nep-fmk New Economics Papers
on Financial Markets
Issue of 2006‒02‒12
fifty-five papers chosen by
Carolina Valiente
London South Bank University

  1. Bank Size and Risk-Taking under Basel II By Hendrik Hakenes; Isabel Schnabel
  2. Foreign Banks in Eastern Europe: Mode of Entry and Effects on Bank Interest Rates By Sophie Claeys; Christa Hainz
  3. Mutual fund flows’ performance reaction: does convexity apply to small markets? By Carlos F. Alves; Victor Mendes
  4. Profitability of foreign and domestic banks in Central and Eastern Europe: does the mode of entry matter? By Olena Havrylchyk; Emilia Jurzyk
  5. The role of longevity bonds in optimal portfolios By Francesco Menoncin
  7. Why Central Banks Should Not Burst Bubbles By Adam S. Posen
  8. Investing in European Stock Markets for High-Technology Firms By Christian Pierdzioch; Andrea Schertler
  9. Does Diversification Improve the Performance of German Banks? Evidence from Individual Bank Loan Portfolios By Evelyn Hayden; Daniel Porath; Natalja von Westernhagen
  10. Exchange Rate Regimes, Capital Account Opening and Real Exchange Rates: Evidence from Thailand By Juthathip Jongwanich
  11. Modeling Conditional Skewness in Stock Returns By Markku Lanne; Pentti Saikkonen
  12. European Financial Market Integration in the Gruenderboom and Gruenderkrach: Evidence from European Cross-Listings By Markus Baltzer
  13. L'impatto di "news" sul valore delle azioni By Elena Corallo
  14. Capital Asset Pricing Model and Changes in Volatility By Andre Oliveira SANTOS
  15. European Banks and their Impact on the Banking Industry in Chile and Brazil: 1862 - 1913 By Ignacio Briones; André Villela
  16. Myths and Truths: The «Law and Finance Theory» Revisited By Michael Graff
  17. Financial Literacy and Planning: Implications for Retirement Wellbeing By Annamarie Lusardi; Olivia S. Mitchell
  18. The Social Cost of Foreign Exchange Reserves By Rodrik, Dani
  19. Cyclical risk exposure of pension funds: a theoretical framework By Francesco Menoncin
  20. Interlocking directorates in Spanish banking in the twentieth century By Francisco J. Pueyo
  21. Bank interest rate pass-through in the euro area: a cross country comparison By Florin Ovidiu Bilbiie; André Meier; Gernot J. Müller
  22. Did Genoa and Venice Kick a Financial Revolution in the Quattrocento? By Michele Fratianni; Franco Spinelli
  23. British Interest Rate Convergence between the US and Europe: A Recursive Cointegration Analysis By Enzo Weber
  24. Public sector efficiency: evidence for new EU member states and emerging markets By António Afonso; Ludger Schuknecht; Vito Tanzi
  25. Openness and the case for flexible exchange rates By Giancarlo Corsetti
  26. From Transition Crises to Macroeconomic Stability? Lessons from a Crises Early Warning System for Eastern European and CIS Countries By Kristina Kittelmann; Marcel Tirpak; Rainer Schweickert; Lúcio Vinhas de Souza
  27. Liquidity runs with endogenous information acquisition By Sanne Zwart
  28. Are mutual fund investors in jail? By Carlos F. Alves; Victor Mendes
  29. Procurement of Goods and Services – Scope and Government By Elmar Wolfstetter
  31. Averting risk in the face of large losses: Bernoulli vs. Tversky and Kahneman By Antoni Bosch; Joaquim Silvestre
  32. Competition in markets for life insurance. By Marc Pomp; M. Bijlsma; Machiel van Dijk; Michiel van Leuvensteijn; C. Zonderland
  33. Valuing companies with a fixed book-value leverage ratio By Fernandez, Pablo
  34. DSGE Models of High Exchange-Rate Volatility and Low Pass-Through By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
  35. Environmental policies relating to the use of pesticides: proximities and innovations (In French) By Véronique SAINT GES (E3i-IFReDE-GRES & INRA)
  36. Corruption in Procurement Auctions By Yvan Lengwiler; Elmar Wolfstetter
  37. Financial Development and Inequality: Brazil 1985-99 By Manoel F. Meyer Bittencourt
  38. The properties of cycles in South African financial variables and their relation to the business cycle By Willem H Boshoff
  39. Democracy and Development: The Devil in the Details By Torsten Persson; Guido Tabellini
  40. Stochastic Processes in Credit Risk Modelling By Roberto Casarin
  41. Mergers under Asymmetric Information – Is there a Lemons Problem? By Thomas Borek; Stefan Buehler; Armin Schmutzler
  42. The Quality of Insurance Intermediary Services - An Analysis of Conduct and Performance in the German Market of Insurance Intermediation By Martina Eckardt
  43. Deductible or Co-Insurance: Which is the Better Insurance Contract under Adverse Selection? By Michael Breuer
  44. AMU Deviation Indicator for Coordinated Exchange Rate Policies in East Asia and its Relation with Effective Exchange Rates By Eiji Ogawa; Junko Shimizu
  46. Testing consumers' asymmetric reaction to wealth changes. By Mauro Mastrogiacomo
  47. A new theory of forecasting By Simone Manganelli
  48. Share Issuing Privatizations in China: Determinants of Public Share Allocation and Underpricing By Qi Quan; Nancy Huyghebaert
  49. The commodity currency puzzle By Bjørnland, Hilde C.; Hungnes, Håvard
  50. Purchasing Power Parity and Heterogenous Mean Reversion By Koedijk, Kees; Tims, Ben; Van Dijk, Mathijs A
  51. Current Account Dynamics and Capital Mobility in Asian Small Economies By Selim, Sheikh Tareq
  52. Monetary policy and exchange rate interactions in a small open economy By Bjørnland, Hilde C.
  53. Assessing ECB?s Credibility During the First Years of the Eurosystem: A Bayesian Empirical Investigation By Gianni Amisano; Marco Tronzano
  54. Credit Spread Specification and the Pricing of Spread Options By Nicolas Mougeot
  55. S-Based Taxation under Default Risk By Paolo Panteghini

  1. By: Hendrik Hakenes (MPI for Research on Collective Goods, Kurt-Schumacher-Str. 10, 53113 Bonn, Germany.; Isabel Schnabel (MPI for Research on Collective Goods, Kurt-Schumacher-Str. 10, 53113 Bonn, Germany.
    Abstract: We analyze the relationship between bank size and risk-taking under the New Basel Capital Accord. Using a model with imperfect competition and moral hazard, we show that the introduction of an internal ratings based (IRB) approach improves upon flat capital requirements if the approach is applied uniformly across banks and if the costs of implementation are not too high. However, the banks’ right to choose between the standardized and the IRB approaches under Basel II gives larger banks a competitive advantage and, due to fiercer competition, pushes smaller banks to take higher risks. This may even lead to higher aggregate risk-taking.
    Keywords: Basel II, IRB approach, bank competition, capital requirements, SME financing
    JEL: G21 G28 L11
    Date: 2006–02
  2. By: Sophie Claeys (Department of Financial Economics and CERISE, Ghent University, W. Wilsonplein 5D, B-9000 Ghent, Tel.: +32-9-264 34 91, Fax.: +32-9-264 89 95.; Christa Hainz (Department of Economics, University of Munich, Akademiestr. 1/III, 80799 Munich, Tel.: +49-89-2180 3232, Fax.: +49-89-2180 2767.
    Abstract: Credit markets in many Eastern European countries are now dominated by foreign-owned banks. We analyze the development for foreign ownership and its impact on lending rate in ten Eastern European countries between 1995 and 2003. Currently, the majority of loans from foreign banks is granted by acquired banks. The presence of foreign acquired banks as measured by their relative number among the banks in our dataset increased somewhat slower than that of foreign de novo banks. However, since market entry through acquisition allows acquiring a credit portfolio and a customer base, acquired banks were able to expand their market share much faster than the foreign de novo banks. Our results also show that the interest rate decreased after foreign bank entry. Moreover, while the reduction in interest rates of domestic banks is more pronounced in the case of foreign entry through a de novo investment, foreign de novo banks charge higher interest rates than foreign acquired banks.
    Keywords: SME, Banking, Foreign Entry, Mode of Entry, Interest Rate
    JEL: D4 G21
    Date: 2006–02
  3. By: Carlos F. Alves (CEMPRE, Faculdade de Economia, Universidade do Porto); Victor Mendes (CMVM - Portuguese Securities Commission)
    Abstract: In this paper we study the performance reaction of investors in a small market context. Instead of the asymmetrical investors’ reaction to winners and losers, as usually documented for the US, an absence of risk-adjusted performance reaction was observed. The absence of reaction can be attributed to either lower investor sophistication, conflicts of interests in the context of the Portuguese universal banking industry, or the existence of relevant back-end load cost which prevent investors from reacting. A high persistence of net investment flows was also noted. Our results are consistent with the idea that the financial groups with larger market shares have the capacity “to drive” their customers to funds with larger fees. This practice emerges as a non-transparent means of increasing prices.
    Keywords: Mutual Funds, Performance Reaction, Investor Behaviour, Small Markets and Regulation
    JEL: G20 G23 G28
    Date: 2006–02
  4. By: Olena Havrylchyk; Emilia Jurzyk
    Abstract: Using data for 265 banks in the Central and Eastern European Countries for the period of 1995-2003, this paper analyses the differences in profitability between domestic and foreign banks. We show that foreign banks, especially greenfield institutions, earn higher profits than domestic banks. However, this effect is acquired, rather than inherited, since there is evidence that foreign banks tend to take over less profitable institutions. Profits of foreign banks in the CEEC also exceed profits of their parent banks, explaining the reasons for their entry. Further, we study benefits and costs of foreign ownership by analyzing determinants of profitability for domestic, takeover, and greenfield banks. Profits of foreign banks are less affected by macroeconomic conditions in their host countries. However, greenfield banks are sensitive to the situation of their parent banks. Only domestic banks enjoy higher profits in more concentrated banking markets, whereas takeover banks suffer from diseconomies of scale due to the fact that they acquired large institutions.
    Keywords: Foreign banks, Bank profits, Multinational banking, Transition economies
    JEL: G15 G21 F36
    Date: 2006
  5. By: Francesco Menoncin
    Abstract: A longevity bond pays coupons which are proportional to the survival rate of a given population. In such a way the longevity risk becomes hedgeable on the financial market. In our model there are: (i) a longevity bond as a derivative on the population survival rate, (ii) a bond as a derivative on the stochastic instantaneously riskless interest rate, and (iii) a stock. The investor maximizes the expected (CRRA) utility of his intertemporal consumption. In such a framework we demonstrate that the amount of wealth invested in the longevity bond reduces the portfolio weight of the bond without affecting neither the weight of the stock nor the weight of the riskless asset.
  6. By: Arturo Galindo; Ricardo Bebczuk
    Abstract: We explore the impact and evolution of loan portfolio diversification during the 2001-2002 Argentine financial crisis. Using a novel dataset that combines public information on the main activity of the largest 930 Argentine firms with their borrowing from each bank operating in the country during the 1999-2004 period, we find that banks did not modify much their loan portfolio mix as a response to the crisis, even though the econometric results point to a positive effect of sectoral diversification and lending to tradeable sectors on bank profitability and risk mitigation. Our results suggest that larger banks benefit more from diversification that smaller ones, and that the benefits of diversification are greater during the downside of the business cycle.
    Date: 2005–09–15
  7. By: Adam S. Posen (Institute for International Economics)
    Abstract: Central banks should not be in the business of trying to prick asset price bubbles. Bubbles generally arise out of some combination of irrational exuberance, technological jumps, and financial deregulation (with more of the second in equity price bubbles and more of the third in real estate booms). Accordingly, the connection between monetary conditions and the rise of bubbles is rather tenuous, and anything short of inducing a recession by tightening credit conditions prohibitively is unlikely to stem their rise. Even if a central bank were willing to take that one-in-three or less shot at cutting off a bubble, the cost-benefit analysis hardly justifies such preemptive action. The macroeconomic harm from a bubble bursting is generally a function of the financial system’s structure and stability—in modern economies with satisfactory bank supervision, the transmission of a negative shock from an asset price bust is relatively limited, as was seen in the United States in 2002. However, where financial fragility does exist, as in Japan in the 1990s, the costs of inducing a recession go up significantly, so the relative disadvantages of monetary preemption over letting the bubble run its course mount. In the end, there is no monetary substitute for financial stability, and no market substitute for monetary ease during severe credit crunch. These two realities imply that the central bank should not take asset prices directly into account in monetary policymaking but should be anything but laissez-faire in responding to sharp movements in inflation and output, even if asset price swings are their source.
    Keywords: bubbles, asset prices, monetary policy, central banks
    JEL: E44 G18 E52 E58
    Date: 2006–01
  8. By: Christian Pierdzioch; Andrea Schertler
    Abstract: We used a recursive modeling approach to study whether investors could, in real time, have used information on the comovement of stock markets to forecast stock returns in European stock markets for high-technology firms. We used weekly data on returns in the Neuer Markt, the Nouveau Marché, the Alternative Investment Market, and the NASDAQ. We found substantial changes over time in the usefulness of the inter-European and cross-Atlantic comovement of stock markets for predicting stock returns. We also studied how monitoring the comovement of stock markets would have affected the performance of simple trading rules and investor’s markettiming skills.
    Keywords: Recursive modeling approach; Comovement of returns; Hightechnology firms learning by exporting, total factor productivity, export destination, quantile regression, instrumental variables
    JEL: B22 C32 E24
    Date: 2006–01
  9. By: Evelyn Hayden (Oesterreichische Nationalbank, Banking Analysis and Inspections Division); Daniel Porath (Deutsche Bundesbank, Banking and Financial Supervision Department); Natalja von Westernhagen (Deutsche Bundesbank, Banking and Financial Supervision Department)
    Abstract: Should banks be diversified or focused? Does diversification indeed lead to increased performance and therefore greater safety on the part of banks as traditional portfolio and banking theory would suggest? This paper investigates the link between banks’ profitability and their portfolio diversification across different industries, broader economic sectors and geographical regions. To explore this issue, we use a unique data set of the individual bank loan portfolios of 983 German banks for the period from 1996 to 2002. The overall evidence we provide shows that there are no large performance benefits associated with diversification since each type of diversification tends to reduce the banks’ returns. Additionally, we find that banks do not use diversification to operate at a constant level of risk-return efficiency, which implies that banks are not risk-return efficient. Moreover, we find that the impact of diversification strongly depends on the risk level. However, only for moderate risk levels and in the case of industrial diversification does diversification significantly improve the banks’ returns.
    Date: 2006–09–01
  10. By: Juthathip Jongwanich
    Abstract: This paper examines the roles of pegged exchange rate regime and capital account opening inducing persistent RER appreciation in the lead-up to the 1997 currency crisis in Thailand. The three-sector (primary, manufacturing, and nontradable) economy-wide model is constructed and policy simulation experiments are undertaken. Key findings are imposing capital control under a pegged exchange rate regime would have averted the persistent internal RER appreciation and boom in nontradable sector. However, it would not have averted persistent external RER appreciation. Exports and output would have eventually declined because of the capital shortage. A freely floating regime only with a high developmental level of foreign exchange and financial markets would have been able to avert both persistent internal and external RERs appreciation. The export and output would have eventually increased. However, this regime would have generated fluctuations in domestic prices and output. The managed floating regime (combined with inflation targeting) would have helped reduce such adverse effects while retaining the benefit from exchange rate flexibility. In a context where the foreign exchange and financial markets are not well developed, capital control measures could be beneficial to ensure smooth functioning of a managed floating regime.
    Keywords: Exchange rate regime, Capital account, and Real exchange rate
    JEL: O11 F32 F41
    Date: 2006
  11. By: Markku Lanne; Pentti Saikkonen
    Abstract: In this paper we propose a new GARCH-in-Mean (GARCH-M) model allowing for conditional skewness. The model is based on the so-called z distribution capable of modeling moderate skewness and kurtosis typically encountered in stock return series. The need to allow for skewness can also be readily tested. Our empirical results indicate the presence of conditional skewness in the postwar U.S. stock returns. Small positive news is also found to have a smaller impact on conditional variance than no news at all. Moreover, the symmetric GARCH-M model not allowing for conditional skewness is found to systematically overpredict conditional variance and average excess returns.
    Keywords: Conditional skewness, GARCH-in-Mean, Risk-return tradeoff
    JEL: C16 C22 G12
    Date: 2005
  12. By: Markus Baltzer (Department of Economics, University of Tuebingen)
    Date: 2006–01–13
  13. By: Elena Corallo (Cattaneo University (LIUC))
    Abstract: The aim of this work is to verify whether the price of a bank quoted in the stock market is affected by two types of news: news coming from the market and announces defined "price sensitive" publicly released by the bank. Making use of a methodology based on heteroskedasticity, proposed in the literature by Rigobon and Sack (2003), we verify whether the price of Unicredit, which is one of the biggest Italian bank and which is characterised by a high exchange of stocks, are influenced in a significant way by announces of interest rate changes, released by the Monetary Authority and by news which affect the value of the bank, released by the bank itself.
    Date: 2005–06
  14. By: Andre Oliveira SANTOS (Graduate Institute of International Studies)
    Abstract: This article applies regime-switching models to assess the effects of different regimes of volatility in asset pricing. Different variance-covariance matrices for different regimes of volatility are introduced in the Capital Asset Pricing Model. They are scaled with respect to a conditional variance-covariance matrix that simply follows a GARCH process. The probabilities that U.S. financial markets were in a low, medium, or high regime of volatility from March 1958 to December 1995 are computed.
    Keywords: Creation-Date : 1998-09
  15. By: Ignacio Briones (Business School, Universidad Adolfo Ibáñez, Chile); André Villela (Escola de Pós-Graduação em Economia, Fundação Getulio Vargas, Brazil)
    Abstract: The history of foreign banks in Chile and Brazil in the late XIXth century and early XXth century is the history of British and German banks. Their penetration in both countries was significant, and not neutral in terms of its impact on the Chilean and Brazilian banking industry. In the main, we found that in both countries foreign banks appear to have had a positive effect at least in some of the dimensions identified by the current literature. However, the extent of this influence is different depending on the country. First, even if a formal banking industry emerged roughly simultaneously in both countries, foreign bank entry in Chile was a more recent phenomenon than in Brazil. Second, while from a financial point of view native and foreign banks in Chile behaved in a relatively similar fashion, in Brazil we observe differences, although a tendency towards convergence was observable by the eve of WWI.
    Date: 2006–04–01
  16. By: Michael Graff (Swiss Institute for Business Cycle Research (KOF), Swiss Federal Institute of Technology Zurich (ETH))
    Abstract: The "law and finance theory" predicts that the common law system provides the best basis for financial development and economic growth, followed by Scandinavian and German origin civil law and finally French origin civil law. Referring to a number of sceptical views, this paper argues that the theory faces an identification problem, since the majority of common law countries have a market-based financial system, whereas the majority of civil law countries have a bank-based financial system. Moreover, there are plausible alternative hypotheses to explain the quality of the financial system; but that they cannot rule out that the theory refers to a relevant link between the legal tradition and financial development. Finally it is argued that the corner stone of the law and finance theory is the proposition that different legal traditions imply different degrees of investor protection. It is demonstrated that a few minor, but sensible modifications in aggregating the original indicator set produce results that are different from those reported so far and contradictory to the theory's ranking of the four major legal families in terms of investor protection. Accordingly, the validity of the theory's investor protection measures for international comparisons, the supremacy of the common law legacy in protecting investors and, consequently, the validity of legal origin variables to instrument for financial development, have to be regarded as myths rather than truths.
    Keywords: Financial Development, Legal System, Investor Protection
    JEL: K22 G20 P00
    Date: 2006–01
  17. By: Annamarie Lusardi (Dartmouth College); Olivia S. Mitchell (Wharton School, University of Pennsylvania)
    Abstract: Only a minority of American households feels “confident” about retirement saving adequacy, and little is known about why people fail to plan for retirement, and whether planning and information costs might affect retirement saving patterns. To better understand these issues, we devised and fielded a purpose-built module on planning and financial literacy for the 2004 Health and Retirement Study (HRS). This module measures how workers make their saving decisions, how they collect the information for making these decisions, and whether they possess the financial literacy needed to make these decisions. Our analysis shows that financial illiteracy is widespread among older Americans only half of the age 50+ respondents could correctly answer two simple questions regarding interest compounding and inflation, and only one-third correctly answered these two questions and a question about risk diversification. Women, minorities, and those without a college degree were particularly at risk of displaying low financial knowledge. We also evaluate whether people tried to figure out how much they need to save for retirement, whether they devised a plan, and whether they succeeded at the plan. In fact, these calculations prove to be difficult: fewer than one-third of our age 50+ respondents ever tried to devise a retirement plan, and only two-thirds of those who tried actually claim to have succeeded. Overall, fewer than one-fifth of the respondents believed they engaged in successful retirement planning. We also find that financial knowledge and planning are clearly interrelated: those who displayed financial knowledge were more likely to plan and to succeed in their planning. Moreover, those who did plan were more likely to rely on formal methods such as retirement calculators, retirement seminars, and financial experts, and less likely to rely on family/relatives or co-workers.
    Date: 2005–12
  18. By: Rodrik, Dani
    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% 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% 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.
    Keywords: emerging markets; financial crises
    JEL: F4
    Date: 2006–01
  19. By: Francesco Menoncin
    Abstract: We study the asset allocation problem for a pension fund which operates in a PAYG system and periodically revises its investment strategies. If the optimal amount of wealth invested in risky assets is always positive, then during the management period the optimal portfolio is constantly riskier (less risky) than Merton’s portfolio when the growth rate of workers is higher (lower) than the growth rate of pensioners. In particular, there exists a time when the risk exposure is a maximum (minimum).
  20. By: Francisco J. Pueyo
    Abstract: Spanish banking historiography asserts that the largest banks performed in the twentieth century as though they constituted a monopoly. One of their main coordination schemes would have been a network of interlocking bank directors that would include most of the financial firms. Evidence available for the 1920s and 1960s seems to confirm the veracity of this hypothesis. In this paper, more systematic evidence is presented to cover the whole twentieth century with the aim of checking whether these networks persisted over the entire period or they were by-products of temporary situations. Our results show that no general network remained for more than a decade. Therefore, it should be ruled out that interlocking directorates worked as a coordination device of an alleged banking cartel.
    Keywords: Monopolization strategies, Interlocking directorates, Spanish banking
    JEL: L12 L14 N24
    Date: 2006–01
  21. By: Florin Ovidiu Bilbiie (Nuffield College, New Road, OX1 1NF, Oxford, United Kingdom.); André Meier (International Monetary Fund, 700 19th Street NW, Washington, DC 20431, USA.); Gernot J. Müller (Goethe University Frankfurt, Department of Economics, Mertonstrasse 17, D-60325 Frankfurt am Main, Germany)
    Abstract: Using vector autoregressions on U.S. time series for 1957-1979 and 1983-2004, we find government spending shocks to have stronger e¤ects on output, consumption, and wages in the earlier sample. We try to account for this observation within a DSGE model featuring price rigidities and limited asset market participation. Speci?cally, we estimate the structural parameters of the model for both samples by matching impulse responses. Model-based counterfactual experiments suggest that increased asset market participation accounts for some of the changes in fiscal transmission. However, the key quantitative factor appears to be the more active monetary policy of the Volcker-Greenspan period.
    Keywords: Government Spending; Asset Market Participation; Fiscal Policy; Monetary Policy; DSGE; Vector Autoregression; Minimum Distance Estimation
    JEL: E21 E62 E63
    Date: 2006–01
  22. By: Michele Fratianni (Indiana University, Kelley School of Business, Department of Business Economics and Public Policy); Franco Spinelli (Università degli Studi di Brescia, Dipartimento di economia.)
    Abstract: Did the city-states of Genoa and Venice kick a financial revolution all the way back in the Quattrocento, much sooner than the financial revolutions of the Netherlands, England and America? To answer this question we analyze the classic revolutions in terms of three key criteria: credibility of debtor’s promises, the role of national banks in facilitating the development of financial markets, and the extent and depth of financial and monetary innovations. We then compare the record of Genoa and Venice with the benchmark from the three classic financial revolutions. The upshot is that the two maritime city-states had developed many of the features that were to be found later on in the Netherlands, England and the United States. The importance of Genoa and Venice as financial innovators has been eclipsed by the fact that these two city-states did not survive politically. Instead, the innovations were absorbed in the long chain of financial evolution and, in the process, lost the identity of their creators.
    Date: 2006–01–18
  23. By: Enzo Weber
    Abstract: This paper addresses the question of the British state of convergence towards the Euro area, compared to the USA. Economically, the analysis is based on dependences in the money and capital markets, namely the uncovered interest parity (UIP) and the expectation hypothesis of the term structure (EHT). The econometric procedure consists of backward recursive calculations carried out in a cointegration framework. As the evidence for the single parities remains unconvincing, UIP and EHT are combined in a common model. Generally, the results are in favour of a growing British integration into the European Currency Union.
    Keywords: Nominal Convergence, Cointegration, UIP, Term Structure, Euro Area
    JEL: E43 E44 C32
    Date: 2006–01
  24. By: António Afonso (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.); Ludger Schuknecht (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.); Vito Tanzi (Inter-American Development Bank, 1300 New York Avenue, NW Washington, DC 20577, USA.)
    Abstract: In this paper we analyse public sector efficiency in the new member states of the European Union compared to that in emerging markets. After a conceptual discussion of expenditure efficiency measurement issues, we compute efficiency scores and rankings by applying a range of measurement techniques. The study finds that expenditure efficiency across new EU member states is rather diverse especially as compared to the group of top performing emerging markets in Asia. Econometric analysis shows that higher income, civil service competence and education levels as well as the security of property rights seem to facilitate the prevention of inefficiencies in the public sector.
    Keywords: Interest rate pass-through; euro area countries; panel cointegration
    JEL: E43 G21
    Date: 2006–01
  25. By: Giancarlo Corsetti
    Abstract: Models of stabilization in open economy traditionally emphasize the role of exchange rates as a substitute for nominal price flexibility in fostering relative price adjustment. This view has been recently criticized on the ground that, to the extent that prices are sticky in local currency, the exchange rate does not play the stabilizing role envisioned by the received wisdom. An important question is whether, for this very reason, stabilization policies should limit exchange rate movements, or even eliminate them altogether. In this paper, I re-assess this issue by extending the Corsetti and Pesenti (2001) model to allow for home bias in consumption, so that I can exploit the advantages of closed-form solutions. While this extension leaves most properties of the model unaffected, home bias implies that the real exchange rate in an efficient equilibrium is not constant, but fluctuates with the terms of trade. The weight that monetary authorities optimally place on stabilizing domestic marginal costs is increasing in Home bias. With asymmetric shocks, fixed exchange rates are incompatible with efficient monetary rules. Yet, the adverse welfare consequences of exchange rate movements constrain the optimal intensity of monetary responses to domestic shocks. Openness matters: the larger the import content of consumption, the lower the exchange rate volatility implied by optimal stabilization rules.
    Keywords: optimal monetary policy, nominal rigidities, exchange rate pass-through, exchange rate regimes, international cooperation
    JEL: E31 E52 F42
    Date: 2005
  26. By: Kristina Kittelmann; Marcel Tirpak; Rainer Schweickert; Lúcio Vinhas de Souza
    Abstract: This paper uses a Markov regime-switching model to assess the vulnerability of a series of Central and Eastern European countries (i.e. Czech Republic, Hungary, Slovak Republic) and two CIS countries (i.e., Russia and Ukraine) during the period 1993–2004. For the new EU member states in Central and Eastern Europe, the results of our model show that the majority of crises in those countries can be explained by inconsistencies in the domestic policy mix and by the deterioration of macroeconomic fundamentals, as emphasized by first generation crises models, while for the CIS countries analysed, financial vulnerability type indicators were the most relevant, i.e., indicators connected with the second and third generation of crisis model better explain the vulnerability of these countries. Additionally, the set of indicators choosen by our model is rather heterogenous, supporting the superiority of a country-by-country approach.
    Keywords: EU, Central and Eastern Europe, CIS, early warning system, currency crisis, Markov switching
    JEL: F47 P20 C22
    Date: 2006–02
  27. By: Sanne Zwart
    Abstract: This paper discusses a liquidity run model where investors optimally decide whether or not to acquire private information. This endogenizes the dichotomy "private information/no private information". The price of the information makes the equilibrium partitioning of the fundamentals two dimensional. For intermediate fundamentals multiplicity can be eliminated by the private information that investors can have. The dichotomy represents the information structures for low and high prices respectively. However, it presents a distorted view for intermediate prices and fundamentals for which unique equilibria without private information can occur. These results are preserved if the quality of the information is endogenized.
    Keywords: Bank runs, information acquisition, coordination games
    JEL: C73 D81 F34 G14
    Date: 2005
  28. By: Carlos F. Alves (CEMPRE, Faculdade de Economia, Universidade do Porto); Victor Mendes (CMVM - Portuguese Securities Commission)
    Abstract: The absence of investor reaction to the poor performance of mutual funds is a widely reported phenomenon. This paper investigates the role of load costs as an explanation for the phenomenon and concludes that back-end load fees are an obstacle to reaction. We find that investors with a high likelihood of undergoing a liquidity crisis, preferring liquidity in decision making, act contrary to the reaction hypothesis, and investors with broader investment horizons do not react to poor performances due to the fact that they are “imprisoned” by back-end load fees.
    Keywords: Mutual Fund, Performance Reaction, Load Costs, Investor Behaviour
    JEL: G20 G23 G28
    Date: 2006–02
  29. By: Elmar Wolfstetter (Humboldt University at Berlin, Institute of Economic Theory I, Spandauer Str. 1, D–10178 Berlin, Germany.
    Date: 2005–12
  30. By: Arturo Galindo; Alejandro Micco
    Abstract: We develop a model that shows that inefficient legal protections, disproportionately increase financial restrictions for debtors that have less wealth. Due to fixed monitoring costs in equilibrium banks will not monitor small firms and therefore these firms will adopt risky technologies that imply a higher probability of bankruptcy. This implies that inefficiencies in the bankruptcy procedure will have a greater effect on small firms vis a vis large ones. Using a survey of firms in 62 countries around the world (WBES) and econometric techniques that allow us to deal with observed and unobserved country specific components as well as with partial endogeneity, we explore the role of creditor protection on small and medium-size enterprises' access to bank credit. We find that better protection of creditors reduces the financing gap between small and large firms
    Date: 2005–09–10
  31. By: Antoni Bosch; Joaquim Silvestre
    Abstract: We experimentally question the assertion of Prospect Theory that people display risk attraction in choices involving high-probability losses. Indeed, our experimental participants tend to avoid fair risks for large (up to € 90), high-probability (80%) losses. Our research hinges on a novel experimental method designed to alleviate the house-money bias that pervades experiments with real (not hypothetical) loses. Our results vindicate Daniel Bernoulli’s view that risk aversion is the dominant attitude, But, contrary to the Bernoulli-inspired canonical expected utility theory, we do find frequent risk attraction for small amounts of money at stake. In any event, we attempt neither to test expected utility versus nonexpected utility theories, nor to contribute to the important literature that estimates value and weighting functions. The question that we ask is more basic, namely: do people display risk aversion when facing large losses, or large gains? And, at the risk of oversimplifying, our answer is yes.
    Keywords: Losses, Risk Attraction, Risk Aversion, Experiments, Prospect Theory, Bernoulli, Kahneman, Tversky
    JEL: C91 D81
    Date: 2006–01
  32. By: Marc Pomp; M. Bijlsma; Machiel van Dijk; Michiel van Leuvensteijn; C. Zonderland
    Abstract: This report presents an empirical analysis of competition in the market for life insurance. In this market, financial advisors play a large role. Therefore, the report devotes considerable attention to the functioning of the market for financial advice. The main findings are as follows. Empirical indicators of competition find only weak competition in the market for life insurance. There are substantial economies of scale, large X-inefficiencies, and limited competition as measured by the Boone-indicator compared to other services sectors. Also, the higher profitability of Dutch life insurers compared to their foreign peers suggests weak competition, although it should be pointed out that this indicator mainly reflects the situation in the past. Better functioning of financial advisors offers a key towards improving competition. Consumers who purchased annuities through advisors are found to achieve lower pay-outs than consumers who purchased directly from life insurers. This finding underlines the importance of more transparency of life insurance products and of independent advice.
    Keywords: competition; life insurance; financial advice
    JEL: L13 D14
    Date: 2005–09
  33. By: Fernandez, Pablo (IESE Business School)
    Abstract: We develop valuation formulae for a company that maintains a fixed book-value leverage ratio and claim that it is more realistic than to assume, as Miles-Ezzell (1980) do, a fixed market-value leverage ratio. The value of tax shields depends only on the present value of the net increases of debt. The value of tax shields in a world with no leverage cost is the tax rate times the current debt plus the present value of the net increases of debt. We also show that the appropriate discount rates for the equity cash flows and for the expected value of the equity are different.
    Keywords: Company valuation; value of tax shields; present value of the net increases of debt; required return to equity;
    JEL: G12 G31 G32
    Date: 2005–11–03
  34. By: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
    Abstract: This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of pass-through stems from both nominal rigidities (in the form of local currency pricing) and price discrimination. We model real exchange rate volatility in response to real shocks by reconsidering and extending two approaches suggested by the quantitative literature (one by Backus Kehoe and Kydland [1995], the other by Chari, Kehoe and McGrattan [2003]), within a common framework with incomplete markets and segmented domestic economies. Our model accounts for a variable degree of ERPT over different horizons. In the short run, we find that a very small amount of nominal rigidities - consistent with the evidence in Bils and Klenow [2004] - lowers the elasticity of import prices at border and consumer level to 27% and 13%, respectively. Remarkably, exchange rate depreciation worsens the terms of trade - in accord to the evidence stressed by Obstfeld and Rogo [2000]. In the long run, exchange-rate pass-through coefficients are also below one, as a result of price discrimination. The latter is an implication of distribution services, which makes the goods demand elasticity market specific.
    Keywords: international business cycle, exchange rate volatility, pass-through, international transmission, DSGE models
    JEL: F33 F41
    Date: 2005
  35. By: Véronique SAINT GES (E3i-IFReDE-GRES & INRA)
    Abstract: The aim of this paper is to question the cognitive capitalism hypothesis: are the major transformations of the wage labour nexus and regime of accumulation, created a new capitalism era? A positive answer to this question then relegates to a second rank the thesis of financial capitalism. For this last thesis, the financialisation of accumulation deeply transforms the firms. This paper develops this second point of view. Our conclusion is disappointing for the cognitive capitalism hypothesis. If the production of knowledge is important for the accumulation, nevertheless this production of knowledge is subordinated to the view of global finance. Indeed, it’s this global finance who decides which are new profitable activities.
    Keywords: Collective action, Environmental technologies, Technology diffusion, Geographical proximity, organized proximity, vine growing.
    JEL: O13 Q16 Q Q
    Date: 2006
  36. By: Yvan Lengwiler (University of Basel, Dept. of Economics (WWZ), Petersgraben 51, CH–4003 Basel, Switzerland.; Elmar Wolfstetter (Humboldt University at Berlin, Institute of Economic Theory I, Spandauer Str. 1, D–10178 Berlin, Germany.
    Abstract: We review different kinds of corruption that have been observed in procurement auctions and categorize them. We discuss means to avoid corruption, by choice of preferable auction formats, or with the help of technological tools, such as secure electronic bidding systems. Auctions that involve some soft elements, such as complex bids consisting of technical and financial proposals, are particularly prone to corruption. We do not believe that it is possible to eradicate corruption altogether in such situations, but we discuss means to make it less likely.
    Date: 2006–01
  37. By: Manoel F. Meyer Bittencourt
    Abstract: We examine the impact that financial development had on earnings inequality in Brazil in the 1980's and 90's. The empirical evidence, based on panel time series and time series data, shows that more broad access to financial and credit markets had a significant and robust effect in reducing inequality during the period investigated. We suggest that this is not only because the poor can invest the acquired credit in all sorts of productive activities, but also because those with access to financial markets can insulate themselves against recurrent poor macroeconomic performance, which is exemplified by high inflation rates. The main implication of the results is that a seemingly nondistortionary policy, such as more credit aimed at the poor, alleviates the extreme inequality present in Brazil and consequently improves welfare without distorting economic efficiency.
    Keywords: Financial development and markets, credit, inequality and welfare, inflation.
    JEL: D31 E44 O11 O54
    Date: 2006–01
  38. By: Willem H Boshoff (Department of Economics, Stellenbosch University)
    Abstract: Linkages between the financial and real sectors of the economy have been studied extensively over the past twenty years to enhance business cycle forecasting on the one hand and improve portfolio allocation on the other. The broad aim of the paper is to investigate the relationship between cycles in the real economy and cycles in several financial variables from the South African money, bond and stock markets for the period from 1986 onwards. The paper will aim to describe the properties of cycles in such financial variables, where cycles were derived using a dating algorithm similar to that used to determine business cycle turning points. This method is consistent with the Burns and Mitchell tradition of business cycle analysis, but in contrast with the dominant approach in academic research, i.e. deviation cycles relying on time-series detrending. Consequently, the paper will attempt to relate phases in the cycles of financial variables with business cycle phases to establish which variables satisfy preliminary requirements for leading indicators of the business cycle. The paper will consider both classical cycles as well as cycles in the growth rate of the different variables and include international variables, due to the potential importance of international developments for financial markets in an open economy.
    Keywords: business cycles, South Africa, financial variables, real economy
    JEL: E30 E32 E37 E44 E47
    Date: 2005
  39. By: Torsten Persson; Guido Tabellini
    Abstract: Does democrazy promote economic development? Reviews recent attempts to addresses this question that exploited within-country variation. It shows that the answer is largely postive, but also depends on the details of democratic reforms. First, the sequence of economic vs political reforms matters: countries liberalizing their economy before extending political rights do better. Second, different forms of democratic government lead to different economic policies, and this might explain why presidential democracy leads to faster growth than parliamentary democracy. Third, it is important to distinguish between expected and actual political reforms. Taking expectations of regime change into account helps identify a stronger growth effect of democracy.
  40. By: Roberto Casarin
    Abstract: In credit risk modelling, jump processes are widely used to de- scribe both default and rating migration events. This work is mainly a review of some basic denitions and properties of the jump processes intended for a preliminary step before more ad- vanced lectures on credit risk modelling. We focus on the Poisson process and some generalisations, like the compounded and the double stochastic Poisson processes, which are widely used for describing the time-inhomogeneous dynamic either of the default process or of the credit rating transition. As such, much of the material is not new, but focused and organized from a credit risk perspective. Moreover it contains detailed proofs of some funda- mental results. Other original contributions come from examples and simulated studies, which help the reader to better understand the features of the described processes.
  41. By: Thomas Borek (Department of Mathematics, Swiss Federal Institute of Technology Zurich); Stefan Buehler (Socioeconomic Institute, University of Zurich); Armin Schmutzler (Socioeconomic Institute, University of Zurich)
    Abstract: We analyze a Bayesian merger game under two-sided asymmetric information about firm types. We show that the standard prediction of the lemons market model–if any, only low-type firms are traded–is likely to be misleading: Merger returns, i.e. the difference between pre- and post-merger profits, are not necessarily higher for low-type firms. This has two implications. First, under very general conditions, equilibria exist where mergers take place, and there is no presumption that there is ineffciently low trade. Second, in these equilibria it is typically not the case that only low-type firms enter an agreement.
    Keywords: merger, asymmetric information, oligopoly, single crossing
    JEL: D43 D82 L13 L33
    Date: 2004–07
  42. By: Martina Eckardt (Herdecke University Witten)
    Abstract: Based on a sample of 946 German insurance intermediaries, the factors that affect the quality of the information services provided by them are studied using OLS-estimations. Applying a search theoretical approach, we analyze the impact of supply and demand side variables on service quality. Besides, the working of signaling devices (like reputation, advertising or certificates) to reduce asymmetric information with respect to the service quality of insurance intermediaries is examined. The results obtained support the main hypotheses derived from industrial organization theories as to the poor working of quality competition under incomplete and asymmetric information on the side of consumers. Thus, public policy should concentrate on increasing transparency about intermediaries' (in-)dependence from insurance companies and improve consumers' financial literacy to raise the overall quality of the information services provided by insurance intermediaries.
    Keywords: Performance of Insurance Distribution Systems, Information Quality
    JEL: D83 G22 L15
    Date: 2006
  43. By: Michael Breuer (Socioeconomic Institute, University of Zurich)
    Abstract: The standard solution to adverse selection is the separating equilibrium introduced by Rothschild and Stiglitz. Usually, the Rothschild-Stiglitz argument is developed in a model that allows for two states of the world only. In this paper adverse selection is dis-cussed for continuous loss distributions. This gives rise to the new problem of finding the proper form of an insurance contract to impose partial insurance of the low risks. This paper contributes to the discussion on optimal insurance. It analyzes two basic forms of insurance contracts: A contract with a deductible and a contract imposing a positive co-insurance rate. Since high risks can always self-reveal themselves as high risks and buy the optimal insurance contract at high risks’ premiums the Pareto-superior insurance contract is the one that leaves the low risks with higher expected utility while deterring high risks from joining the contract that is designed for low risks. The deductible contract turns out to be superior if premiums contain a sufficiently high loading.
    Keywords: Insurance, Adverse Selection, Deductible, Co-Insurance
    JEL: D81 D82 D62
    Date: 2004–01
  44. 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.
    JEL: F31 F33
    Date: 2006–01
  45. By: Rodrigo Fernando Tejada Morales
    Abstract: El objetivo de esta tesis es implementar un modelo empírico que permita comprobar si la mayor competencia en el sistema financiero tiene un efecto negativo o positivo sobre la calidad de sus activos. Como media de los cambios en la competencia y el poder de mercado de las entidades se utiliza la q de James Tobin, ya que ningún otro instrumento utilizado hasta ahora en la literatura para este fin permite capturar apropiadamente estos efectos. En la aplicación del modelo se emplearon tres paneles con información de los establecimientos de crédito para Colombia durante el periodo 1989-1997. Su aplicación permitió demostrar que las entidades experimentan un deterioro en la calidad de su cartera a medida que su poder de mercado se incrementa,
    Date: 2006–01–01
  46. By: Mauro Mastrogiacomo
    Abstract: This study contains several tests to show that individuals overreact to negative wealth changes, relative to positive wealth changes. This asymmetry, that is found using micro data, suggests that economists should not treat symmetrically the relation between economic variables (consumption for instance) and wealth in their models when wealth decreases. We find that this asymmetry increases with age and picks at retirement.
    Keywords: asymmetry; wealth; saving; expectations; threshold model
    JEL: D10 D84 J14
    Date: 2006–01
  47. By: Simone Manganelli (European Central Bank, Kaiserstrasse 29, Postfach 16 03 19, 60066 Frankfurt am Main, Germany.)
    Abstract: This paper argues that forecast estimators should minimise the loss function in a statistical, rather than deterministic, way. We introduce two new elements into the classical econometric analysis: a subjective guess on the variable to be forecasted and a probability reflecting the confidence associated to it. We then propose a new forecast estimator based on a test of whether the first derivatives of the loss function evaluated at the subjective guess are statistically different from zero. We show that the classical estimator is a special case of this new estimator, and that in general the two estimators are asymptotically equivalent. We illustrate the implications of this new theory with a simple simulation, an application to GDP forecast and an example of mean-variance portfolio selection.
    Keywords: Decision under uncertainty; estimation; overfitting; asset allocation
    JEL: C13 C53 G11
    Date: 2006–01
  48. By: Qi Quan; Nancy Huyghebaert
    Abstract: Using data on 451 Chinese privatizations over the period 1994-2002, this paper empirically investigates the firm and stock market characteristics that determine the size of the portion of new shares sold to the general public and underpricing at SIP-time. We find that poor performance and financing constraints, reflected by a low profitability and high leverage, mainly drive public share allocation. Also, the government widens ownership to a larger extent in firms that receive substantial subsidies. By contrast, stock market returns pre-SIP and variables capturing the firm’s growth opportunities do not positively affect public share allocation. Yet, in firms with a low market-to-book ratio, the government is more likely to relinquish its majority stake at SIP-time. The determinants of underpricing further illustrate the uniqueness of SIPs compared to private-firm IPOs. Overall, there is little evidence that information asymmetries regarding firm value influence first-day returns whereas stock market conditions have an impact. After accounting for the endogeneity of the public share allocation decision, we find that the fraction of ownership divested is significantly positively related to underpricing.
    Keywords: privatization; motives for going public; government divestment; underpricing
    JEL: G32 G38
    Date: 2005
  49. By: Bjørnland, Hilde C. (Dept. of Economics, University of Oslo); Hungnes, Håvard (Statistics Norway, Research Department.)
    Abstract: This paper addresses the purchasing power parity (PPP) puzzle for a commodity currency. In particular, we analyse the real exchange rate behaviour in Norway, which has a primary commodity (oil) that constitutes the majority of its exports. A substantial part of the literature on commodity currencies has found that, despite controlling for the effect of commodity prices, PPP does not hold in the long run. We show that once we also control for the effect of the interest rate differential in the real exchange rate relationship, the discrepancies from PPP are fully accounted for. Furthermore, with the interest rate differential included in the long run real exchange rate relationship, the real oil price plays only a minor role. Adjustment to equilibrium (half-lives) is also substantially reduced, taking no more than one year on average. Hence, contrary to earlier findings on commodity currencies, we have effectively removed the PPP puzzle.
    Keywords: Exchange rate; commodity currencies; real oil price; purchasing power parity; uncovered interest parity.
    JEL: C32 F31
    Date: 2005–12–20
  50. By: Koedijk, Kees; Tims, Ben; Van Dijk, Mathijs A
    Abstract: This paper analyses the properties of multivariate tests of purchasing power parity (PPP) that fail to take heterogeneity in the speed of mean reversion across real exchange rates into account. We compare the performance of homogeneous and heterogeneous unit root testing methodologies. The recent literature has successfully contested several severe restrictions on the structure of the model, but the assumption of homogeneous mean reversion is still widely used and its consequences are virtually unexplored. Using Monte Carlo simulation, we uncover important adverse properties of the methodology that relies on homogeneous estimation and testing. More specifically, power functions are low and assume irregular shapes. Furthermore, homogeneous estimates of the mean reversion parameters exhibit potentially large biases. This can have a dramatic impact on inferences made on the validity of the PPP hypothesis. Our findings highlight the importance of allowing for heterogeneous estimation when testing for a unit root in panels of real exchange rates.
    Keywords: heterogeneity; international economics; panel models; Purchasing power parity; real exchange rates; unit root tests
    JEL: F31 F33 G15
    Date: 2006–01
  51. By: Selim, Sheikh Tareq (Cardiff Business School)
    Abstract: This paper explores current account dynamics in eight small economies of Asia to examine whether or not capital flows have been excessive in these countries. Standard assumptions of perfect capital mobility and small open economy are jointly instrumental in simplifying theoretical tractability of many open economy models. In empirical estimations, however, the identification of a small open economy is often oversimplified, which makes celebrated results, such as excessive or too low capital flows in OECD economies, questionable. This paper establishes that the actual extent of capital mobility in small open economies cannot be generally too high or too low. This in turns implies that the general idea of excessive capital flows in small open economies requires revision.
    Keywords: Current account dynamics; intertemporal approach; consumption-smoothing; capital mobility
    Date: 2006–01
  52. By: Bjørnland, Hilde C. (Dept. of Economics, University of Oslo)
    Abstract: This paper analyses the transmission mechanisms of monetary policy in a small open economy like Norway through structural VARs, paying particular attention to the interdependence between the monetary policy stance and exchange rate movements in the inflation-targeting period. Previous studies of the effects of monetary policy in open economies have typically found small or puzzling effects on the exchange rate; puzzles that may arise due to the recursive restrictions imposed on the contemporaneous interaction between monetary policy and the exchange rate. By instead imposing a long-run neutrality restriction on the real exchange rate, thereby allowing the interest rate and the exchange rate to react simultaneously to any news, the interdependence increases considerably. In particular, following a contractionary monetary policy shock, the real exchange rate appreciates immediately and thereafter depreciates back to baseline. Furthermore, output and consumer price inflation fall gradually as expected; thereby also ruling out any price puzzle that has commonly been found in the literature. Results are compared and found to be consistent with among other the findings from an “event study” that focuses on immediate responses in asset prices following a surprise monetary policy decision.
    Keywords: VAR; monetary policy; open economy; identification; event study.
    JEL: C32 E52 F31 F41
    Date: 2005–12–15
  53. By: Gianni Amisano; Marco Tronzano
    Abstract: This paper extends Svensson (1994) ?simplest test?of in?ation target credibility inside a Bayesian econometric framework. We apply this approach to the initial years of the Eurosystem and obtain various estimates of ECB?s monetary policy credibility. Overall, our empirical evidence is robust to alternative prior assumptions, and suggests that the strategy followed by the ECB was successful in building a satisfactory degree of reputation. However, we ?nd some signi?cant credibility reversals concerning both anti-in?ationary and anti-de?ationary credibility. These reversals, in turn, are closely related to the evolution of the cyclical macroeconomic conditions in the Euro area.
  54. By: Nicolas Mougeot (FAME and Institute of Banking and Financial Management, Ecole des HEC)
    Abstract: This paper presents a simple approach to the pricing of options on spread and some arguments in favor of modelling the spread using its two components instead of the spread itself. We show that, even in a simple Gaussian setting, the spread should not be modelled directly, and that convergence speeds of the two components are crucial parameters. There exist conditions, discussed in this paper, under which the analysis can be reduced to a two-factor model based on the dynamics of the spread itself. Hence, we propose a three-factor model based on the dynamics of the riskless rate and of the two components of the spread. This is done by following the Longstaff (1990) methodology and with the assumption that both the riskless rate and the spread or its two components follow correlated Ornstein-Uhlenbeck processes. Greeks analysis shows that spread options have some very specific features compared to the Black-Scholes-Merton (1973) option model. Moreover, the results show that the mispricing is important and not systematic when one chooses a spread option model based on the dynamics of the spread instead of using the dynamics of its two components. We finally show how the spread option model allows us to price other yield derivatives, like options to exchange a yield for another or the options on the maximum or the minimum of two yields.
    Keywords: Credit spread, Option valuation, Change of probability measure
    JEL: G13
  55. By: Paolo Panteghini
    Abstract: This article studies the characteristics of a S-based tax system under default risk. In particular we show that its neutrality properties depend on whether debt is protected or unprotected. In the former case, this system is neutral. In the latter case, where default timing is optimally chosen by shareholders, the S-based system is neutral with respect to real decisions only if the ?rm?s and the lender?s tax rate are equal. However, the shareholders? decision to default is always distorted.

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