Models By Bjorn A. Hauksson
  84. Advisors and Asset Prices: A Model of the Origins of Bubbles By Harrison Hong; Jose Scheinkman; Wei Xiong
  85. On the Timing Option in a Futures Contract By Björk, Tomas; Biagini, Francesca
  86. Consumer Lending When Lenders are More Sophisticated Than Households By Inderst, Roman
  87. How important are financing co nstraints ? The role of finance in the business environment By Maksimovic, Vojislav; Demirguc-Kunt, Asli; Ayyagari, Meghana
  88. Forecasting the central bank’s inflation objective is a good rule of thumb By Marie Diron; Benoît Mojon
  89. The duration of fixed exchange rate regimes By Sébastien Wälti
  90. Structural Breakpoints in Volatility in International Markets By Viviana Fernandez;
  91. Calibration Risk for Exotic Options By Kai Detlefsen; Wolfgang Härdle
  92. Shareholder Protection, Stock Market Development and Politics By Pagano, Marco; Volpin, Paolo
  93. Monetary policy and stock prices: theory and evidence By Stefano Neri
  94. Prospects For Enhanced Exchange Rate Cooperation in East Asia: Some Preliminary Findings from Generalized PPP Theory By Peter Wilson; Choy Keen Meng
  95. Estimating state price densities by Hermite polynomials: theory and application to the Italian derivatives market By Paolo Guasoni
  96. The Indexing Paradox -- Be Thankful for Irrational Investors By David Eagle
  97. Does trade credit substitute for bank credit? By Guido De Blasio
  98. Il credito commerciale: problemi e teorie By Massimo Omiccioli
  99. Demand-Based Option Pricing By Garleanu, Nicolae B.; Pedersen, Lasse Heje; Poteshman, Allen M
  100. Repurchasing Shares on a Second Trading Line By Dusan ISAKOV; Dennis Y. CHUNG; Christophe PERIGNON
  101. Does The Stock Market Punish Corporate Malfeasance? A Case Study of Citigroup By Bruce Mizrach; Susan Zhang Weerts
  102. Equity and Efficiency under Imperfect Credit Markets By Reto Foellmi; Manuel Oechslin
  103. Security Design with Investor Private Information By Axelson, Ulf
  104. Kapitalmarktorientierte Risikosteuerung in Banken: Marktwertsteuerung statt Marktzinsmethode By Rolf Reichardt
  105. Overconfidence and Trading Volume By Glaser, Markus; Weber, Martin
  106. Funzionamento della giustizia civile e struttura finanziaria delle imprese: il ruolo del credito commerciale By Amanda Carmignani
  107. L’impact des opérations transactionnelles sur la croissance de la productivité dans le secteur bancaire. By Mario Fortin; Andre Leclerc; Jean-Baptiste Nesmy
  109. The modelling of operational risk: experience with the analysis of the data collected by the Basel Committee By Marco Moscadelli
  110. Taxation and the Financial Structure of Foreign Direct Investment By Frances Ruane; Padraig Moore
  111. Distribution Risk and Equity Returns By Jean-Pierre DANTHINE; John B. DONALDSON; Paolo SICONOLFI
  112. Portfolio Value at Risk Based on Independent Components Analysis By Ying Chen; Wolfgang Härdle; Vladimir Spokoiny
  113. Market Discipline, Information Processing, and Corporate Governance By Martin Hellwig
  114. Endogeneities of Optimum Currency Areas: What brings Countries Sharing a Single Currency Closer together? By Paul de Grauwe; Francesco Paolo Mongelli
  115. Financial Repression, Tax Evasion and Long-Run Monetary and Fiscal Policy Trade-Off in an Endogenous Growth Model with Transaction Costs By Patrick Villieu; Alexandru Minea
  116. Le capital social : un concept utile pour la finance et le développement By Thierry Montalieu; Thierry Baudassé
  117. Pay-at-the-Pump Auto Insurance By Khazzoom, J. Daniel

  1. By: Thomas Harr (Danske Bank Group); Thomas Rønde (Department of Economics, University of Copenhagen)
    Abstract: We study the optimal regulation of banking groups (“banks”), taking both minimum capital requirements and legal structure into account. A bank can set up either as one legal unit facing limited liability jointly (branch structure) or as a bank holding company with subsidiaries (subsidiary structure). Banks are exposed to risk from their unobservable asset choices and to exogenous risk from their environment. We show that banks with branches are more prudent in normal times than banks with subsidiaries, but are also less prudent when problems arise. A regulator that observes banks’ exogenous risk should optimally determine both capital requirements and legal structure. If the exogenous risk is private information to banks, it can be optimal to screen banks according to risk by setting capital requirements appropriately, and letting banks choose their legal structure.
    Keywords: banking groups; capital requirements; legal structure
    JEL: G21 G28 L51
    Date: 2006–01
  2. By: Michael Ehrmann (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper explores whether there are systematic patterns as to when members of the decision-making committees of the Federal Reserve, the Bank of England and the European Central Bank communicate with the public, and under what circumstances such communication has the ability to move financial markets. The findings suggest that communication is generally seen as a tool to prepare markets for upcoming decisions, as it becomes more intense before committee meetings, and particularly so prior to interest rate changes. At the same time, markets react more strongly to communication prior to policy changes. Other instances where communication becomes more intense, or where financial markets become more responsive are also identified; even though these are more specific to the individual central banks, they are consistent with differences in the central banks’ monetary policy strategies and communication policies.
    Keywords: Communication; central bank; monetary policy; timing.
    JEL: E43 E52 E58 G12
    Date: 2005–12
  3. By: Stephan Schulmeister (Austrian Institute of Economic Research)
    Abstract: This paper examines the mutually reinforcing interactions between exchange rate dynamics and technical trading strategies. I first show that technical trading systems have been quite profitable during the floating rate period. This profitability stems from the successful exploitation of exchange-rate trends and not from taking winning positions relatively frequently. I then show that technical models exert an excess demand pressure on currency markets. When these models produce trading signals, almost all signals are on the same side of the market, either buying or selling. When technical models maintain open positions they are either long or short. Initial exchange rate movements triggered by news or by stop-loss orders are strengthened by technical trading and are often transformed into a trend. This 'multiplier effect' is reflected by the close relationship between technical trading signals and order flows. Hence, order flows are not only driven by (fundamental) news but also by technical trading, which reinforces exchange rate trends to which it responds.
    Keywords: Exchange rate; Technical trading; Heterogeneous agents.
    JEL: F31 G14 G15
    Date: 2005–12–29
  4. By: Dimitris Kenourgios (University of Athens); Aristeidis Samitas (University of Aegean); Spyros Papathanasiou (Hellenic Open University)
    Abstract: This paper investigates the day of the week effect in the Athens Stock Exchange (ASE) General Index over a ten year period divided into two subperiods: 1995-2000 and 2001-2004. Five major indices are also considered: Banking, Insurance, and Miscellaneous for the first subperiod, and FTSE-20 and FTSE-40 for the second subperiod. Using a conditional variance framework, which extends previous work on the Greek stock market, we test for possible existence of day of the week variation in both return and volatility equations. When using the GARCH (1,1) specification only for the return equation and the Modified-GARCH (1,1) specification for both the return and volatility equations, findings indicate that the day of the week effect is present for the examined indices of the emerging ASE over the period 1995-2000. However, this stock market anomaly seems to loose its strength and significance in the ASE over the period 2001-2004, which might be due to the Greek entry to the Euro-Zone and the market upgrade to the developed.
    Keywords: Day of the week effect; mean stock returns; volatility; GARCH
    JEL: G10 G12
    Date: 2005–12–28
  5. By: Szilárd Erhart (Magyar Nemzeti Bank)
    Abstract: This study examines overnight (O/N) interest rates which constitute the short end of the yield curve and the factors which have an impact on such rates. The MNB, unlike several other central banks, does not have a direct overnight interest rate target; it does, however, limit the divergence of O/N interest rates from its policy rate with the settings of its operational framework. First, the MNB’s regulations on compulsory reserves allow banks to apply averaging in the reserve maintenance period, which reduces overnight interest rate volatility. Second, the interest rate corridor – determined by MNB’s collateralised loan and deposit – limits the maximum fluctuation band of overnight interbank interest rates. The study finds that the role of reserve averaging to reduce yield fluctuations is imperfect, as a clear seasonal pattern is observed in the intra-maintenance period evolution of overnight rates. The frequency of cumulative front-loading and excess reserves is significantly higher than the frequency of reserve deficit. Therefore, the level of overnight interest rates tends to remain below the policy rate and drop towards the interest rates of overnight central bank deposits at the end of the maintenance period. Moreover, statistical analysis finds evidence that the impact of liquidity withdrawing shocks are typically greater – approximately twice as much – as of those injecting liquidity. This phenomenon could be explained by the volatility of autonomous liquidity factors, especially that of the government accounts, which is particularly high on VAT payment days. Institutional settings (credit limits, limitation of maximum deviation from reserve requirements, high interbank concentration) curtail the potential of the interbank market to efficiently distribute liquidity over the entire system, which may also explain the asymmetric liquidity management characteristics of Hungarian banks.
    Keywords: overnight rate, central bank instruments, operational framework, averaging, reserve requirements.
    JEL: G14 E42 E52
    Date: 2005
  6. By: Christoffer Kok Sorensen (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.); Thomas Werner (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: The present paper investigates the pass-through between market interest rates and bank interest rates in the euro area. Compared to the large interest rate pass-through literature the paper mainly improves upon two points. First, a novel data set, partially based on new harmonised ECB bank interest rate statistics is used. Moreover, the market rates are selected in a way to match the maturities of bank and market rates using information provided by the new statistics. Secondly, new panel-econometric methods are applied to test for heterogeneity in the pass-through process. The paper shows a large heterogeneity in the pass-through of market rates to bank rates between euro area countries and finally possible explanations of the heterogeneity are discussed.
    Keywords: Interest rate pass-through; euro area countries; panel cointegration
    JEL: E43 G21
    Date: 2006–01
  7. By: Erik Feijen (University of Amsterdam); Enrico Perotti (University of Amsterdam, World Bank, and CEPR)
    Abstract: While financial liberalization has in general favorable effects, reforms in countries with poor regulation is often followed by financial crises. We explain this variation as the outcome of lobbying interests capturing the reform process. Even after liberalization, market investors must rely on enforcement of investor protection, which may be structured so as to block funding for new entrants, or limit their access to refinance after a shock. This forces inefficient default and exit by more leveraged entrepreneurs, protecting more established producers. As a result, lobbying may deliberately worsen financial fragility. After large external shocks, borrowers from the political elite in very corrupt countries may successfully lobby for weak enforcement, and retain control of collateral. We provide evidence that industry exit rates and profit margins after banking crises are higher in the most corrupt countries.
    Keywords: Politics; Lobbying; Financial Development; Investor protection
    JEL: G21 G28 G32
    Date: 2005–12–15
  8. By: Edouard Challe; Xavier Ragot
    Abstract: Financial crises are often associated with an endogenous credit reversal followed by a fall in asset prices and serious disruptions in the financial sector. To account for this sequence of events, this paper constructs a model where the excessive risk-taking of portfolio investors leads to a bubble in asset prices (in the spirit of Allen and Gale, "Bubbles and Crises", Economic Journal, 2000), and where the supply of credit to these investors is endogenous. We show that the interplay between the risk shifting problem and the endogeneity of credit may give rise multiple equilibria associated with different levels of lending, asset prices, and output. Stochastic equilibria lead, with positive probability, to an inefficient liquidity dry-up at the intermediate date, a market crash, and widespread failures of borrowers. The possibility of multiple equilibria and self-fulfilling crises is showed to be related to the severity of the risk shifting problem in the economy.
    Date: 2005
  9. By: Luca Casolaro (Banca d'Italia); Leonardo Gambacorta (Banca d'Italia)
    Abstract: This paper analyzes the linkages between banks’ profitability and the main real and financial indicators. The results, derived by means of a reduced-form model for the period 1984-2002, highlight a strict relation between all income and cost components and the evolution of the economic cycle. Net interest income shows a high correlation with nominal GDP and the interest rate term structure; income from services and trading are also influenced by the trend and volatility of stock and financial markets. Operating expenses depend on wage dynamics and changes in a bank’s organizational structure. Simulations performed for the period 2001-02 show a good predictive power of the model.
    Keywords: redditività bancaria, ciclo economico, modello econometrico
    JEL: C53 G21
    Date: 2004–10
  10. By: Fabio Panetta (Banca d'Italia); Fabiano Schivardi (Banca d'Italia); Matthew Shum (Johns Hopkins University)
    Abstract: We examine the informational effects of M&As by investigating whether bank mergers improve banks’ ability to screen borrowers. By exploiting a dataset in which we observe a measure of a borrower’s default risk that the lenders observe only imperfectly, we find evidence of these informational improvements. Mergers lead to a closer correspondence between interest rates and individual default risk: after a merger, risky borrowers experience an increase in the interest rate, while non-risky borrowers enjoy lower interest rates. This finding is robust with respect to a series of alternative explanations. Further results suggest that these information benets derive from improvements in information processing resulting from the merger, rather than from explicit information sharing on individual customers among the merging parties.
    Keywords: Mergers, asymmetric information, banking
    JEL: G21 L15
    Date: 2004–10
  11. By: Daley, J; Matthews, Kent (Cardiff Business School); Whitfield, K
    Abstract: Research on the causes of bank failure has focused on developed countries, particularly the United States of America. Relatively little empirical work has examined developing countries. We examine the total population of banks in Jamaica between 1992 and 1998 and find that real GDP growth, size, and managerial efficiency were the most significant factors contributing to the failure of banks. Bank failure is defined to include bailout and regulator-induced or supervised merger. Our results suggest that there were implicit 'Too-big-to-Fail' policies during this period.
    Keywords: Bank failures; Too-big-to-Fail; developing economies; Jamaica
    JEL: G21 G28
    Date: 2006–01
  12. By: Jan Frederik Slijkerman (Faculty of Economics, Erasmus Universiteit Rotterdam); Dirk Schoenmaker (Vrije Universiteit Amsterdam, and Ministry of Finance, The Hague); Casper de Vries (Faculty of Economics, Erasmus Universiteit Rotterdam)
    Abstract: We study the dependence between the downside risk of European banks and insurers. Since the downside risk of banks and insurers differs, an interesting question from a supervisory point of view is the risk reduction that derives from diversification within large banks and financial conglomerates. We discuss the limited value of the normal distribution based correlation concept, and propose an alternative measure which better captures the downside dependence given the fat tail property of the risk distribution. This measure is estimated and indicates better diversification benefits for conglomerates versus large banks.
    Keywords: Financial conglomerates; Banking; Insurance; Diversification; Extreme Value Theory
    JEL: G21 G22 G28 C49
  13. By: Terhi Jokipii; Brian Lucey
    Abstract: This paper examines banking and financial sector return co-movements between the three largest Central and Eastern European countries to have recently joined the European Union, namely the Czech Republic, Hungary and Poland. In order to build up an understanding of the soundness and stability of the banking systems of these new member states, we try to determine whether it is contagion, or interdependence that is driving the co-movements between these markets. Employing various different tests of propagation and controlling for own-country news and other fundamentals, we find evidence of cross-border banking sector contagion and determine that it is regional rather than international shocks that are driving the market movements.
    Keywords: Contagion, Macroeconomic news, Banking sector, Stock returns
    Date: 2005–12–15
  14. By: Marta Gómez-Puig
    Abstract: With European Monetary Union (EMU), there was an increase in the adjusted spreads (corrected from the foreign exchange risk) of euro participating countries' sovereign securities over Germany and a decrease in those of non-euro countries. The objective of this paper is to study the reasons for this result, and in particular, whether the change in the price assigned by markets was due to domestic factors such as credit risk and/or market liquidity, or to international risk factors. The empirical evidence suggests that market size scale economies have increased since EMU for all European markets, so the effect of the various risk factors, even though it differs between euro and non-euro countries, is always dependent on the size of the market.
  15. By: Buiter, Willem H; Sibert, Anne
    Abstract: Market interest rates on sovereign debt issued by the 12 Eurozone national governments differ very little from each other, despite the credit ratings of these governments ranging from triple A to single A, and despite significant differences among their objective indicators of fiscal-financial sustainability. We argue that this market failure is at least in part due to a policy failure: the operational practices of the European Central Bank and the rest of the Eurosystem in its collateralised open market operations convey the message that the Eurosystem views the debt of the 12 Eurozone sovereigns as equivalent. The euro-denominated debt instruments of all twelve Eurozone governments are deemed to be eligible for use as collateral in collateralised lending by the Eurosystem. They are in addition allocated to the same (highest) liquidity category (Tier One, Category 1) as the debt instruments of the Eurosystem itself and subject to the lowest 'valuation haircut' (discount on the market value). Haircuts also increase with the remaining time to maturity. This discourages the use as collateral of longer maturity debt which would be more likely to reveal differences in sovereign default risk. We propose that the size of the haircut on each debt instrument be related inversely to its credit rating. A further re-enforcement of the market’s ability to penalise and constrain unsustainable budgetary policies would be to declare the sovereign debt of nations that violate the conditions of the Stability and Growth Pact to be ineligible as collateral in Eurosystem Repos.
    Keywords: collateralised loans; Eurosystem; sovereign default risk
    JEL: E58 E63 G12
    Date: 2005–12
  16. By: Wong Keung-Wing (Department of Economics, National University of Singapore); Habibullah Khan (Graduate School of Business, Universitas21Global); Jun Du (Department of Economics, National University of Singapore)
    Abstract: This paper examines the long-term as well as short-term equilibrium relationships between the major stock indices and selected macroeconomic variables (such as money supply and interest rate) of Singapore and the United States by employing the advanced time series analysis techniques that include cointegration, Johansen multivariate cointegrated system, fractional cointegration and Granger causality. The cointegration results based on data covering the period January 1982 to December 2002 suggest that Singapore’s stock prices generally display a long- run equilibrium relationship with interest rate and money supply (M1) but a similar relationship does not hold for the United States. To capture the short-run dynamics of the relationship, we replicate the same experiments with different subsets of data representing shorter time periods. It is evident that stock markets in Singapore moved in tandem with interest rate and money supply before the Asian Crisis of 1997, but this pattern was not observed after the crisis. In the United States, stock prices were strongly cointegrated with macroeconomic variables before the 1987 equity crisis but the relationship gradually weakened and totally disappeared with the emergence of Asian Crisis that also indirectly affected the United States. The results of fractional cointegration and the Johansen multivariate system are consistent with the earlier cointegration result that both Singapore and US stock markets did possess equilibrium relationship with M1 and interest rate at the early days. However, the stability of the systems was disturbed by a series of well-known financial turbulence in the past two decades and eventually weakened for Singapore and completely disappeared for the U.S. This may imply that monetary authority may take action to respond to the asset price turbulence in order to maintain the stability of monetary economy and thus break the existing equilibrium between stock markets and macroeconomic variables like interest rate and M1. Another possible explanation is that the market became more efficient after 1997 Asian crisis. Finally, the results of Granger causality tests uncover some systematic causal relationships implying That stock market performance might be a good gauge for Central Bank’s monetary policy adjustment.
  17. By: Matthews, Kent (Cardiff Business School); Murinde, Victor; Zhao, Tianshu
    Abstract: We aim to undertake an empirical assessment of the competitiveness and market contestability of UK banks / financial institutions [before and after some major regulatory regime changes ????]. We specify a model, which consists of reduced form bank revenue equations. We use a non-structural estimation technique to evaluate the elasticity of total revenues with respect to changes in input prices. Specifically, we estimate and test the model on a panel of xx banks / financial institutions for the period 19xx-2002
    Keywords: Competitive conditions in banking; market contestability; UK
    JEL: G21 D24
    Date: 2006–01
  18. By: Mario Quagliariello
    Abstract: This paper discusses the role that macroeconomic uncertainty plays in banks’ choices regarding the optimal asset allocation. Following the portfolio model proposed by Baum et al. (2005), the paper aims at disentangling how Italian banks choose between loans and risk-free assets when the uncertainty on macroeconomic conditions increases. The econometric results confirm that macroeconomic uncertainty is a significant determinant of Italian banks’ investment decisions, also after controlling for other factors. In periods of increasing turmoil, bank-specific ability to accurately forecast future returns is hindered and herding behaviour tends to emerge, as witnessed by the reduction of the cross-sectional variance of the share of loans held in portfolio.
    Keywords: Bank, business cycle, uncertainty, lending decisions, GARCH
    JEL: E44 G21 G28
    Date: 2006–01
  19. By: Michel Beine (University of Luxemburg, and Free University of Brussels); Charles S. Bos (Vrije Universiteit Amsterdam); Sebastian Laurent (University of Namur, and CORE)
    Abstract: This paper is the first attempt to assess the impact of official FOREX interventions of the three major central banks in terms of the dynamics of the currency components of the major exchange rates (EUR/USD and YEN/USD) over the period 1989-2003. We identify the currency components of the mean and the volatility processes of exchange rates using the recent Bayesian framework developed by Bos and Shephard (2004). Our results show that in general, the concerted interventions tend to affect the dynamics of both currency components of the exchange rate. In contrast, unilateral interventions are found to primarily affect the currency of the central bank present in the market. Our findings also emphasize a role for interventions conducted by these central banks on other related FOREX markets.
    Keywords: Central banks; interventions; exchange rates; stochastic volatility; state space
    JEL: C11 C32 E58 F31
    Date: 2005–11–10
  20. By: Fernando González (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Simo Launonen (SEB Merchant Banking, Unioninkatu 30, P. O. Box 630, 00101 Helsinki, Finland)
    Abstract: We assess monetary convergence preceding the implementation of the EuropeanMonetary Union (EMU) through Kalman filtering estimates of the risk premium of eleven forward exchange rates of European and non-European currencies. Since all participating currencies are in effect identical from inception of a currency union, the convergence process to such an identical status should be reflected in the participating currencies' risk premiums prior to monetary union implementation. Starting from this assumption, we show the paths followed by the participating currencies towards monetary union. We find that the co-movements of risk premiums among the preceding European Monetary System (EMS) currencies differ across time periods but display a tendency to convergence to the German mark’s risk premium up to EMU implementation. The paper also shows a clear pattern of asymmetry of the participating currencies in relation to the German mark.
    Keywords: Currency unions, European Monetary Union, foreign exchange risk premium.
    JEL: F02 F31 F33 F36 G15 G18
    Date: 2005–12
  21. By: Linda S. Goldberg; Michael W. Klein
    Abstract: The credibility of a central bank’s anti-inflation stance, a key determinant of its success, may reflect institutional structure or, more dynamically, the history of policy decisions. The first years of the European Central Bank (ECB) provide a natural experiment for considering whether, and how, central bank credibility evolves. In this paper, we present a model demonstrating how the high-frequency response of asset prices to news reflects market perceptions of the anti-inflation stance of a central bank. Empirical tests of this model on high frequency data, regressing both the change in the slope of the German yield curve and the change in the euro/dollar exchange rate on the surprise component of price news, suggest significant instability in the market’s perception of the policy stance of the ECB during its first five years of operation. Estimated smoothed paths of the coefficients linking news to asset prices show that these coefficients change with policies undertaken by the ECB. In contrast, there is no evidence of parameter instability for the response of the slope of the United States yield curve to price news during this period, suggesting no comparable evolution in the market perceptions of the commitment to inflation fighting by the Federal Reserve.
    Keywords: Central Banking, European Central Bank, Federal Reserve, inflation, exchange rate, credibility, yield curve
    JEL: F3 E5 E6
    Date: 2005–12–15
  22. By: Alberto Franco Pozzolo (Universita' degli Studi del Molise and Ente Luigi Einaudi)
    Abstract: Guarantees play an important role in debt contracts. They alter the risk for the lender, transform borrowers’ incentives and, possibly, modify the equilibrium allocation of financial resources. This paper studies the role of guarantees on bank loans, using a sample of over 50,000 individual lines of credit granted by Italian banks. Two empirical models are used. The first directly verifies the relationship between ex-ante publicly available information on borrowers’ default riskiness and the presence of guarantees on their bank loans; the second compares the interest rates charged on secured and unsecured loans made by different banks to the same borrower, thus perfectly controlling for idiosyncratic riskiness and singling out the direct effect of the presence of guarantees on credit risk. The empirical results show that real guarantees (physical assets or equities that the lender can sell if the borrower defaults), which are often internal, are mainly used to provide a priority to some creditors. Personal guarantees (contractual obligations of third parties to make payments in case of default, e.g. suretyships), which can only be external, are used instead as incentive devices against moral hazard problems. Controlling for borrowers’ characteristics, both real and personal guarantees reduce ex-ante credit risk.
    Keywords: Bank loans, collateral, guarantee
    JEL: G21 G32
    Date: 2004–12
  23. By: Enrico Perotti (Universiteit van Amsterdam); Ernst-Ludwig von Thadden (Mannheim Universität)
    Abstract: In a democracy, a political majority can influence both the corporate governance structure and the return to human and financial capital. We argue that when financial wealth is sufficiently diffused, there is political support for a strong governance role for dispersed equity market investors, and low labor rents. When financial wealth is concentrated, a political majority prefers high labor rents and a stronger governance role for banks or large investors, even at the cost of profits. The intuition is that labor claims are exposed to undiversifiable risk, so voters with low financial stakes prefer investors who choose lower risk strategies. The model may explain the 'great reversal' phenomenon in the first half of the 20th century (Rajan and Zingales, 2003). We argue that in several financially developed countries a financially weakened middle class became concerned about labor income risk associated with free markets and supported a more corporatist financial system. We offer suggestive evidence using post WW1 inflationary shocks as the source of identifying exogenous variation.
    Keywords: Corporate governance; political economy; bank control; investor protection
    JEL: G2 G3 P16
    Date: 2005–11–14
  24. By: Galina Hale;
    Abstract: With the rise of international bond markets in the 1990s, the role of sovereign credit ratings has become increasingly important. In the aftermath of Asian Crises a series of empirical studies on the effects of sovereign ratings appeared. The theoretical literature on the topic, however, remains rather scarce. We propose a model of rating agencies that is an application of global game theory in which heterogeneous investors act strategically. The model is consistent with the main findings of the empirical literature. In particular, it is able to explain the independent effect of sovereign ratings on the cost of debt. Our model also predicts that, in addition to affecting the level of debt roll–over, the mere existence of the rating agency's announcement can increase the magnitude of the response of capital flows to changes in fundamentals. In addition, introducing a rating agency to a market that otherwise would have the unique equilibrium can bring multiple equilibria. The model also allows us to explore the reasons why agencies may over–react to crises, how they can spread financial contagion, and the failure of rating agencies to predict crises. Classification-F34, G14, G15
    Keywords: credit rating, rating agency, sovereign debt, global game
    Date: 2005–04–20
  25. By: M. Hashem Pesaran
    Date: 2005–12
  26. By: Alessio Anzuini (Banca d'Italia); Aviram Levy (Banca d'Italia)
    Abstract: The paper analyses the financial structure of the private sector in the Czech Republic, Hungary and Poland and assesses its implications for the monetary transmission mechanism. The financial accounts of these countries provide a picture of a private sector which is predictably financially less mature than the EU average: the corporate sector relies significantly on non-market financial liabilities (such as trade credits and non-traded shares) and bears a substantial exchange rate risk; the household sector is less sophisticated both in terms of financial assets, whose composition is tilted towards bank deposits, and liabilities, the volume of which is still negligible. VAR system estimates conducted separately on each acceding country suggest that, despite the inferior financial development of these countries, the co-movement of macroeconomic variables conditional on a monetary policy shock is similar across countries and not dissimilar to what is found in the more advanced economies.
    Keywords: Financial structure, identified VAR, monetary policy shock, price puzzle.
    JEL: C30 E44 E52 F41
    Date: 2004–07
  27. By: A. Burak Guner; Ulrike Malmendier; Geoffrey Tate
    Abstract: We show that financial experts on boards significantly affect corporate decisions, but not necessarily in the interest of shareholders. Employing a novel director-level data set from 1988 to 2001, we find that, when commercial bankers enter a board, loan size increases and investment-cash flow sensitivity decreases. However, the increased financing benefits mostly financially unconstrained firms with good credit but poor investment opportunities. Investment bankers on boards are associated with larger public debt issues and worse acquisitions. Among financial experts without bank affiliation, finance professors increase the size of CEO option grants, reducing, however, the sensitivity of total compensation to performance.
    JEL: D82 G21 G24 G31
    Date: 2006–01
  28. By: Heng Chen (Department of Economics, National University of Singapore); Bento J. Lobo (University of Tennessee at Chattanooga); Wing-Keung Wong (Department of Economics, National University of Singapore)
    Abstract: This study examines the bilateral relations between three pairs of stock markets, namely India-U.S., India-China and China-U.S. We use a Fractionally Integrated Vector Error Correction Model (FIVECM) to examine the cointegration mechanism between markets. By augmenting the FIVECM with a multivariate GARCH formulation, we study the first and second moment spillover effects simultaneously. Our empirical results show that all three pairs of stock markets are fractionally cointegrated. The U.S. stock market plays a dominant role in the relations with the other two markets, whereas there is an interactive relationship between the Indian and Chinese stock markets. In particular, the Indian stock market dominates the first moment feedback with the Chinese market, while the latter dominates the second moment feedback with the former.
    Keywords: Stock market, Cointegration, Fractionally Integrated Vector Error Correction Model, Multivariate GARCH
  29. By: Graham Bird (University of Surrey); Dane Rowlands (Carleton University)
    Abstract: Over the course of the 1990s economists appeared to favour exchange rate regimes that were either completely flexible or rigidly fixed through mechanisms such as currency boards. According to this "bipolar" view of exchange rates, intermediate regimes were deemed to be ineffective and prone to crisis. This paper examines the link between exchange rate regimes and International Monetary Fund (IMF) programme use and finds fairly strong evidence that countries with intermediate exchange rate regimes are less likely to go to the IMF than others. To the extent that International Monetary Fund (IMF) programmes are a proxy for balance of payments difficulties, this finding supports the more recent, nuanced, literature on exchange rate regime choice.
    JEL: F33
    Date: 2005–04
  30. By: Helge Berger (Free University Berlin, Department of Economics, Boltzmannstr. 20, 12161 Berlin, Germany & CESifo.); Michael Ehrmann (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank,Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: Monetary policy in the euro area is conducted within a multi-country, multicultural, and multi-lingual context involving multiple central banking traditions. How does this heterogeneity affect the ability of economic agents to understand and to anticipate monetary policy by the ECB? Using a database of surveys of professional ECB policy forecasters in 24 countries, we find remarkable differences in forecast accuracy, and show that they are partly related to geography and clustering around informational hubs, as well as to country-specific economic conditions and traditions of independent central banking in the past. In large part this heterogeneity can be traced to differences in forecasting models. While some systematic differences between analysts have been transitional and are indicative of learning, others are more persistent.
    Keywords: monetary policy; ECB; forecast; geography; history; heterogeneity; Taylor rule; learning; transmission; survey data; communication.
    JEL: E52 E58 G14
    Date: 2006–01
  31. By: Glaser, Markus (University of Mannheim); Weber, Martin (University of Mannheim)
    Abstract: Anecdotal evidence and recent theoretical models argue that past stock returns affect subsequent stock trading volume. We study 3,000 individual investors over a 51 month period to test this prediction using linear panel regressions as well as negative binomial panel regressions and Logit panel regressions. We find that both past market returns as well as past portfolio returns affect trading activity of individual investors (as measured by stock portfolio turnover, the number of stock transactions, and the probability to trade stocks in a given month) and are thus able to confirm predictions of overconfidence models. However, contrary to intuition, the effect of market returns on subsequent trading volume is stronger for the whole group of investors. Using survey data of our investor sample, we present evidence that individual investors, on average, are unable to give a correct estimate of their own past realized stock portfolio performance. The correlation between return estimates and past realized returns is insignificant. For the subgroup of respondents, we are able to analyze the link between the ability to correctly estimate the past realized stock portfolio performance on the one hand and the dependence of trading volume on past returns on the other hand. We find that for the subgroup of investors that is better able to estimate the own past realized stock portfolio performance, the effect of past portfolio returns on trading volume is stronger. We argue that this finding might explain our results concerning the relation between past returns and subsequent trading volume.
    Keywords: Individual investors; Investor behavior; Trading volume; Stock returns and Trading Volume; Overconfidence; Discount broker; Online broker; Online banks; Panel data; Count data
    JEL: D80 G10
    Date: 2005–10–15
  32. By: Bruce Mizrach (Rutgers University)
    Abstract: I examine the effects of Nasdaq's introduction of an anonymous trading facility called SIZE. I compare SIZE to competing ECNs in terms of liquidity and market impact. Despite rapid growth, SIZE has not yet attained a significant market share and rarely influences short-run price evolution. I conclude with discussion of the Nasdaq-ECN mergers and speculate about a role for SIZE in trading listed securities.
    Keywords: ECN; Super Montage; Total View; market impact;
    JEL: G14 G20
    Date: 2006–01–09
  33. By: Kin Lam (Department of Finance & Decision Sciences, Hong Kong Baptist University); May Chun Mei Wong (Dental Public Health, The University of Hong Kong); Wing-Keung Wong (Department of Economics, The National University of Singapore)
    Abstract: We develop some properties on the autocorrelation of the k-period returns for the general mean reversion (GMR) process in which the stationary component is not restricted to the AR(l) process but take the form of a general ARMA process. We then derive some properties of the GMR process and three new non-parametric tests comparing the relative variability of returns over different horizons to validate the GMR process as an alternative to random walk. We further examine the asymptotic properties of these tests which can then be applied to identify random walk models from the GMR processes.
    Keywords: mean reversion, variance ratio test, random walk, stock price, stock return
    JEL: G12 G14
  34. By: Boyd, James (Resources For the Future)
    Abstract: Financial responsibility rules are an increasingly common form of environmental regulation. Currently, the operators of landfills, underground petroleum storage tanks, offshore rigs, and oil tankers must demonstrate the existence of adequate levels of capital as a precondition to the legal operation of their businesses. Environmental financial responsibility ensures that firms possess the resources to compensate society for pollution costs created in the course of business operations. In addition to providing a source of funds for victim compensation and pollution remediation, financial responsibility is thought to motivate better decision-making, particularly regarding the management of long-term risks. This article describes both the promise of financial responsibility as a complement to conventional environmental regulation and a set of weaknesses associated with its current implementation under U.S. environmental statutes.
  35. By: Francis E. Warnock; Veronica C. Warnock
    Abstract: Abstract: Foreign flows have an economically large and statistically significant impact on longterm interest rates. Controlling for various macroeconomic factors we estimate that had there been no foreign flows into U.S. bonds over the past year, the 10-year Treasury yield would currently be 150 basis points higher; even a step-down to average inflows would imply an increase of 105 basis points. The impact of the headline-making foreign official flows—a relatively small subset of total foreign accumulation of U.S. bonds—is also significant but markedly smaller. Our results are robust to a number of alternative specifications.
    Keywords: bond yields, Japan, China
    JEL: E43 E44 F21
    Date: 2005–12–15
  36. By: Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper assesses the prospects for monetary integration between Emerging East Asian (EEA) economies. Our empirical analysis is based on a simple analytical framework for currency unions of small open economies, with a focus on the conduct of monetary policy in the presence of different types of shocks. Our empirical analysis looks at a number of supply-side characteristics of EEA countries, distinguishing between aggregate and tradable sector structural features. Moreover, we discuss the evidence on the cross-country variation of disturbances hitting the region. Our study indicates that, at present, EEA economies exhibit a high degree of cross-country supply diversity, while there is no compelling evidence that shocks are highly correlated across the region.
    Keywords: East Asia, emerging economies, currency union, stabilisation.
    JEL: E52 E58 F33 F40
    Date: 2005–12
  37. By: Frederic Boissay (European Central Bank, DG-Research, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany)
    Abstract: The purpose of this paper is to analyze how shocks propagate through a network of firms that borrow from, and lend to, each other in a trade credit chain, and to quantify the effects of financial contagion across firms. I develop a theoretical model of financial contagion, in which the default of one firm may cause a chain reaction such that its creditors also get into financial difficulties, even though they are sound in the first place. I calibrate and simulate the model using US annual data over the period 1986-2004. At the microeconomic level, I find that, when customers of a sound firm are financially distressed, then this firm gets into financial difficulties with probability that ranges from 4.1% to 12.8% (depending on the business cycle and the underlying economic scenario). Looking at the macroeconomic level, I find that defaults on trade debts lower aggregate GDP by at least 0.4%. During the second half of the 90’s, these deadweight losses doubled and reached a high of 0.9% to 2.3% of GDP (depending on the underlying economic scenario) before the recession of 2001. The results of the simulations also suggest that financial contagion across businesses had been 25% higher during the last recession than during the recession of the early 90’s.
    Keywords: Financial contagion, trade credit, business fluctuations.
    JEL: E32 G29 G33
    Date: 2006–01
  38. By: Tuomas A. Peltonen (European Central Bank, Postfach 16 03 19, 60066 Frankfurt am Main, Germany)
    Abstract: This paper analyzes the predictability of emerging market currency crises by comparing the often used probit model to a new method, namely a multi-layer perceptron artificial neural network (ANN) model. According to the results, both models were able to signal currency crises reasonably well in-sample, but the forecasting power of these models out-ofsample was found to be rather poor. Only in the case of Russian (1998) crisis were both models able to signal the crisis well in advance. The results reinforced the view that developing a stable model that can predict or even explain currency crises is a challenging task.
    Keywords: Currency crises, emerging markets, artificial neural networks.
    JEL: F31 E44 C25 C23 C45
    Date: 2006–01
  39. By: Thomas Colignatus (Thomas Cool Consultancy & Econometrics)
    Abstract: Proper monetary accounting rules are: (1) Central Banks should conform to the practice of the US Federal Reserve to distinguish its Balance Sheet from its Statement of Conditions. (2) Fiat money should not appear as a liability in a Balance Sheet. (3) The Central Bank should not record more government bonds than required for open market operations. Surplus bonds should be accounted as being void (on loan from the government who should destroy them). If these rules are not observed, a wrong measure of government debt arises, distorting the requirements for policy making.
    Keywords: Fiat Money, Money, Central Bank, Government Debt, Seigniorage, Inflation Tax, Gold Standard, Accounting
    JEL: A00
    Date: 2005–12–31
  40. By: Nihal Bayraktar (Pennsylvania State University Harrisburg, Middletown, PA 17057, United States); Plutarchos Sakellaris (Athens University of Economics and Business, and IMOP, correspondence Department of Economics, AUEB, Patission 76, 10434 Athens, Greece.); Philip Vermeulen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: We formulate and estimate a structural model of firm investment behavior that specifies the exact channel through which financial frictions bite. The model also allows for the existence of both convex andnon-convex costs to adjusting capital. Essentially, we move beyond simply testing and rejecting a neoclassical model without frictions. Our quantitative estimates show that both real and financial frictions have an important effect on firm investment dynamics.
    Keywords: Investment, adjustment costs, financing constraints.
    JEL: E22
    Date: 2005–12
  41. By: Kaestner, Michael
    Abstract: Behavioral Finance aims to explain empirical anomalies by introducing investor psychology as a determinant of asset pricing. Two kinds of anomalies, namely underreaction and overreaction, have been established by an impressive record of empirical work. While underreaction defines a slow adjustment of prices to corporate events or announcements, overreaction deals with extreme stock price reactions to previous information or past performance. Theoretical models have shown that both phenomena find potential explanations in cognitive biases, that is, investor irrationality. This study investigates current and past earnings surprises and subsequent market reaction for listed US companies over the period 1983-1999. The results suggest that investors simultaneously exhibit short-term underreaction to earnings announcements and long-term overreaction to past highly unexpected earnings. A potential explanation for the reported overreaction phenomenon is the representativeness bias. As I show, the overreaction and the later reversal is stronger for events, which exhibit a long series of similar past earnings surprises.
    Keywords: Behavioral finance, overreaction, underreaction, pead, representativeness bias, earnings announcements
    JEL: G14 D84
    Date: 2005–12–07
  42. By: Dumas, Bernard J; Kurshev, Alexander; Uppal, Raman
    Abstract: Our objective is to understand the trading strategy that would allow an investor to take advantage of 'excessive' stock price volatility and 'sentiment' fluctuations. We construct a general equilibrium model of sentiment. In it, there are two classes of agents and stock prices are excessively volatile because one class is overconfident about a public signal. As a result, this class of irrational agents changes its expectations too often, sometimes being excessively optimistic, sometimes being excessively pessimistic. We determine and analyse the trading strategy of the rational investors who are not overconfident about the signal. We find that because irrational traders introduce an additional source of risk, rational investors reduce the proportion of wealth invested into equity except when they are extremely optimistic about future growth. Moreover, their optimal portfolio strategy is based not just on a current price divergence but also on a model of irrational behaviour and a prediction concerning the speed of convergence. Thus, the portfolio strategy includes a protection in case there is a deviation from that prediction. We find that long maturity bonds are an essential accompaniment of equity investment, as they serve to hedge this 'sentiment risk.' Even though rational investors find it beneficial to trade on their belief that the market is excessively volatile, the answer to the question posed in the title is: 'There is little that rational investors can do optimally to exploit, and hence, eliminate excessive volatility, except in the very long run.'
    Keywords: behavioural equilibrium theory; non-Bayesian behaviour; portfolio choice
    JEL: G1
    Date: 2005–12
  43. By: Christina E. Bannier (Faculty of Economics and Business Administration, Johann Wolfgang Goethe Universität, Center for Financial Studies)
    Abstract: Market participants often suspect that large traders have a disproportionate effect on financial markets, increasing the aggressiveness of market responses. Prior studies have shown that the impact of a large trader on a currency crisis depends positively on his "size" and informational position. By contrast, this article highlights the role that market sentiment has on the impact of a large trader. If the market believes that fundamentals are weak, then the probability of a crisis depends positively on the trader’s size but negatively on the precision of his information, with these effects reversed in a generally optimistic market. A large player, therefore, need not make market responses more aggressive.
    Keywords: currency crises, large traders, market sentiment, coordination, private and public information
    JEL: F31 D82
    Date: 2005–10
  44. By: Javier Gil-Bazo; David Moreno; Mikel Tapia
    Abstract: This paper studies the properties of the continuous double auction trading mechanishm using an artificial market populated by heterogeneous computational agents. In particular, we investigate how changes in the population of traders and in market microstructure characteristics affect price dynamics, information dissemination and distribution of wealth across agents. In our computer simulated market only a small fraction of the population observe the risky asset’s fundamental value with noise, while the rest of agents try to forecast the asset’s price from past transaction data. In contrast to other artificial markets, we assume that the risky asset pays no dividend, so agents cannot learn from past transaction prices and subsequent dividend payments. We find that private information can effectively disseminate in the market unless market regulation prevents informed investors from short selling or borrowing the asset, and these investors do not constitute a critical mass. In such case, not only are markets less efficient informationally, but may even experience crashes and bubbles. Finally, increased informational efficiency has a negative impact on informed agents’ trading profits and a positive impact on artificial intelligent agents’ profits.
    Date: 2005–12
  45. By: Lionel de Boisdeffre (INSEE (CREST) et CERMSEM)
    Abstract: In a general equilibrium model of incomplete nominal-asset markets and adverse selection, Cornet-De Boisdeffre [3] introduced refined concepts of " no-arbitrage " prices and equilibria, which extended to the asymmetric information setting the classical concepts of symmetric information. In subsequent papers [4, 5], we generalized standard existence results of the symmetric information literature, as demonstrated by Cass [2], for nominal assets, or Geanakoplos-Polemarchakis [8], for numeraire assets, and showed that a no-arbitrage condition characterized the existence of equilibrium, in both asset structures, whether agents had symmetric or asymmetric information. We now introduce the model with arbitrary types of assets and a weaker concept of " pseudo-equilibrium " consistent with asymmetric information, to which we extend a classical theorem of symmetric information models with real assets. Namely, we show that the existence of a pseudo-equilibrium is still guaranteed by a no-arbitrage condition, under the same standard conditions with symmetric or asymmetric information.
    Keywords: General equilibrium, asymmetric information, arbitrage, inference, existence of a pseudo-equilibruim.
    JEL: D52
    Date: 2005–12
  46. By: KLAUS ABBINK (School of Economics, The University of Nottingham); BETTINA ROCKENBACH (Lehrstuhl fuer Mikrooekonomie, Universitaet Erfurt)
    Abstract: We compare the behaviour of students and professional traders from an influential German bank in an experiment involving financial options. The arbitrage free option price is independent of the probability distribution of the underlying asset. The experimental data uncover a probability dependent option valuation of the students, however, they learn to exploit more arbitrage as they gain experience. The professional traders exhibit a less probability sensitive valuation, but their overall performance is lower than the students’. We offer the explanation that the professional traders choose a more intuitive and less analytic pattern of behaviour than the students, despite their superior knowledge in financial market theory and practice. At real financial markets, traders are typically not confronted with given and known exact probability distributions, but they must rather rely on their intuitive calibration of the prospects.
    Keywords: Experiment, Option Pricing, Arbitrage, Bounded Rationality
    JEL: C91 G12 G14
    Date: 2005–07
  47. By: Attila Csajbók (Magyar Nemzeti Bank); András Rezessy (Magyar Nemzeti Bank)
    Abstract: This article investigates the potential impact of a shift in market expectations about a country’s eurozone entry date on long-term yields and the spot exchange rate in a simple uncovered interest parity (UIP) framework. The results suggest that the size of the reactions depend on how far the entry date is postponed, how far current inflation is from the Maastricht-satisfying level, and whether the credibility of the central bank’s target inflation path is sensitive to changes in the expected entry date. In the empirical part, the authors apply the framework for Hungary and draw some policy conclusions for the timing of ERM II entry.
    Keywords: monetary policy, monetary union, expectations, euro zone entry, uncovered interest parity.
    JEL: E42 E52 F33 F42
    Date: 2005
  48. By: Rene M. Stulz
    Abstract: For many countries, the most significant barriers to trade in financial assets have been knocked down. Yet, the financial world is not flat because poor governance prevents firms from being widely held and from taking full advantage of financial globalization. Poor governance has implications for corporate finance as well as for macroeconomics. I show that poor governance in Eastern Europe is accompanied, as expected, by high corporate ownership concentration, low firm valuation, poor financial development, and low foreign participation.
    JEL: G11 G15 G32 F30
    Date: 2006–01
  49. By: Bjönnes, Geir H. (Norwegian School of Management (BI)); Holden, Steinar (University of Oslo and Norges Bank); Rime, Dagfinn (Norges Bank (Central Bank of Norway)); Solheim, Haakon O.Aa. (Ministry of Trade and Industry)
    Abstract: What is the role of "large players" like hedge funds and other highly leveraged institutions in speculative attacks? In recent theoretical work, large players may induce an attack by an early move, providing information to smaller agents. In contrast, many observers argue that large players are in the rear. We propose a model that allows both the large player to move early in order to induce speculation by small players, or wait so as to benefit from a high interest rate prior to the attack. Using data on net positions of "large" (foreigners) and "small" (locals) players, we find that large players moved last in three attacks on the Norwegian krone (NOK) during the 1990s: The ERM-crisis of 1992, the NoK-pressure in 1997, and after the Russian moratorium in 1998. In 1998 there was a contemporaneous attack on the Swedish krona (SEK) in which large players moved early. Interest rates did not increase in Sweden so there was little to gain by a delayed attack.
    Keywords: Speculative attacks; Microstructure; International finance; Large players
    JEL: F31 F41 G15
    Date: 2005–12–15
  50. By: Marco Gallegati (Department of Economics, Università Politecnica delle Marche)
    Abstract: In this paper we revisit the issue of integration of emerging stock markets with each other and with the developed markets over different time horizons using weekly stock indices data from June 1997 until March 2005 of the five major MENA equity markets (Egypt, Israel, Jordan, Morocco and Turkey) and applying the discrete wavelet decomposition analysis. We decompose the weekly stock market returns of the main indices of the MENA countries into different time scale components using the non-decimated discrete wavelet transform and then analyze the time- scale relationship between the stock market indices of some developed areas (SP and Eurostoxx) and those of the MENA countries. The results from wavelet correlation analysis both among MENA stock markets and between these markets and some major stock markets suggests that MENA stock markets are nor regionally nor internationally integrated.
    Keywords: stock market returns, comovements, wavelet correlation analysis
    JEL: C22 E31 G12
    Date: 2005–12–27
  51. By: Paolo, COLLA; Marc, GERMAIN (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics); Vincent, VAN STEENBERGHE
    Abstract: Tradable emission permits share many characteristics with financial assets. As on financial markets, speculators are likely to be active on large markets for emission permits such as those developing under the Kyoto Protocol. We show how the presence of speculators on a market for emission permits affects the price of these permits when firms face risk aversion. The agency in charge of the optimal environmental policy should account for the presence of speculators when determining the total amount of permits to issue.
    Date: 2005–10–15
  52. By: Laura Rinaldi (University of Leuven, Research Center of International Economics, Naamsestraat 69, B-3000 Leuven, Belgium); Alicia Sanchis-Arellano (Bank of Spain, Alcalá 50, E-28014 Madrid, Spain)
    Abstract: Sound household financial conditions are relevant for both financial and monetary stability. Therefore, we analyse household financial fragility in a sample of euro area countries with the aim to shed some light on the nature of the large debt increase accumulated in recent years. We focus on household arrears on payment obligations, which are one of the most direct measures of financial stress of the sector. The probability of falling into arrears is derived from a life-cycle type of model and is investigated empirically using a cross-section and time series approach. We analyse cointegration and model arrears within an errorcorrection framework. The results suggest that the financial conditions of households might become more vulnerable to adverse shocks in their income and wealth.
    Keywords: Panel cointegration, non-performing loans, household debt sustainability, default.
    JEL: C23 G21 D14
    Date: 2006–01
  53. By: Derek Bond (University of Ulster); Michael J. Harrison (Department of Economics, Trinity College); Niall Hession (University of Ulster); Edward J. O'Brien (Department of Economics, Trinity College and CBFSAI)
    Abstract: This paper looks at issues surrounding the testing of fractional integration and nonlinearity in relation to the forward exchange rate anomaly of Fama (1984). Recent tests for fractional integration and nonlinearity are discussed and used to investigate the behaviour of three exchange rates and premiums. The findings provide some support for I(1) exchange rates but suggest fractionality for premiums, mixed evidence on cointegration, and a strong possibility of time-wise nonlinearity. Significantly, when the nonlinearity is modelled using a random field regression, the forward anomaly disappears.
    JEL: C22 F31 F41
  54. By: Gonzalo Cortazar (Pontificia Universidad Catolica de Chile); Alejandro Bernales (Inter-American Development Bank); Diether Beuermann (Inter-American Development Bank)
    Abstract: This paper deals with the issue of calculating daily Value-at-Risk (VaR) measures within an environment of thin trading. Our approach focuses on fixed income portfolios with low frequency of transactions in which the missing data problem makes VaR measures difficult to calculate. We propose and implement a methodology to calculate VaR measures with an incomplete panel of prices. The methodology is composed of three phases: Phase I, generates a complete panel of prices, using a term-structure dynamic model of interest rates. Phase II, calculates portfolio VaR measures with several alternative methods using the complete panel data generated in phase I. Phase III, shows how to back-test the VaR measures obtained in phase II using the original incomplete panel of prices. We provide an empirical implementation of the methodology for the Chilean fixed income market. The proposed methodology seems to provide reliable VaR measures for thinly traded markets addressing an important issue for financial risk management in emerging markets.
    Keywords: Risk, Value-at-Risk, Fixed Income, Incomplete Panels, Term- Structure Dynamic Models, Extreme Value, GARCH, Kalman Filter.
    JEL: C51 C52 G11 G15
    Date: 2005–12–28
  55. By: András Rezessy (Magyar Nemzeti Bank)
    Abstract: The paper estimates the immediate impact of Hungarian monetary policy on three classes of asset prices: the exchange rate of the forint vis-à-vis the euro, spot and forward government bond yields and the index of the Budapest Stock Exchange. The endogeneity problem is treated with the method of identification through heteroskedasticity as described by Rigobon and Sack (2004). The results suggest a significant impact on the exchange rate in one day i.e. an increase in the policy rate leads to an appreciation of the domestic currency, which is in line with the classic intuition. The effect increases markedly when the estimation is carried out with a two-day window suggesting the inefficiency of markets in incorporating monetary policy decisions in asset prices in a short period of time. Monetary policy affects spot yields positively, but the effect gradually dies out as the horizon gets longer. This can be explained with the impact on forward yields, as the results suggest a positive impact on short-term and a negative impact on long-term forward yields meaning that a surprise change in the policy rate leads to a rotation of the forward curve. The method does not provide interpretable and significant results for the stock exchange index.
    Keywords: Monetary transmission mechanism, Asset prices, Exchange rate, Yield curve, Stock market, Identification, Heteroskedasticity.
    JEL: E44 E52
    Date: 2005
  56. By: Eiji Ogawa; Junko Shimizu
    Abstract: The monetary authorities in East Asian countries have been strengthening their regional monetary cooperation since the Asian Currency Crisis in 1997. In this paper, we propose a deviation measurement for coordinated exchange rate policies in East Asia to enhance the monetary authorities' surveillance process for their regional monetary cooperation. We calculate the AMU as a weighted average of East Asian currencies following the method used to calculate the European Currency Unit (ECU) and the AMU Deviation Indicators, which how the degree of deviation from the hypothetical benchmark rate for each of the East Asian currencies in terms of the AMU. Furthermore, we investigate the relationships between the AMU and its Deviation Indicators and the effective exchange rates of each East Asian currency. As a result, we found the strong relationships between the AMU or the AMU Deviation Indicators and the effective exchange rates except for some currencies. These results indicate that the AMU Deviation Indicators have positive relationship with their effective exchange rates. Accordingly, we should monitor both the AMU and the AMU Deviation Indicator for the monetary authorities' surveillance in order to stabilize effective exchange rate in terms of trader partners' currencies.
    Date: 2006–02
  57. By: Kaestner, Michael
    Abstract: Behavioral Finance aims to explain empirical anomalies by introducing investor psychology as a determinant of asset pricing. This study provides strong evidence that anomalous stock price behavior following earnings announcements is due to a representativeness bias. It investigates current and past earnings surprises and subsequent market reaction for listed US companies over the period 1983-1999. The results suggest that investors overreact to past earnings surprises. As, on average, extreme past surprises are not confirmed by actual earnings figures, they are followed by stock market reactions of the opposite sign. Moreover, the longer the similar earnings surprise series, the higher the subsequent reversal.
    Keywords: Behavioral finance, overreaction, representativeness bias, earnings announcements
    JEL: G14 D84
    Date: 2005–04–21
  58. By: Stefano Battilossi
    Abstract: What determined the multinational expansion of European banks in the pre1914 era of globalization? And how were banks’ foreign investments related to other facets of the globalizing world economy such as trade and capital flows? The paper reviews both the contemporary and historical literature, and empirically investigates these issues by using an original panel data based on a sample of more than 50 countries. The dependent variable, aiming at measuring the intensity of crossborder activities operated by banks from foreign locations, is the number of foreign branches and subsidiaries of British, French and German banks. Explanatory variables are mainly selected on the base of the eclectic theory of multinational banking, but also include geographical factors (as suggested by gravity models) and institutional indicators advanced by recent studies inspired by new institutional economics, such as legal families and adherence to the Gold Standard. These regressors captures the impact of economic integration (trade and capital flows), informational development, institutional and economic characteristics of the hostmarket, as well as exchange rate and country risk factors, on banks’ foreign investment decisions. The results suggest that, due to its prevailing ‘colonial’ features, pre1914 multinational banking does not fit easily into augmented gravity models. The role of trade as a key determinant of banks expansion overseas is qualified, and both institutional factors as well as competitive interaction emerge as critical determinants of banks’ decisions to invest in foreign countries. Moreover, the systematic comparison of determinants of foreign investiments of banks from major core countries reveals that multinational banking was not a homogenous phenomenon, as banks of different nationality responded differently to economic, geographical and institutional factors.
    Date: 2005–12
  59. By: Moritz Schularick; Thomas M. Steger (Institute of Economic Research (WIF), Swiss Federal Institute of Technology Zurich (ETH))
    Abstract: Does international financial integration boost economic growth? The question has been discussed controversially for a long time, and a large number of studies has been devoted to its empirical investigation. As of yet, robust evidence for a positive impact of capital market integration on economic growth is lacking, as documented by Edison et al. (2002). However, there is substantial narrative evidence from economic history that highlights the contribution European capital made to economic growth of peripheral economies during the so-called first age of financial globalization before 1914. For this paper, we have compiled the first comprehensive data set to test econometrically if capital market integration had a positive impact on economic growth before WW1. Using the same models and techniques as contemporary studies, we show that there was indeed a significant and robust growth effect of international financial integration in the first era of financial globalization. Our temptative explanation for this marked difference between now and then stresses property rights protection as a prerequisite for the standard neoclassical model to work properly.
    Keywords: International financial integration; Economic growth; First era of globalization.
    JEL: F15 F21 F30 N10 N20 O11 O16
    Date: 2006–01
  60. By: Dasgupta, Amil; Prat, Andrea
    Abstract: What are the equilibrium features of a dynamic financial market where traders care about their reputation for ability? We modify a standard sequential trading model to study a financial market with career concerns. We show that this market cannot be informationally efficient: there is no equilibrium in which prices converge to the true value, even after an infinite sequence of trades. This finding, which stands in sharp contrast with the results for standard financial markets, is due to the fact that our traders face an endogenous incentive to behave in a conformist manner. We show that there exist equilibria where career-concerned agents trade in a conformist manner when prices have risen or fallen sharply. We also show that each asset carries an endogenous reputational benefit or cost, which may lead to systematic mispricing if asset supply is not infinitely elastic.
    Keywords: career concerns; financial equilibrium; information cascades; mispricing
    JEL: C7 G0
    Date: 2005–12
  61. By: Ping Zhang (School of Economics, University of Nottingham)
    Abstract: We compare the performances of uniform price auctions with fixed price offerings using laboratory experiments. In the uniform treatment, there is no evidence that the tacit collusion equilibrium has been achieved. On the contrary, subjects with higher expected value bid more aggressively. Their behaviour is close to an equilibrium derived where all players participate. The resulting market prices are significantly higher than the market value of a bidder with a low value signal. As a consequence, in our experiment uniform price auctions are superior to fixed price offerings in terms of revenue raising.
    Keywords: experiment, IPO, uniform price auction, fixed price offering, multi-unit demand, divisible goods
    JEL: D44 G12 C91
    Date: 2005–10
  62. By: Blackman, Allen (Resources For the Future)
    Abstract: Most of the literature attributes credit constraints in small-farm developing-country agriculture to the variability of returns to investment in this sector. But the literature does not fully explain lenders’ reluctance to finance investments in technologies that provide both higher average and less variable returns. To fill this gap, this article develops an information-theoretic credit market model with endogenous technology choice. The model demonstrates that lenders may refuse to finance any investment in a riskless high-return technology— regardless of the interest rate they are offered—when they are imperfectly informed about loan applicants’ time preferences and, therefore, about their propensities to default intentionally in order to finance current consumption.
    Keywords: : agriculture, asymmetric information, credit, developing country, technology adoption.
    JEL: O12 O16 O33 Q14 D82
  63. By: Probst, Katherine (Resources For the Future); Bauer, Carl (Resources For the Future)
  64. By: Refet Gurkaynak; Justin Wolfers
    Abstract: In September 2002, a new market in “Economic Derivatives” was launched allowing traders to take positions on future values of several macroeconomic data releases. We provide an initial analysis of the prices of these options. We find that market-based measures of expectations are similar to survey-based forecasts although the market-based measures somewhat more accurately predict financial market responses to surprises in data. These markets also provide implied probabilities of the full range of specific outcomes, allowing us to measure uncertainty, assess its driving forces, and compare this measure of uncertainty with the dispersion of point-estimates among individual forecasters (a measure of disagreement). We also assess the accuracy of market-generated probability density forecasts. A consistent theme is that few of the behavioral anomalies present in surveys of professional forecasts survive in equilibrium, and that these markets are remarkably well calibrated. Finally we assess the role of risk, finding little evidence that risk-aversion drives a wedge between market prices and probabilities in this market.
    JEL: C5 C82 D8 E3 E4 G15
    Date: 2006–01
  65. By: Francesco Spadafora (Banca d'Italia)
    Abstract: In striking contrast with the majority of other European economies, the UK pension system does not pose problems of financial sustainability to public finances. Public expenditure for pensions is foreseen to remain relatively stable for the next 50 years, around 5 percent of GDP, thanks to the considerable stock of privately-funded, actuarially-fair pension provision accumulated by the country, thus making the system (in government’s words) “a fair deal between generations”. Nonetheless, an intense debate is under way on the alleged crisis of the pension system, resulting not only from the private cost but also from the level of the benefits. The debate encompasses both the demand and the supply side of the pension system. On the one hand, the discussion focuses on the allegedly inadequate level of national savings, particularly by the population on lowest income, which would not produce in the future a level of pension high enough to guarantee an appropriate standard of living in retirement. On the other hand, the fall in equities in the period 2000-02 highlighted the fact that one of the main characteristics of the system, the prevalence of defined-benefit occupational pension funds, would act as a transmission channel of equity market shocks to the corporate sector of the economy. Moreover, in the light of the major role played by life assurances in the supply of pension products and growing interlinkages between the banking and insurance sectors, the financial soundness of life assurances takes on a particular relevance for the stability of the financial system as a whole. The present work illustrates the structural characteristics and significant peculiarities of the UK pension system, with particular emphasis on the evolution of pension savings in the private sector. Furthermore, it surveys the main aspects of the current debate and the different measures put forward as possible solutions. With reference to Italy, the UK experience may constitute a source of meaningful reflections for the current debate on the evolution of private pensions.
    Keywords: fondi pensione, previdenza privata, means-testing
    JEL: H55 J26 J32
    Date: 2004–06
  66. By: Adrian Pop (LEO - Laboratoire d'économie d'Orleans - - CNRS : FRE2783 - Université d'Orléans)
    Abstract: A straightforward method to enhance market discipline in banking is the Mandatory Sub-Debt Policy (MSDP), i.e. a requirement by which some large banks are forced to regularly issue a certain minimum amount of subordinated and non-guaranteed debt. The reasons behind the mandatoty attribute of a MSDP are not trivial. At first glance, a MSDP may be even superfluous if one notes that existing sub-debt issues by many large banking organizations actually meet or exceed the minimum requirements put forward by the proponents of this reform proposal. Our objective is to demonstrate that despite this stylized fact, a MDSP is not unnecessary. Under the current regulation framework - that is, in the absence of a formal MSDP - market discipline can be easily alleviated because, as a bank's conditions deteriorates, the funding manager will shift toward insured deposits as a source of funding and will reduce the reliance on market-sensitive debt instruments. A MSDP eliminates this perverse quid pro quo by foring banks to regularly tap the primary market even when their financial conditions are weak. In the second part of the paper, we illustrate this intuition by performing several tests on European data. If the decision of issuing sub-debt is endogenous and/or subordinated creditors are really able to influence bank managers' behavior, we should find a positive correlation between the amount of sub-debt held in bank balance sheets and banking performance. Our main empirical findings can be summarized as follows. First, the sub-debt issues are made generally by the most profitable European banking organizations. Second, voluntary sub-debt issues allow banks to reduce their Tier 1 rations, while improving their overall capitalization (Tier 1 + Tier 2 ratios). Third, as far as concerns the risk profile, the amount of sub-debt held in bank balance sheet is negatively correlated with the quality of credit portfolio, but positively correlated with the ratio of loan loss reserve to total (gross) loans. These results arouse several reflections about the virtues and limitations of market discipline in banking in the absence of a formal MSDP.
    Keywords: Banking Regulation ; Market Discipline ; Mandatory Sub-Debt Policy.
    Date: 2006–01–06
  67. By: Monica Paiella (Banca d'Italia)
    Abstract: This paper analyses the dynamics of Italian household wealth over the 1990s and assesses the strength of the wealth effects on consumption, using as a benchmark the United States. In a period of sharply rising asset prices, Italian household net worth rose significantly, but on the whole individuals were net buyers of assets and they appear to have realized, directly or indirectly, only a small portion of the capital gains accrued on their wealth. This is consistent with the lack of evidence of important direct wealth effects on consumption. Financial wealth effects turn out to be small because Italian households are not large scale owners of financial assets, even though their marginal propensity to consume out of financial wealth lies within the range commonly reported for the US and other industrialized countries. By contrast, housing market effects are small, even smaller than financial market effects, despite widespread homeownership, because the marginal propensity to consume out of real assets is very low. The propensity to consume out of financial wealth has tended to diminish as pension reforms have reduced household pension wealth. On the other hand, the propensity to consume out of real wealth has increased as financial deregulation and the intensification of competition among financial institution have eased credit constraints for households.
    Keywords: household saving behavior, housing wealth, financial wealth, capital gains, marginal propensity to consume out of wealth
    JEL: D12 E21 E44
    Date: 2004–07
  68. By: John Landon-Lane (Rutgers University); Kim Oosterlinck (Université Libre de Bruxelles)
    Abstract: By their extreme nature, repudiations rarely occur. History is therefore crucial to analyze their impact on bond prices. This paper provides an empirical study based on an original database: prices of a Tsarist bond traded in Paris before and after its repudiation by the Soviets. A structural vector autoregression is used to identify shocks to this bond that are orthogonal to shocks hitting a proxy for the Paris bond market, the French 3% rente. French market shocks are thus disentangled from repudiation specific shocks hitting the Russian bond. Consistent with expectations no major Russian shocks appears before the 1917 revolution. For 1918, shocks are mainly related with bailouts or hopes of partial bailouts. In 1919, however, the nature of shocks changes as they can be explained either by the negotiations with the Soviets or by the fate of the White Armies. In view of these elements, we argue that the bonds’ value were subject to a “Peso problem”. Their prices essentially reflected expected extreme events that never took place.
    Keywords: repudiation; sovereign debt;
    JEL: F34 G1 N24
    Date: 2005–11–16
  69. By: Marco Gallegati (Department of Economics, Università Politecnica delle Marche)
    Abstract: In this paper we investigate the relationship between stock market returns and economic activity by using signal decomposition techniques based on wavelet analysis. In particular, we apply the maximum overlap discrete wavelet transform (MODWT) to the DJIA stock price index and the industrial production index for US over the period 1961:1- 2005:3 and using the definitions of wavelet variance, wavelet correlation and cross-correlations analyze the association as well as the lead/lag relationship between stock prices and industrial production at the different time scales. Our results show that stock market returns tends to lead the level of economic activity but only at the highest scales (lowest frequencies), corresponding to periods of 16 months and longer, and that the periods by which stock returns lead output increase as the wavelet time scale increases.
    Keywords: stock market, industrial production, wavelet analysis
    JEL: C32 E44
    Date: 2005–12–27
  70. By: Viviana Fernandez
    Abstract: In this article, we analyze the impact of recent political conflicts in the Middle East on stock markets worldwide. In particular, we study how political instability––mainly due to the war in Iraq––has affected long-term volatility of stock markets. In doing so, we utilize two approaches to detecting structural breakpoints in volatility: Inclan and Tiao’s Iterative Cumulative Sum of Squares (ICSS) algorithm and wavelet-based variante analysis. After controlling for conditional heteroskedasticity and serial correlation in returns, we conclude that Middle East conflicts have had an impact primarily on the stock markets of countries in that region and emerging Asian countries (e.g., Turkey, Morocco, Egypt, Pakistan, and Indonesia). Further evidence, from an international version of the CAPM, shows that political instability in the Middle East has increased the sensitivity of stock markets to exchange rate risk and, to a lesser extent, to market risk (e.g., Pakistan and Spain).
    Date: 2005
  71. By: Geethanjali Selvaretnam
    Abstract: In the literature on bank runs where depositors decide whether to withdraw early from the bank or not based on the noisy signals they receive about the future returns, a unique equilibrium is established with a threshold level below which depositor would withdraw. However, these papers assume precise information. In reality noise levels need not be very small. The information that is available to the depositors can be endogenised. This paper finds that to either minimise the probability of a bank-run or maximise the expected utility of the depositors, there should be high transparency of the banks' long term returns.
    Date: 2006–01–09
  72. By: Thomas Lagoarde Segot; Brian M Lucey
    Abstract: The objective of this paper is to test for predictability in the Middle-Eastern North African (MENA) markets by investigating both the weak-form efficiency hypothesis (WFEMH) and the presence of abnormal returns. Starting with tests for the random-walk hypothesis, we use daily data returns and a battery of econometric tests including unit-root analysis, individual and multiple variance ratio, wild bootstrapping and non-parametric tests based on ranks. Our results suggest that only the region’s largest markets, Israel and Turkey, follow a random walk. Turning to technical trade analysis, our results reinforce the hypothesis of stock market predictability. Both variable moving average (VMA) and trade range breaking (TRB) trade rules yield significant abnormal returns. We complete the analysis with profit simulations based on the breakeven costs computation methodology and taking into account local transaction costs. Our findings highlight the presence of significant portfolio investment opportunities in the MENA.
    Keywords: Emerging markets, stock market predictability, portfolio analysis.
    JEL: G14 G15 O16
    Date: 2005–12–15
  73. By: Graham Bird (University of Surrey); Dane Rowlands (Carleton University)
    Abstract: Increasing attention is being paid to IMF governance, and the structure and size of the Fund’s lending operations. However, less interest has been shown in the array of lending windows through which the IMF makes resources available. There have nonetheless been clear trends over recent years in the extent to which the windows are used. What discussion has occurred has been largely qualitative. In this paper, and as far as the data allow, we adopt a quantitative approach and focus on the extent to which the economic circumstances in which countries sign extended and concessionary arrangements differ from those in which they sign conventional stand bys. On this basis, we claim that there is a strong case for discontinuing the EFF but for continuing the PRGF. The paper also discusses, more broadly, reforms to the structure of the IMF’s lending windows.
    JEL: F33
    Date: 2005–04
  74. By: Jongkyou Jeon (Kyung Hee University); Yonghyup Oh (Korea Institute for International Economic Policy); Doo Yong Yang (Korea Institute for International Economic Policy)
    Abstract: One of the main culprits of the Asian crisis in 1997-1998 is believed to have been the lack of the strong regional financial market in East Asia. While East Asian countries do not seem to have completely tided over the memory of the crisis, two policy objectives are certianly set up: regional exchange rate stability and regional financial market development, aiming to strengthen financial market deepening within the region. This paper attempts to see how strong the degree of regional financial market integration in east Asia, viewed in a market perspective. We use three approaches and try to infer on how strong regional integration of these markets is relative to their integration with a global market.
    Keywords: Integration, East Asia, regional, financial market, exchange rate, global economy
    JEL: G15 G34 O24
    Date: 2005–10
  75. By: Luana Gava
    Abstract: The objective of this work is to study empirically the factors influencing the execution time in the Spanish Stock Exchange. Our dataset includes the orders and transactions of the assets belonging to IBEX 35 in the period between July and September 2000. We divide the assets into three sub samples according to their trading activity, and we use an econometric model based on survival analysis to analyze the effect of variables such as the relative inside spread, price aggressiveness, asset volatility and depth. We find that limit orders priced at the quotes or within the quotes have a shorter expected time of execution. The same happens when the asset is more volatile and active. Time of execution is shorter at the beginning and at the end of the trading session depending on the group of the assets considered, and it is longer when the inside bid--ask spread is larger. If the trader takes into account the type of the last order introduced before the order placement we can observe that if the previous order was a market order on the opposite (same) side of the book then the expected time of execution of the new limit order is shorter (longer), while if it was a limit order on the same (opposite) side of the book then it is longer (shorter). Finally, we study the effect of the explanatory variables on the expected time of execution over the different periods of the trading session.
    Date: 2005–12
  76. By: Francois-Éric Racicot (Département des sciences administratives, Université du Québec (Outaouais) et LRSP); Raymond Théoret (Département de stratégie des affaires, Université du Québec (Montréal))
    Abstract: Since the end of the nineties, Basle Committee has required that banks compute periodically their VaR and maintain sufficient capital to pay the eventual losses projected by VaR. Unfortunately, there is not only one measure of VaR because volatility, which is a fundamental component of VaR, is latent. Therefore, banks must use many VaR models to compute the range of their prospective losses. These computations might be complex because the distribution of high frequency returns is not normal. This article analyses many VaR models and produces their programs in Visual Basic. It considers also other new measures of market risk and the use of copulas and Fourier Transform for the computation of VaR.
    Keywords: Ingénierie financière, simulation de Monte Carlo, banques, copules, transformée de Fourier.
    JEL: G12 G13 G33
    Date: 2006–01–12
  77. By: Karam, Philippe; Hostland, Dou g
    Abstract: The authors apply stochastic simulation methods to assess debt sustainability in emerging market economies and provide probability measures for projections of the external and public debt burden over the medium term. The vulnerability of public debt to adverse shocks is determined by a number of interrelated factors, including the volatility of output, financial fragility, the endogenous response of the risk premium, and sudden stops in private capital flows. The vulnerability of external debt is sensitive to the determination of the exchange rate and to the pricing of traded goods. The authors show that fiscal policy can act in a preemptive manner to prevent the debt burden from rising significantly over the medium term. This requires flexibility in fiscal planning, which many emerging market economies lack. Emerging market economies therefore face a difficult tradeoff between managing the risk of a debt crisis and pursuing other important fiscal policy objectives.
    Keywords: Economic Theory & Research,Strategic Debt Management,Settlement of Investment Disputes,Macroeconomic Management,External Debt
    Date: 2006–01–01
  78. By: Antonio Di Cesare (Banca d'Italia)
    Abstract: The jump-diffusion model introduced by Merton is used to price a cross- section of options at different dates. At any point in time, the parameters of the model are estimated by minimizing the sum of squared implied volatility errors, and their informational content is compared with the widely used Black and Scholes implied volatility, calculated on at-the-money options. While in normal conditions the parameters of Merton's model do not seem to provide any additional information, in periods of high variability of asset prices the jump-diffusion approach may help to disentangle the cases in which volatility reflects only uncertainty on economic fundamentals from those in which it is fuelled by fears of ¯nancial crisis.
    Keywords: jump-diffusion stochastic processes, option pricing, volatility
    JEL: G12 G13
    Date: 2004–07
  79. By: Dani Rodrik
    Abstract: There has been a very rapid rise since the early 1990s in foreign reserves held by developing countries. These reserves have climbed to almost 30 percent of developing countries' GDP and 8 months of imports. Assuming reasonable spreads between the yield on reserve assets and the cost of foreign borrowing, the income loss to these countries amounts to close to 1 percent of GDP. Conditional on existing levels of short-term foreign borrowing, this does not represent too steep a price as an insurance premium against financial crises. But why developing countries have not tried harder to reduce short-term foreign liabilities in order to achieve the same level of liquidity (thereby paying a smaller cost in terms of reserve accumulation) remains an important puzzle.
    JEL: F3
    Date: 2006–01
  80. By: Thorsten Hens; Martin Vlcek
    Abstract: The disposition eect is the observation that investors hold winning stocks too long and sell losing stocks too early. A standard explanation of the disposition effect refers to prospect theory and in particular to the asymmetric risk aversion according to which investors are risk averse when faced with gains and risk-seeking when faced with losses. We show that for reasonable parameter values the disposition effect can however not be explained by prospect theory as proposed by Kahneman and Tversky. The reason is that those investors who sell winning stocks and hold loosing assets would in the rst place not have invested in stocks. That is to say the standard prospect theory argument is sound ex-post, assuming that the investment has taken place, but not ex-ante, requiring that the investment is made in the first place.
    Keywords: Disposition effect, prospect theory, portfolio choice
    JEL: C91
    Date: 2006–01
  81. By: Péter Karádi (New York University, USA)
    Abstract: The paper proposes a structural empirical model capable of examining exchange rate smoothing in the small, open economy of Hungary. The framework assumes the existence of an unobserved and changing implicit exchange rate target. The central bank is assumed to use interest rate policy to obtain this preferred rate in the medium term, while market participants are assumed to form rational expectations about this target and influence exchange rates accordingly. The paper applies unobserved variable method – Kalman filtering – to estimate this implicit exchange rate target, and simultaneously estimate an interest rate rule and an exchange rate equation consistent with this target. The results provide evidence for exchange rate smoothing in Hungary by providing an estimated smooth implicit exchange rate target development and by showing significant interest rate response to the deviation of the exchange rate from this target. The method also provides estimates for the ceteris paribus exchange rate effects of expected and unexpected interest rate changes.
    Keywords: exchange rate smoothing, interest rate rules, Kalman filter
    JEL: E52 F31 F41
    Date: 2005
  82. By: Martin Uribe
    Abstract: This paper characterizes the equilibrium dynamics in an economy facing an aggregate debt ceiling. This borrowing limit is intended to capture an environment in which foreign investors base their lending decisions predominantly upon macro indicators. Individual agents do not internalize the borrowing constraint. Instead, a country interest-rate premium emerges to clear the financial market. The implied equilibrium dynamics are compared to those arising from a model in which the debt ceiling is imposed at the level of each individual agent. The central finding of the paper is that the economy with the aggregate borrowing limit does not generate higher levels of debt than the economy with the individual borrowing limit. That is, there is no overborrowing in equilibrium.
    JEL: F4
    Date: 2006–01
  83. By: Bjorn A. Hauksson
    Abstract: I show that the empirical impulse response of the real exchange rate is hump-shaped. This fact can explain why a number of recent authors have been unable to match the persistence of the real exchange rate using sticky-price business cycle models driven by monetary shocks. The key failure of the models used in the recent literature is that they yield monotonic impulse responses for the real exchange rate. While it is extremely difficult for models that have this feature to match the empirical persistence of the real exchange rate, models that yield hump-shaped impulse responses for the real exchange rate can easily match the empirical persistence of the real exchange rate. I present a two-country sticky-price business cycle model that yields humpshaped responses for the real exchange rate in response to a number of different disturbances. This model can match the half-life of the real exchange rate as well as and the humped shape of its impulse response.
    Date: 2005–11
  84. By: Harrison Hong; Jose Scheinkman; Wei Xiong
    Date: 2005–12–31
  85. By: Björk, Tomas (Dept. of Finance, Stockholm School of Economics); Biagini, Francesca (Dipartimento di Matematica, Universita di Bologna)
    Abstract: The timing option embedded in a futures contract allows the short position to decide when to deliver the underlying asset during the last month of the contract period. <p> In this paper we derive, within a very general incomplete market framework, an explicit model independent formula for the futures price process in the presence of a timing option. We also provide a characterization of the optimal delivery strategy, and we analyze some concrete examples.
    Keywords: Futures contract; timing option; optimal stopping
    JEL: G12 G13
    Date: 2005–11–09
  86. By: Inderst, Roman
    Abstract: We present a simple model of household (or consumer) lending in which, building on past information and local expertise, an incumbent lender has an information advantage both vis-a-vis potential competitors and households. We show that if the adverse selection problem faced by other lenders is sufficiently severe, the incumbent preserves his monopoly power and may engage in too aggressive lending. The incumbent lender may then approve credit even against a household’s best interest. In contrast, with effective competition it may now be less informed lenders who lend too aggressively to households who were rejected by the incumbent, though this only occurs if households 'naively' ignore the information contained in their previous rejection. We find that competition may also distort lending as less informed lenders try to free ride on the incumbent’s superior screening ability.
    Keywords: consumer and personal finance; irresponsible lending practices; predatory lending
    JEL: G1
    Date: 2005–12
  87. By: Maksimovic, Vojislav; Demirguc-Kunt, Asli; Ayyagari, Meghana
    Abstract: What role does the business environment play in promoting and restraining firm growth? Recent literature points to a number of factors as obstacles to growth. Inefficient functioning of financial markets, inadequate security and enforcement of property rights, poor provision of infrastructure, inefficient regulation and taxation, and broader governance features such as corruption and macroeconomic stability are discussed without any comparative evidence on their ordering. In this paper, the authors use firm level survey data to present evidence on the relative importance of different features of the business environment. They find that although firms report many obstacles to growth, not all the obstacles are equally constraining. Some affect firm growth only indirectly through their influence on other obstacles, or not at all. Using Directed Acyclic Graph methodology as well as regressions, the authors find that only obstacles related to finance, crime, and political instability directly affect the growth rate of firms. Robustness tests further show that the finance result is the most robust of the three. These results have important policy implications for the priority of reform efforts. They show that maintaining political stability, keeping crime under control, and undertaking financial sector reforms to relax financing constraints are likely to be the most effective routes to promote firm growth.
    Keywords: Pro-Poor Growth and Inequality,Inequality,Economic Conditions and Volatility,Private Participation in Infrastructure,Economic Growth
    Date: 2006–01–01
  88. By: Marie Diron (Brevan Howard Asset Management); Benoît Mojon (Corresponding author: European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
    Abstract: This paper first shows that the forecast error incurred when assuming that future inflation will be equal to the inflation target announced by the central bank is typically at least as small and often smaller than forecast errors of model-based and published inflation forecasts. It then shows that there are substantial benefits in having rule-of-thumb agents who simply trust that the central bank will deliver its pre-announced inflation objective.
    Keywords: Monetary policy, credibility, inflation targeting, inflation forecast.
    JEL: E5
    Date: 2005–12
  89. By: Sébastien Wälti
    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.
    Keywords: Exchange rate regime, currency crisis, regime transition, duration models, survival analysis.
    JEL: F30 F31 F41
    Date: 2005–12–15
  90. By: Viviana Fernandez;
    Abstract: In this article, we test for the presence of structural breaks in volatility by two alternative approaches: the Iterative Cumulative Sum of Squares (ICSS) algorithm and wavelet analysis. Specifically, we look at the effect of the outbreak of the Asian crisis and the terrorist attacks of September 11, 2001 on Emerging Asia, Europe, Latin America and North America's stock markets. In addition, we focus on the behavior of interest rates in Chile after the Central Bank switched its monetary policy interest rate from an inflationindexed to a nominal target in August 2001. Our estimation results show that the number of shifts detected by the two methods is substantially reduced when filtering out the data for both conditional heteroskedasticity and serial correlation. In addition, we conclude that the wavelet-based test tends to be more robust.
    Keywords: ICSS algorithm, wavelet analysis, volatility breakpoints.
    Date: 2005–12–15
  91. By: Kai Detlefsen; Wolfgang Härdle
    Abstract: Option pricing models are calibrated to market data of plain vanillas by minimization of an error functional. From the economic viewpoint, there are several possibilities to measure the error between the market and the model. These different specifications of the error give rise to different sets of calibrated model parameters and the resulting prices of exotic options vary significantly. These price differences often exceed the usual profit margin of exotic options. We provide evidence for this calibration risk in a time series of DAX implied volatility surfaces from April 2003 to March 2004. We analyze in the Heston and in the Bates model factors influencing these price differences of exotic options and finally recommend an error functional. Moreover, we determine the model risk of these two stochastic volatility models for the time series and consider its relation to calibration risk.
    Keywords: calibration risk, calibration, model risk, Heston model, Bates model, barrier option, cliquet option
    JEL: C13 G12
    Date: 2006–01
  92. By: Pagano, Marco; Volpin, Paolo
    Abstract: This paper presents a political economy model where there is mutual feedback between investor protection and stock market development. Better investor protection induces companies to issue more equity and thereby leads to a broader stock market. In turn, equity issuance expands the shareholder base and increases support for shareholder protection. This feedback loop can generate multiple equilibria, with investor protection and stock market size being positively correlated across equilibria. The model's predictions are tested on panel data for 47 countries over 1993-2002, controlling for country and year effects and endogeneity issues. We also document international convergence in shareholder protection to best-practice standards, and show that it is correlated with cross-border M&A activity, consistent with the model.
    Keywords: corporate governance; political economy; shareholder protection; stock market development
    JEL: G34 K22 K42
    Date: 2005–12
  93. By: Stefano Neri (Banca d'Italia)
    Abstract: The objective of this paper is to evaluate the effects of monetary policy shocks on stock market indices in the G-7 countries and Spain using the methodology of structural VARs. A model is estimated for each country and the effects of monetary policy shocks are evaluated by means of impulse responses. A contractionary shock has a negative and temporary effect on stock market indices. There is evidence of a significant cross-country heterogeneity in the persistence, magnitude and timing of the responses. A limited participation model with households trading in stocks is set up and the responses of stock prices to a monetary policy shock under different rules are evaluated. The model is able to account for the empirical response of stock prices to monetary policy shocks under different policy rules.
    Keywords: monetary policy; stock prices; structural VAR; limited participation model
    JEL: C32 E52 G12
    Date: 2004–07
  94. By: Peter Wilson (Department of Economics, National University of Singapore); Choy Keen Meng
    Abstract: The Asian financial crisis increased economic disparities in the East Asian region, thus making monetary integration more difficult, but rekindled political interest in Asian monetary and exchange rate cooperation. This paper applies the theory of Generalized Purchasing Power Parity (G-PPP), which looks at the behavior of long-run real exchange rates, to assess the potential for an optimum currency area (OCA) among a subset of East Asian countries based on five of the more advanced members of the Association of Southeast Asian Nations (ASEAN5). Our findings suggest little support for an OCA for ASEAN5 as a bloc prior to the Asian financial crisis and mixed results in the post-crisis period. In particular, asymmetries in the way countries adjust to shocks and low or insignificant speeds of adjustment were found. Thus, although the application of single OCA criteria is notoriously demanding and our tests apply to only one of the many criteria for the successful formation of an OCA, we cannot find persuasive evidence that ASEAN5 as a group constitute a potential currency area with either the USA or Japan, even when the ‘noisy’ period of the Asian financial crisis is omitted.
    Keywords: Optimum currency area, exchange rates, East Asia, ASEAN
    JEL: F31 F33 F36
  95. By: Paolo Guasoni (Universita' di Pisa)
    Abstract: We study the problem of extracting the state price densities from the market prices of listed options. Adapting a model of Madan and Milne to a multiple expiration setting, we present an estimation method for the risk-neutral probability at a moving horizon of fixed length. With the exception of volatility, all model parameters can be estimated by linear regression and their number can be chosen arbitrarily, depending on the size of the dataset. We discuss empirical issues related to the application of this model to real data and show results on listed options on the Italian MIB30 equity index.
    Keywords: option pricing, state-price densities, orthogonal polynomials, risk-neutral valuation, calibration
    JEL: G12 G13
    Date: 2004–07
  96. By: David Eagle (Eastern Washington University)
    Abstract: This paper introduces the indexing paradox, which states that it if all investors are rational with rational expectations and have a common risk-averse investment performance measure, then no investor can expect to do better than the market. If the cost of indexing is less than the cost of active investing, then all investors would index, which would result with no mechanism to price the possible investments. This paradox relies merely on understanding averages. It does not rely on markets being “informationally efficient,” as demonstrated in a model where different investors have differing degrees of informational advantages and disadvantages.
    Keywords: index funds, indexing paradox
    JEL: G
    Date: 2005–12–30
  97. By: Guido De Blasio (Banca d'Italia)
    Abstract: The paper examines micro data on Italian manufacturing firms’ inventory behavior to test the Meltzer (1960) hypothesis according to which firms substitute trade credit for bank credit during periods of monetary tightening. It finds that their inventory investment is constrained by the availability of trade credit. As for the magnitude of the substitution effect, however, this study finds that it is not sizable. This is in line with the micro theories of trade credit and the evidence on actual firm practices, according to which credit terms display modest variations over time.
    Keywords: trade credit, monetary policy, manufacturing firms
    JEL: E51 E52 E65
    Date: 2004–06
  98. By: Massimo Omiccioli (Banca d'Italia)
    Abstract: This paper presents a survey of the literature on the determinants of inter-firm credit and on its implications for the transmission mechanism of monetary policy. Theoretical explanations for trade credit can be divided in two categories: a) theories based on real functions performed by trade credit; b) theories based on transaction and financial motivations. The former category includes theories that interpret the supply of trade credit as a tool to achieve a variety of marketing objectives (to build customer relationships, as a guarantee for product quality, as a mechanism for price discrimination, as a response to demand variability). The latter category includes theories that consider trade credit as a tool to reduce transaction costs (as a substitute for money) or as a financial alternative to bank credit or to other forms of financing. The paper also examines the macroeconomic implications of these theories, with special reference to the relations between trade credit and monetary policy. Conclusions set forward some hypotheses for research, by looking at preliminary evidence on European countries, which are characterised by strong differences in the length of payment terms that led to the adoption of an EC Directive on combating late payment in commercial transactions.
    Keywords: credito commerciale, dilazioni di pagamento, politica monetaria
    JEL: G32 L14 E52
    Date: 2004–06
  99. By: Garleanu, Nicolae B.; Pedersen, Lasse Heje; Poteshman, Allen M
    Abstract: We model the demand-pressure effect on prices when options cannot be perfectly hedged. The model shows that demand pressure in one option contract increases its price by an amount proportional to the variance of the unhedgeable part of the option. Similarly, the demand pressure increases the price of any other option by an amount proportional to the covariance of their unhedgeable parts. Empirically, we identify aggregate positions of dealers and end users using a unique dataset, and show that demand-pressure effects contribute to well-known option-pricing puzzles. Indeed, time-series tests show that demand helps explain the overall expensiveness and skew patterns of both index options and single-stock options.
    Keywords: dealers; demand; hedging; implied volatility; intermediation; market makers; option; price pressure; risk; valuation
    JEL: G0 G12 G13 G14 G2
    Date: 2005–12
  100. By: Dusan ISAKOV (University of Fribourg and FAME); Dennis Y. CHUNG (Simon Fraser University); Christophe PERIGNON (Simon Fraser University)
    Abstract: This paper studies a unique buyback method allowing firms to reacquire their own shares on a separate trading line where only the firm is allowed to buy shares. This temporary trading platform is opened concurrently with the original trading line on the stock exchange. This share repurchase method is called the Second Trading Line and has been extensively used by Swiss companies since 1997. This type of repurchase is unique for two reasons. First, unlike open market programs, the repurchasing company does not trade under the cover of anonymity. Second, all transactions made by the repurchasing firm are publicly available in real time to every market participant. This is a case of instantaneous disclosure which contrasts sharply with other markets characterized by delayed or no disclosure. Using actual repurchase data from all buybacks implemented through second trading lines, we find that managers exhibit timing ability for the majority of programs. We also document that the daily repurchase decision is statistically associated with short-term price changes. However, we reject the opportunistic repurchase hypothesis and find no evidence that managers exploit their information advantage when reacquiring shares. We also find that repurchases on the second trading line have a beneficial impact on the liquidity of repurchasing firms (i.e., higher trading volumes, smaller bid-ask spreads, and thicker total depths). Exchanges and regulators may consider the second trading line an attractive share reacquisition mechanism because of its transparency and positive liquidity effects.
    Keywords: Share Repurchases;Disclosure Environment;Information Asymmetry;Liquidity
    JEL: G14 G35
    Date: 2005–11
  101. By: Bruce Mizrach (Rutgers University); Susan Zhang Weerts (Rutgers University)
    Abstract: This paper examines how well the market anticipates regulatory sanction. We look at key dates of SEC, NASD, FTC, Congressional and foreign investigations and their subsequent resolution. Our event study confirms that the settlements provide little new information to the market. In six major case groupings, we find highly accurate predictions from market capitalization changes of settlements and associated private litigation.
    Keywords: SEC; subpoena; probe; settlement; event study;
    JEL: K22
    Date: 2006–01–09
  102. By: Reto Foellmi; Manuel Oechslin
    Abstract: Recent macroeconomic research discusses credit market imperfections as a key channel through which inequality retards growth. Limited borrowing prevents the less affluent individuals from investing the efficient amount, and the inefficiencies are considered to become stronger as inequality rises. This paper, though, argues that higher inequality may actually boost aggregate output even with convex technologies and limited borrowing. Less equality in the middle or at the top end of the distribution is associated with a lower borrowing rate and hence better access to credit for the poor. We find, however, that rising relative poverty is unambiguously bad for economic performance. Hence, we suggest that future empirical work on the inequality-growth nexus should use more specific measures of inequality rather than measures of “overall” inequality such as the Gini index.
    Keywords: capital market imperfections, inequality, growth, efficiency
    JEL: O11 F13 O16
    Date: 2006–01
  103. By: Axelson, Ulf (Swedish Institute for Financial Research)
    Abstract: I study the security design problem of a firm when investors rather than managers have private information about the firm. I find that it is often optimal to issue information-sensitive securities like equity. The "folklore proposition of debt" from traditional signalling models only goes through if the firm can vary the face value of debt with investor demand. When the firm has several assets, debt backed by a pool of assets is optimal when the degree of competition among investors is low, while equity backed by individual assets can be optimal when competition is high.
    Keywords: Security design; Capital Structure; Auctions; Asset backed securities
    JEL: D44 G32
    Date: 2005–10–15
  104. By: Rolf Reichardt
    Abstract: In diesem Beitrag wird das Konzept der Marktzinsmethode als Grundlage der dualen Risiko¬steuerung von Kredit- und Marktpreisrisiken in Frage gestellt. Die Kreditrisiken einer Bank implizieren bonitätsinduzierte Marktpreisrisiken und bankspezifische Refinanzierungskosten. Während die bonitätsinduzierten Marktpreisrisiken in der dualen Risikosteuerung keine Be-rücksich¬tigung finden, werden die bankspezifischen Refinanzierungskosten zwar erkannt, a-ber bank¬intern nicht verursachungsgerecht zugeordnet. Das Grundmodell der Marktzinsmethode bietet keine Lösungsansätze zur Behebung dieser Probleme. Demgegenüber lassen sich die Fehlsteuerungsimpulse von vornherein durch eine konsequente Marktbewertung (Mark to Market) aller Finanzinstrumente vermeiden. Als Aus¬blick werden erste Überlegungen zur Implementierung einer umfassenden Marktwert¬steuerung in Banken entwickelt und exemplarisch ein hierfür geeignetes Bewertungsmodell vorgestellt.
    JEL: G
    Date: 2005–10
  105. By: Glaser, Markus (University of Mannheim); Weber, Martin (University of Mannheim)
    Abstract: Theoretical models predict that overconfident investors will trade more than rational investors. We directly test this hypothesis by correlating individual overconfidence scores with several measures of trading volume of individual investors (number of trades, turnover). Approximately 3,000 online broker investors were asked to answer an internet questionnaire which was designed to measure various facets of overconfidence (miscalibration, volatility estimates, better than average effect). The measures of trading volume were calculated by the trades of 215 individual investors who answered the questionnaire. We find that investors who think that they are above average in terms of investment skills or past performance (but who did not have above average performance in the past) trade more. Measures of miscalibration are, contrary to theory, unrelated to measures of trading volume. This result is striking as theoretical models that incorporate overconfident investors mainly motivate this assumption by the calibration literature and model overconfidence as underestimation of the variance of signals. In connection with other recent findings, we conclude that the usual way of motivating and modeling overconfidence which is mainly based on the calibration literature has to be treated with caution. Moreover, our way of empirically evaluating behavioral finance models - the correlation of economic and psychological variables and the combination of psychometric measures of judgment biases (such as overconfidence scores) and field data - seems to be a promising way to better understand which psychological phenomena actually drive economic behavior.
    Keywords: Overconfidence; Differences of opinion; Trading volume; Individual investors; Investor behavior; Correlation of economic and psychological variables; Combination of psychometric measures of judgment biases and field data
    JEL: D80 G10
    Date: 2005–12–15
  106. By: Amanda Carmignani (Banca d'Italia)
    Abstract: This paper empirically investigates the role of the efficiency of judicial enforcement in shaping firms’ financial structure, by focusing on the choice between trade credit and alternative external sources. Suppliers have an advantage over other short-term lenders in enforcing credit contracts, thus being less dependent on the institutional mechanisms for the protection of creditor rights. Trade credit represents in-kind finance: in contrast with other investors, who lend cash, suppliers lend inputs. Being illiquid, inputs are less easily diverted than cash, hence trade credit providers are less subject to moral hazard problems than other creditors. As a consequence, in countries where creditor protection is weaker the importance of trade credit compared to bank credit should be greater, especially when asymmetric information problems are more significant. The issue is analysed by using information on firm-specific characteristics and on the local structure of the manufacturing, of the banking and of the judicial sector over the period 1995-1998. The empirical evidence highlights the importance of judicial enforcement for corporate finance choices: in areas characterised by a lower degree of judicial enforcement, firms use more trade credit compared to alternative short-term sources. The effects vary according to firms’ characteristics such as their credit-worthiness and the average cost of funds.
    Keywords: struttura finanziaria, credito commerciale, tutela dei creditori, enforcement giudiziario.
    JEL: G3 K4
    Date: 2004–06
  107. By: Mario Fortin (GREDI, Département d'économique, Université de Sherbrooke); Andre Leclerc (Secteur sciences humaines, Université de Moncton, campus d’Edmundston); Jean-Baptiste Nesmy (Département d’économique, Université de Sherbrooke)
    Abstract: This study seeks to establish how banking productivity is affected by taking into account, in addition to loans and deposits, transactions carried out by banks for their customers. We use a panel of data on Desjardins covering the period 1999 - 2002. Two methods are applied to measure productivity growth, that is, a variant of the standard accounting method used by Statistics Canada based on the Fisher ideal index, and the Malmquist index based on the nonparametric DEA model. We also apply two different methods for determining the price of loans and deposits. The first is the Barnet/Donovan user cost approach which is based on the difference between the effective rate and a reference rate representing the pure cost of the funds borrowed without allowance for risk. The other is the effective interest rate. As a whole, we find that transaction products do not change importantly the productivity growth. The main reason is that these products represent quite a small share in the aggregate output (between 6,8% and 21,4%). We observe however that the index of productivity based on the Fisher ideal indexes is higher than the aggregative indexes Malmquist for all the studied period.
    Date: 2006
  108. By: Helena Veiga
    Abstract: This paper provides empirical evidence that continuous time models with one factor of volatility are, in some circumstances, able to fit the main characteristics of financial data and reports insights about the importance of introducing feedback factors for capturing the strong persistence caused by the presence of changes in the variance. We use the Efficient Method of Moments (EMM) by Gallant and Tauchen (1996) to estimate and to select among logarithmic models with one and two stochastic volatility factors (with and without feedback).
    Date: 2006–01
  109. By: Marco Moscadelli (Banca d'Italia)
    Abstract: The revised Basel Capital Accord requires banks to meet a capital requirement for operational risk as part of an overall risk-based capital framework. Three distinct options for calculating operational risk charges are proposed (Basic Approach, Standardised Approach, Advanced Measurement Approaches), reflecting increasing levels of risk sensitivity. Since 2001, the Risk Management Group of the Basel Committee has been performing specific surveys of banks’ operational loss data, with the main purpose of obtaining information on the industry’s operational risk experience, to be used for the refinement of the capital framework and for the calibration of the regulatory coefficients. The second loss data collection was launched in the summer of 2002: the 89 banks participating in the exercise provided the Group with more than 47,000 observations, grouped by eight standardised Business Lines and seven Event Types. A summary of the data collected, which focuses on the description of the range of individualgross loss amounts and of the distribution of the banks’ losses across the business lines/event types, was returned to the industry in March 2003. The objective of this paper is to move forward with respect to that document, by illustrating the methodologies and the outcomes of the inferential analysis carried out on the data collected through 2002. To this end, after pooling the individual banks’ losses according to a Business Line criterion, the operational riskiness of each Business Line data set is explored using empirical and statistical tools. The work aims, first of all, to compare the sensitivity of conventional actuarial distributions and models stemming from the Extreme Value Theory in representing the highest percentiles of the data sets: the exercise shows that the extreme value model, in its Peaks Over Threshold representation, explains the behaviour of the operational risk data in the tail area well. Then, measures of severity and frequency of the large losses are gained and, by a proper combination of these estimates, a bottom-up operational risk capital figure is computed for each Business Line. Finally, for each Business Line and in the eight Business Lines as a whole, the contributions of the expected losses to the capital figures are evaluated and the relationships between the capital charges and the corresponding average level of Gross Incomes are determined and compared with the current coefficients envisaged in the simplified approaches of the regulatory framework.
    Keywords: operational risk, heavy tails, conventional inference, Extreme Value Theory, Peaks Over Threshold, median shortfall, Point Process of exceedances, capital charge, Business Line, Gross Income, regulatory coefficients
    JEL: C11 C13 C14 C19 C29 C81 G21 G28
    Date: 2004–07
  110. By: Frances Ruane; Padraig Moore
    Abstract: The vast increase in foreign assets globally has raised interest in how the home country should tax profits flowing from these investments. Broadly speaking, countries have chosen either to exempt foreign income from taxation or to subject foreign income to taxation with credits/deductions given for foreign taxes paid. Recent research has focused on the effect of these foreign income tax rules on the relationship between aggregate FDI flows and corporate tax rates. In this paper we examine how foreign income tax rules can affect the financial structure of subsidiary-level FDI in Europe. The tax-deductibility of interest payments suggests that higher (host-country) corporate tax rates should be associated with a greater proportion of debt-financed FDI, as foreign income tax credit systems should, in theory, limit the benefits of shielding foreign income from host country taxation. Our results indicate that whilst multinationals from tax exemption countries adjust the financial structure of foreign investments in response to corporate tax rates, the effect of corporate tax rates is insignificant for FDI originating from tax credit countries. These results reveal an additional channel through which foreign income tax credit systems attenuate the forces of tax competition.
    JEL: F21 F23 H25 H87 F36 G32
    Date: 2005–12–15
  111. By: Jean-Pierre DANTHINE (University of Lausanne, FAME and CEPR); John B. DONALDSON (Columbia University); Paolo SICONOLFI (Columbia University)
    Abstract: In this paper we entertain the hypothesis that observed variations in income shares are the result of changes in the balance of power between workers and capital owners in labor relations. We show that this view implies that income share varia- tions represent a risk factor of ¯rst-order importance for the owners of capital and, consequently, are a crucial determinant of the return to equity. When both risks are calibrated to observations, this distribution risk dominates in importance the usual systematic risk for the pricing of assets. We also show that distribution risks may originate in non-traded idiosyncratic income shocks.
    Keywords: Income shares; Distribution risk; equity premium; limited market participation
    JEL: E3 G1
    Date: 2005–11
  112. By: Ying Chen; Wolfgang Härdle; Vladimir Spokoiny
    Abstract: Risk management technology applied to high dimensional portfolios needs simple and fast methods for calculation of Value-at-Risk (VaR). The multivariate normal framework provides a simple off-the-shelf methodology but lacks the heavy tailed distributional properties that are observed in data. A principle component based method (tied closely to the elliptical structure of the distribution) is therefore expected to be unsatisfactory. Here we propose and analyze a technology that is based on Independent Component Analysis (ICA). We study the proposed ICVaR methodology in an extensive simulation study and apply it to a high dimensional portfolio situation. Our analysis yields very accurate VaRs.
    Keywords: independent component analysis, Value-at-Risk
    JEL: C14 C15 C32 C53 G20
    Date: 2005–09
  113. By: Martin Hellwig (Max-Planck-Institute for Research on Collective Goods)
    Abstract: The paper reviews and assesses our understanding of the notion of “market discipline” in corporate governance. It questions the wholesale appeal to this notion in policy discussion, which fails to provide an account of the underlying mechanisms in terms of theory and empirical analysis. Discipline that is provided by the “market” must be compared to discipline that is provided by other institutions, e.g., intermediaries acting as “delegated monitors”. The comparative assessment depends on (i) the information technology, (ii) the role of strategic interactions, and (iii) the disciplinary mechanism itself. Concerning (i), the question is whether the benefits of multiple sources of information exceed the costs. Concerning (ii), strategic interactions concern the free-rider problem in acquiring information that benefits all financiers, as well as distributive externalities involved in exploiting an information advantage to the detriment of other financiers. Concerning (iii), the question is whether investors have explicit intervention rights or whether “discipline” results from managerial acquiescence. As for the acquisition and aggregation of information in organized markets, positive welfare effects arise only if the information is put to productive use, either through improvements in real investment and managerial incentives, or through changes in corporate control. Necessary conditions for such benefits to arise are fairly restrictive, especially if the changes that occur are based on managerial acquiescence rather than the legal intervention rights of investors. The expansion of market-based managerial incentives in the nineties had little to do with these theoretical accounts. The experience of moral hazard that has accompanied this expansion, on the side of gatekeeping institutions as well as corporate management, confirms the predictions of theory about the potential for shortfalls in market discipline and the agency costs of equity finance through the open market.
    Date: 2005–10
  114. By: Paul de Grauwe (Leuven University); Francesco Paolo Mongelli (European Central Bank)
    Abstract: This paper brings together several strands of the literature on the endogenous effects of monetary integration: i.e., whether sharing a single currency may set in motion forces bringing countries closer together. The start of the European Economic and Monetary Union (EMU) has spurred a new interest in this debate. There are four areas that we analyse in this context: the endogeneity of economic integration, in which we look primarily at evidence on prices and trade; the endogeneity of financial integration or equivalently insurance schemes that can be provided by capital markets; the endogeneity of symmetry of shocks and (similarly) at synchronisation of outputs; and the endogeneity of product and labour market flexibility. The paper presents a conceptual framework within which to illustrate such endogeneities. We present diverse arguments and, where possible, explore the incipient empirical literature focussing on the euro area. On the whole, concerning EMU, our preliminary conclusion is one of moderate optimism. The different endogeneities that exist in the dynamics towards optimum currency areas are at work. How strong these endogeneities are and how quickly they do their work remains to be seen.
    Keywords: Optimum Currency Area, Economic and Monetary Integration and EMU
    JEL: E42 F13 F33 F42
    Date: 2005–12
  115. By: Patrick Villieu (LEO - Laboratoire d'économie d'Orleans - - CNRS : FRE2783 - Université d'Orléans); Alexandru Minea (LEO - Laboratoire d'économie d'Orleans - - CNRS : FRE2783 - Université d'Orléans)
    Abstract: In this paper, we study maximizing long-run economic growth trade-off in monetary and fiscal policies in an endogenous growth model with transaction costs. We show that both monetary and fiscal policies are subject to threshold effects, a result that gives account of a number of recent empirical findings. Furthermore, the model shows that, to finance public expenditures, maximizing-growth government must choose relatively high seigniorage (respectively income taxation), if "tax evasion" and "financial repression" coefficients are high (respectively low). Thus, our model may explain why some governments resort to seigniorage and inflationary finance, and others rather resort to high tax-rate, as result of maximizing-growth strategies in different structural enviroments (notably concerning tax evasion and financial repression). In addition, the model allows examining how the optimal mix of government finance changes in response to different public debt contexts.
    Keywords: Endogenous growth ; threshold effects ; monetary policy ; fiscal policy ; public deficit ; policy mix ; tax evasion ; financial repression ; financial development
    Date: 2006–01–19
  116. By: Thierry Montalieu (LEO - Laboratoire d'économie d'Orleans - - CNRS : FRE2783 - Université d'Orléans); Thierry Baudassé (LEO - Laboratoire d'économie d'Orleans - - CNRS : FRE2783 - Université d'Orléans)
    Abstract: Le "Capital Social" désigne l'aptitude des individus à coopérer et à se coordonner, ainsi que leur habitude de contribuer à l'effort commun, mais aussi, d'une façon plus générale, leur désir d'être ensemble. Cette notion a reçu au cours des dernières années une grande attention de la part des économistes, tant dans le domaine de la Finance que de l'économie du Développement. Nous proposons une présentation de ce concept et une illustration de sa pertinence dans divers domaines de l'analyse économique.
    Keywords: Capital social ; finance ; microfinance ; secteur informel ; développement
    Date: 2006–01–13
  117. By: Khazzoom, J. Daniel
    Abstract: PAY-AT-THE-PUMP is a proposal to replace the current insurance system of lump sum payments for automobile insurance by a mechanism whereby motorists pay for their insurance as they buy fuel for their vehicles. PAY-AT-THE-PUMP has several advantages. It reduces insurance cost and cross subsidies and enhances equity. It also benefits the environment, safety, balance of payments, and security. In this paper we study limited but very important issues in the theory and implementation of PAY-AT-THE-PUMP insurance. We address issues of efficiency, subsidy, equity, externalities, safety, insurance cost and cost of insuring the uninsured motorist under a PAY-AT-THE-PUMP regime. We use the insurance industry’s criticisms of mandatory auto insurance as a lens through which we view PAY-AT-THE-PUMP insurance and ask how PAY-AT-THE-PUMP fares by comparison. Finally we address one aspect of insurance that has been neglected in the current debate -- the human dimension of the problem of uninsured motorist and the contribution PAY-AT-THE-PUMP can make to solve this problem.

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