New Economics Papers
on Financial Markets
Issue of 2006‒08‒26
78 papers chosen by
Carolina Valiente

  1. On the Coexistence of Banks and Markets By Hans Gersbach; Harald Uhlig
  2. International Capital Flows, Financial Stability and Growth By Graciela L. Kaminsky
  3. Default risk sharing between banks and markets: the contribution of collateralized debt obligations By Günter Franke; Jan Pieter Krahnen
  4. Might a Securities Transactions Tax Mitigate Excess Volatility?: Some Evidence From the Literature By Markus Haberer
  5. Why do Central Bankers Intervene in the Foreign Exchange Market? Some New Evidence and Theory By Pablo A. Guerron
  6. Financial Regulations in Developing Countries: Can they Effectively Limit the Impact of Capital Account Volatility? By Liliana Rojas-Suarez
  7. The Interplay Between the Thai and Several Other International Stock Markets By Valadkhani, Abbas; Chancharat, Surachai; Harvie, Charles
  8. Intra-Day Seasonality in Activities of the Foreign Exchange Markets: Evidence From the Electronic Broking System By Takatoshi Ito; Yuko Hashimoto
  9. Underpriced Default Spread Exacerbates Market Crashes By Winston T. H. Koh; Roberto S. Mariano; Andrey Pavlov; Sock Yong Phang; Augustine H. H. Tan; Susan M. Wachter
  10. Search in asset markets By Ricardo Lagos; Guillaume Rocheteau
  11. Bond Markets as Conduits for Capital Flows: How Does Asia Compare? By Barry Eichengreen; Pipat Luengnaruemitchai
  12. Pricing the Weather Derivatives in the Presence of Long Memory in Temperatures By Hélène Hamisultane
  13. Sovereign debt crises and credit to the private sector By Carlos Arteta; Galina Hale
  14. Limiting Foreign Exchange Exposure through Hedging: The Australian Experience By Chris Becker; Daniel Fabbro
  15. Insurance Underwriter or Financial Development Fund: What Role for Reserve Pooling in Latin America? By Barry Eichengreen
  16. Option Pricing: Real and Risk-Neutral Distributions By Jens Carsten Jackwerth; George M. Constantinaides; Stylianos Perrakis
  17. GDP-Indexed Bonds: Making It Happen By Stephany Griffith-Jones; Krishnan Sharma
  18. Excess Volatility in European Equity Style Indices - New Evidence By Marian Berneburg
  19. Intertemporal Consumption Choices, Transaction Costs and Limited Participation to Financial Markets: Reconciling Data and Theory By Orazio P. Attanasio; Monica Paiella
  20. Highly Interconnected Subsystems of the Stock Market By John Idicula
  21. Utility-based Pricing of the Weather Derivatives By Hélène Hamisultane
  22. Expectations, Asset Prices, and Monetary Policy: The Role of Learning By Simon Gilchrist; Masashi Saito
  23. Optimal Taxation of Entrepreneurial Capital with Private Information By Stefania Albanesi
  24. Reflections on One Year at the Bank of Israel By Stanley Fischer
  25. How Do Trade and Financial Integration Affect the Relationship between Growth and Volatility? By M. Ayhan Kose; Eswar S. Prasad; Marco E. Terrones
  26. Can Central Banks Target Bond Prices? By Kenneth Kuttner
  27. Analytic Models of the ROC Curve: Applications to Credit Rating Model Validation By Stephen Satchel; Wei Xia
  28. The Economic and Social Effects of Financial Liberalization: A Primer for Developing Countries By Jayati Ghosh
  29. Modelling Different Volatility Components in High-Frequency Financial Returns By Yuanhua Feng
  30. The Taxation of Financial Capital under Asymmetric Information and the Tax-Competition Paradox By Wolfgang Eggert; Martin Kolmar
  31. The y-Theory of Investment By Thomas Philippon
  32. Financial Innovation for an Aging World By Olivia S. Mitchell; John Piggott; Michael Sherris; Shaun Yow
  33. Why Do Asset Prices Not Follow Random Walks? By Günter Franke; Erik Lüders
  34. Mispricing of S&P 500 Index Options By Jens Carsten Jackwerth; George M. Constantinaides; Stylianos Perrakis
  35. Conditionally parametric fits for CAPM betas By Klaus Abberger
  36. The Equity Premium in India By Rajnish Mehra
  37. Divergence of credit valuation in Germany - Continuous theory and discrete practice - By Weibach, Rafael; Sibbertsen, Philipp
  38. Financial Globalization, Governance, and the Evolution of the Home Bias By Bong-Chan Kho; René M. Stulz; Francis E. Warnock
  39. Electoral Uncertainty and the Volatility of International Capital Flows By Roberto Chang
  40. Double Taxation, Tax Credits and the Information Exchange Puzzle By Wolfgang Eggert
  41. Benchmarking Money Manager Performance: Issues and Evidence By Josef Lakonishok; Louis Chan; Stephen G. Dimmock
  42. Monetary Equilibria in a Cash-in-Advance Economy with Incomplete Financial Markets By Jinhui H. Bai; Ingolf Schwarz
  43. Diversification and the Value of Exploration Portfolios By James L. Smith; Rex Thompson
  44. The expected effect of the euro on the Hungarian monetary transmission By Gábor Orbán; Zoltán Szalai
  45. The dynamics of overconfidence: Evidence from stock market forecasters By Richard Deaves; Erik Lüders; Michael Schröder
  46. The Role of the Housing Market in Monetary Transmission By Gergely Kiss; Gábor Vadas
  47. External Debt, Adjustment, and Growth By Roberto S. Mariano; Delano Villanueva
  48. On the Determinants of Exporters' Currency Pricing: History vs. Expectations By Shin-ichi Fukuda; Masanori Ono
  49. The Anatomy of Bank Diversification By Elsas, Ralf; Hackethal, Andreas; Holzhaeuser, Markus
  50. Signaling Credibility --- Choosing Optimal Debt and International Reserves By Joshua Aizenman; Jorge Fernández-Ruiz
  51. Capital Controls: Myth and Reality A Portfolio Balance Approach to Capital Controls By Nicolas Magud; Carmen Reinhart; Kenneth Rogoff
  52. Noisy Macroeconomic Announcements, Monetary Policy, and Asset Prices By Roberto Rigobon; Brian Sack
  53. A Survey of Housing Equity Withdrawal and Injection in Australia By Carl Schwartz; Tim Hampton; Christine Lewis; David Norman
  54. A Quasilinear Parabolic Equation with Quadratic Growth of the Gradient modeling Incomplete Financial Markets By Bertram Düring; Ansgar Jüngel
  55. Approximating the Growth Optimal Portfolio with a Diversified World Stock Index By Truc Le; Eckhard Platen
  57. Real Exchange Rate, Monetary Policy and Employment By Roberto Frenkel; Lance Taylor
  58. Multiplicative Background Risk By Günter Franke; Harris Schlesinger; Richard C. Stapleton
  59. Housing Wealth and Aggregate Consumption in Sweden By Chen, Jie
  60. Designing realised kernels to measure the ex-post variation of equity prices in the presence of noise By Ole E Barndorff-Nielsen; Peter Hansen; Asger Lunde; Neil Shephard
  61. Employee Stock Options: Much More Valuable Than You Thought By Jens Carsten Jackwerth; James E. Hodder
  62. Incentive Contracts and Hedge Fund Management By Jens Carsten Jackwerth; James E. Hodder
  63. Used Good Trade Patterns: A Cross-Country Comparison of Electronic Secondary Markets By Anindya Ghose
  64. The EMU after Three Years: Lessons and Challenges By Peter Bofinger
  65. Incremental Risk Vulnerability By Günter Franke; Richard C. Stapleton; Marti G. Subrahmanyam
  66. The Rationality and Heterogeneity of Survey Forecasts of the Yen-Dollar Exchange Rate: A Reexamination By Carl Bonham; Richard Cohen; Shigeyuki Abe
  67. A simple graphical method to explore tail-dependence in stock-return pairs By Klaus Abberger
  68. Convergence of a high-order compact finite difference scheme for a nonlinear Black-Scholes equation By Bertram Düring; Michel Fournié; Ansgar Jüngel
  69. How has CEO Turnover Changed? Increasingly Performance Sensitive Boards and Increasingly Uneasy CEOs By Steven N. Kaplan; Bernadette Minton
  70. Economic and Technical Analysis of Ethano Dry Milling: MOdel User's Manual By Rhys T. Dale; Wallce E. Tyner
  71. Ten Myths of the International Finance Facility By Todd Moss
  72. Moral Hazard, Adverse Selection and Health Expenditures: A Semiparametric Analysis By Patrick Bajari; Han Hong; Ahmed Khwaja
  73. M&A Transaktionen: Fluch und Segen der Realoptionstheorie By Günter Franke; Christian Hopp
  74. Time-Dependent Portfolio Adjustment: Yet Another Look at the Dynamics By Pablo A. Guerron
  75. A Rational Irrational Man? By Alexander Harin
  76. Le financement des actifs des établissements d’enseignement en Nouvelle-Zélande By OCDE
  77. Cross-Border Acquisitions and Target Firms' Performance: Evidence From Japanese Firm-Level Data By Kyoji Fukao; Keiko Ito; Hyeog Ug Kwon; Miho Takizawa
  78. Is Cash Flow a Proxy for Financing Constraints in the Investment Equation? The Case of Unlisted Japanese Firms By Yuzo Honda; Kazuyuki Suzuki

  1. By: Hans Gersbach; Harald Uhlig
    Abstract: We examine the coexistence of banks and financial markets, studying a credit market where the qualities of investment projects are not observable and the investment decisions of entrepreneurs are not contractible. Standard banks can alleviate moral-hazard problems by securing a portion of a repayment in the case of non-investment. Financial markets operated by investment banks and rating agencies have screening know-how and can alleviate adverse-selection problems. In competition, standard banks are forced to increase repayments, since financial markets can attract the highest-quality borrowers. This, in turn, increases the share of shirkers and may make lending unprofitable for standard banks. The coexistence of financial markets and standard banks is socially inefficient. The same inefficiency can happen with the entrance of sophisticated banks, operating with a combination of rating and ongoing monitoring technologies.
    Keywords: contract, debt contract, adverse selection, moral hazard, coexistence of financial intermediaries, regulation
    JEL: G24 G28 G32 G38 D80 D92 D43
    Date: 2006–03
  2. By: Graciela L. Kaminsky
    Abstract: The explosion and dramatic reversal of capital flows to emerging markets in the 1990s have ignited a heated debate, with many arguing that globalization has gone too far and that international capital markets have become extremely erratic. In contrast, others have emphasized that globalization allows capital to move to its most attractive destination, fuelling higher growth. This paper re-examines the characteristics of international capital flows since 1970 and summarizes the findings of research of the 1990s on the behaviour of international investors as well as the short- and long-run effects of globalization on financial markets and growth.
    Keywords: international capital flows, globalization, mutual funds, stock market prices, financial liberalization.
    JEL: F30 F32 F33 F34 F36 G12 G15
    Date: 2005–12
  3. By: Günter Franke (Department of Economics, University of Konstanz); Jan Pieter Krahnen (Center for Financial Studies, Goethe-University Frankfurt)
    Abstract: This paper contributes to the economics of financial institutions risk management by exploring how loan securitization affects their default risk, their systematic risk, and their stock prices. In a typical CDO transaction a bank retains through a first loss piece a very high proportion of the default losses, and transfers only the extreme losses to other market participants. The size of the first loss piece is largely driven by the average default probability of the securitized assets. If the bank sells loans in a true sale transaction, it may use the proceeds to expand its loan business, thereby affecting systematic risk. For a sample of European CDO issues, we find an increase of the banks’ betas, but no significant stock price effect around the announcement of a CDO issue.
    Date: 2005–08–18
  4. By: Markus Haberer (Department of Economics, University of Konstanz)
    Abstract: International financial markets are said to be excessively volatile due to destabilizing speculation and excessive market volume. Transactions taxes might help. From studying the literature we conclude that there must be an optimal market liquidity, which minimizes excess volatility. There are two effects when imposing a transactions tax. Both reduce excess volatility in highly speculative markets when tax rates are small. The total tax effect then is unambiguous. However, in illiquid markets the tax might raise volatility.
    Keywords: International Financial Markets, Securities Transactions Tax, Excess Volatility
    JEL: G15 G18 H20
    Date: 2005–05
  5. By: Pablo A. Guerron (Department of Economics, North Carolina State University)
    Abstract: I provide new empirical and theoretical evidence about the effectiveness of sterilized interventions on exchange rates. These new developments are particularly important to understand why central bankers from developing countries tend to intervene during periods of financial distress. In the first half of the paper, I apply a VAR formulation to measure the effects of sterilized interventions on the U.S. bilateral exchange rate. Information from the Exchange Stabilization Fund in the U.S. for the period 1974 -- 2000 is used to identify a shock that is orthogonal to the U.S. money supply and therefore mimics the role of sterilized interventions. According to my identification strategy, a sterilized intervention shock in favor of the U.S. dollar would appreciate it against a trade-weighted currency index by roughly 1 percent. This appreciation is statistically significant, lasts for about 1 year, and is robust to alternative identification strategies. Then, I devote the second part of the paper to rationalize the results from the empirical section by studying sterilized interventions within a two-country general equilibrium model. I find that if trading bonds is costly worldwide and asset markets are incomplete, a domestic government purchase of domestic bonds accompanied by a sale of foreign bonds, a sterilized intervention, appreciates the domestic currency. Accordingly, a calibrated version of the model renders similar results to those from the VAR formulation.
    Keywords: Exchange Rate, Sterilized Intervention, VAR, Open Economy
    JEL: C32 F3 E58
    Date: 2006–01
  6. By: Liliana Rojas-Suarez
    Abstract: This paper identifies two alternative forms of prudential regulation. The first set is formed by regulations that directly control financial aggregates, such as liquidity expansion and credit growth. An example is capital requirements as currently incorporated in internationally accepted standards; namely capital requirements with risk categories used in industrial countries. The second set, which can be identified as the “pricing-risk-right” approach, works by providing incentives to financial institutions to avoid excessive risk-taking activities. A key feature of this set of regulations is that they encourage financial institutions to internalize the costs associated with the particular risks of the environment where they operate. Regulations in this category include ex-ante risk-based provisioning rules and capital requirements that take into account the risk features particular to developing countries. This category also includes incentives for enhancing market discipline as a way to differentiate risk-taking behavior between financial institutions. The main finding of the paper is that the first set of regulations—the most commonly used in developing economies-- have had very limited usefulness in helping countries to contain the risks involved with more liberalized financial systems. The main reason for this disappointing result is that, by not taking into account the particular characteristics of financial markets in developing countries, these regulations cannot effectively control excessive risk taking by financial institutions. Moreover, the paper shows that, contrary to policy intentions, this set of prudential regulations can exacerbate rather than decrease financial sector fragility, especially in episodes of sudden reversal of capital flows. In contrast, the paper claims, the second set of prudential regulation can go a long way in helping developing countries achieving their goals. The paper advances suggestions for the sequencing of implementation of these regulations for different groups of countries.
    Keywords: regulation, liquidity, credit growth, pricing-risk-right, financial institutions, capital flows, developing countries
    JEL: O16 F30 F32 F33 F36 F43 H3 D81
  7. By: Valadkhani, Abbas (University of Wollongong); Chancharat, Surachai (University of Wollongong); Harvie, Charles (University of Wollongong)
    Abstract: The paper analyses the effect of various international stock market price indices and some relevant macroeconomic variables on the Thai stock market price index, using a GARCH-M model and monthly data from January 1988 to December 2004. It is found, inter alia, that (a) changes in stock market returns in Singapore, Malaysia and Indonesia in the pre-1997 Asian crisis, and changes in Singapore, the Philippines and Korea in the post-1997 era instantaneously influenced returns in the Thai stock market; (b) changes in the price of crude oil negatively impacted on the Thai stock market only in the pre-Asian crisis period; (c) volatility clustering (i.e. ARCH and GARCH effects) as well as a GARCH-M model were statistically significant only in the pre-1997 era; and (d) stock markets outside the region had no significant immediate impact on monthly aggregate returns in the Thai stock market.
    Keywords: Stock market; conditional volatility; macroeconomic variables; GARCH; Thailand
    JEL: E44 G14 G15
    Date: 2006
  8. By: Takatoshi Ito; Yuko Hashimoto
    Abstract: This paper examines intra-day patterns of the exchange rate behavior, using the “firm” bid-ask quotes and transactions of USD-JPY and Euro-USD recorded in the electronic broking system of the spot foreign exchange markets. The U-shape of intra-day activities (deals and price changes) and return volatility is confirmed for Tokyo and London participants, but not for New York participants. Activities and volatility do not increase toward the end of business hours in the New York market, even on Fridays (ahead of weekend hours of non-trading). It is found that there exists a high positive correlation between volatility and activities and a negative correlation between volatility and the bid-ask spread. A negative correlation is observed between the number of deals and the width of bid-ask spread during business hours.
    JEL: F31 F33 G15
    Date: 2006–08
  9. By: Winston T. H. Koh (School of Economics and Social Sciences, Singapore Management University); Roberto S. Mariano (School of Economics and Social Sciences, Singapore Management University); Andrey Pavlov (Simon Fraser University); Sock Yong Phang (School of Economics and Social Sciences, Singapore Management University); Augustine H. H. Tan (School of Economics and Social Sciences, Singapore Management University); Susan M. Wachter (Department of Finance, The Wharton School, University of Pennsylvania)
    Abstract: In this paper, we develop a specific observable symptom of a banking system that underprices the default spread in non-recourse asset-backed lending. Using three different data sets for 18 countries and property types, we find that, following a negative demand shock, the “underpricing” economies experience far deeper asset market crashes than economies in which the put option is correctly priced. Furthermore, only one of the countries in our sample continues to exhibit the underpricing symptom following a market crash. This indicates that market crashes have a cleansing effect and eliminate underpricing at least for a period of time. This makes investing in such markets safer following a negative demand shock.
    Keywords: real estate bubble, lender optimism, disaster myopia, Asian financial crisis
    Date: 2006–03
  10. By: Ricardo Lagos; Guillaume Rocheteau
    Abstract: We investigate how trading frictions in asset markets affect portfolio choices, asset prices and efficiency. We generalize the search-theoretic model of financial intermediation of Duffie, Gârleanu and Pedersen (2005) to allow for more general preferences and idiosyncratic shock structure, unrestricted portfolio choices, aggregate uncertainty and entry of dealers. With a fixed measure of dealers, we show that a steady-state equilibrium exists and is unique, and provide a condition on preferences under which a reduction in trading frictions leads to an increase in the price of the asset. We also analyze the effects of trading frictions on bid-ask spreads, trade volume and the volatility of asset prices, and find that the asset allocation is constrained-inefficient unless investors have all the bargaining power in bilateral negotiations with dealers. We show that the dealers’ entry decision introduces a feedback that can give rise to multiple equilibria, and that free-entry equilibria are generically inefficient.
    Keywords: Assets (Accounting) - Prices ; Portfolio management
    Date: 2006
  11. By: Barry Eichengreen; Pipat Luengnaruemitchai
    Abstract: We use data on the extent to which residents of one country hold the bonds of issuers resident in another as a measure of financial integration or interrelatedness, asking how Asia compares with Europe and Latin America and with the base case in which the purchaser and issuer of the bonds reside in different regions. Not surprisingly, we find that Europe is head and shoulders above other regions in terms of financial integration. More interesting is that Asia already seems to have made some progress on this front compared to Latin America and other parts of the world. The contrast with Latin America is largely explained by stronger creditor and investor rights, more expeditious and less costly contract enforcement, and greater transparency that lead to larger and better developed financial systems in Asia, something that is conducive to foreign participation in local markets and to intra-regional cross holdings of Asian bonds generally. Further results based on a limited sample suggest that one factor holding back investment in foreign bonds in East Asia may be limited geographical diversification by mutual funds, in turn reflecting a dearth of appropriate assets. Asian Bond Fund 2, by creating a passively managed portfolio of local currency bonds potentially attractive to mutual fund managers and investors, may help to relax this constraint.
    JEL: F0 F3
    Date: 2006–08
  12. By: Hélène Hamisultane (EconomiX - [CNRS : UMR7166] - [Université de Paris X - Nanterre])
    Abstract: Weather derivatives are financial contracts for which the underlying is not a traded asset. Therefore, they cannot be priced by the traditional financial theory based on the hedging portfolio and on the arbitrage-free argument. Some authors suggest to use the actuarial pricing approach to value the weather derivatives. But this method suffers from the fact that it is only based on the modelling of the temperature. The market information is not necessary to value the weather derivatives by this approach. On the contrary, the financial method needs to infer the market price of weather risk since the market is incomplete for the weather derivatives. We suggest in this paper to compute and to compare the prices stemming from the both approaches by using the New York weather futures quotations. Prices are calculated on the basis that the daily average temperature has a long memory since tests reveal its presence in the serie.
    Keywords: weather derivatives; incomplete market; long memory; ARFIMA process; FIGARCH process; LMSV process; fractional Brownian motion; PDE; Monte-Carlo simulations
    Date: 2006–08–03
  13. By: Carlos Arteta; Galina Hale
    Abstract: We argue that, through its effect on aggregate demand and country risk premia, sovereign debt restructuring can adversely affect the private sector's access to foreign capital markets. Using fixed effect analysis, we estimate that sovereign debt rescheduling episodes are indeed systematically accompanied by a decline in foreign credit to emerging market private firms, both during debt renegotiations and for over two years after the agreements are reached. This decline is large (over 20%), statistically significant, and robust when we control for a host of fundamentals. We find that this effect is different for financial sector firms, for exporters, and for nonfinancial firms in the non-exporting sector. We also find that the effect depends on the type of debt rescheduling agreement.
    Keywords: Debts, External ; Financial crises
    Date: 2006
  14. By: Chris Becker (Reserve Bank of Australia); Daniel Fabbro (Reserve Bank of Australia)
    Abstract: The Australian economy has proven resilient to sizable exchange rate fluctuations over the post-float period. In part this can be attributed to financial institutions and non-financial firms learning to adapt to swings in the Australian dollar. This has included the increased use of financial derivative contracts to hedge their foreign exchange exposures. This paper examines the available evidence on the nature and extent of this hedging behaviour. Related to this, Australia’s net foreign liability position is often cited as a vulnerability of the Australian economy to exchange rate depreciation. We show this not to be the case because much of the liability position is denominated in local currency terms. In fact, the amount of liabilities denominated in foreign currency is less than the amount of foreign currency assets held by residents.
    Keywords: hedging; foreign currency exposure; derivatives
    JEL: F21 F31 F41
    Date: 2006–08
  15. By: Barry Eichengreen
    Abstract: The accumulation of international reserves by emerging markets raises the question of how to best utilize these funds. This paper explores two routes through which the pooling of reserves could enhance stability and welfare. First, the reserve pool could be used for emergency lending in response to sudden stops. Second, a portion of the reserve pool along with borrowed funds could be used to purchase contingent debt securities issued by governments and corporations, helping to solve the first-mover problem that limits the liquidity of markets in these instruments and hinders their acceptance by private investors. This paper argues that the second option is more likely to be feasible and productive.
    JEL: F0 F02 F39
    Date: 2006–08
  16. By: Jens Carsten Jackwerth (Department of Economics, University of Konstanz); George M. Constantinaides (University of Chicago and NBER); Stylianos Perrakis (Concordia University)
    Keywords: Derivative pricing, risk-neutral distribution, incomplete markets, stochastic dominance bounds, transaction costs, index options, volatility smile
    Date: 2005–09–16
  17. By: Stephany Griffith-Jones; Krishnan Sharma
    Abstract: There has been increasing interest in exploring financial instruments that could limit the cyclical vulnerabilities of developing countries and reduce the likelihood of defaults and debt crises. GDP-indexed bonds fall into this category and may also generate a wider range of benefits for issuer countries, investors and the global financial system. The authors also examine the concerns and obstacles relating to the introduction of this instrument, suggesting that some may be exaggerated while others could be overcome. The paper calls for international public action to help develop markets for GDP-linked bonds and proposes a number of actions, some of which would require collaboration between Governments, multilateral development banks and the private sector.
    Keywords: GDP-indexed bonds, cyclical vulnerabilities, issuers, investors, public good, international public action
    JEL: F21 F30 G15
    Date: 2006–04
  18. By: Marian Berneburg
    Abstract: Are financial markets efficient? One proposition that seems to contradict this is Shiller’s finding of excess volatility in asset prices and its resulting rejection of the discounted cash flow model. This paper replicates Shiller’s approach for a different data set and extends his analysis by testing for a long-run relationship by means of a cointegration analysis. Contrary to previous studies, monthly data for an integrated European stock market is being used, with special attention to equity style investment strategies. On the basis of this analysis’ results, Shiller’s findings seem questionable. While a long-run relationship between prices and dividends can be observed for all equity styles, a certain degree, but to a much smaller extent than in Shiller’s approach, of excess volatility cannot be rejected. But it seems that a further relaxation of Shiller’s assumptions would completely eliminate the finding of an overly strong reaction of prices to changes in dividends. Two interesting side results are, that all three investment styles seem to have equal performance when adjusting for risk, which by itself is an indication for efficiency and that market participants seem to use current dividend payments from one company as an indication for future dividend payments by other firms. Overall the results of this paper lead to the conclusion that efficiency cannot be rejected for an integrated European equity market.
    Date: 2006–08
  19. By: Orazio P. Attanasio; Monica Paiella
    Abstract: This paper builds a unifying framework that, within the theory of intertemporal consumption choices, brings together the limited participation -based explanation of the poor empirical performance of the C-CAPM and the transaction costs-based explanation of incomplete portfolios. Using the implications of the consumption model and observed household consumption and portfolio choices, we identify the preference parameters of interest and a lower bound for the costs rationalizing non-participation in financial markets, in the presence of unobserved heterogeneity in tastes for consumption and portfolio allocation. Using the US Consumer Expenditure Survey and assuming isoelastic preferences, we estimate the coefficient of relative risk aversion at 1.7 and a cost bound of 0.4 percent of non-durable consumption. Our estimate of the preference parameter is theoretically plausible and the bound sufficiently small to be likely to be exceeded by the actual total (observable and unobservable) costs of participating to financial markets.
    JEL: G11 G12
    Date: 2006–08
  20. By: John Idicula (Netz Informatics)
    Abstract: The stock market is a complex system that affects economic and financial activities around the world. Analysis of stock price data can improve our understanding of the past price movements of stocks. In this work, we develop a method to determine the highly interconnected subsystems of the stock market. Our method relies on a k-core decomposition scheme to analyze large networks. Our approach illustrates that the stock market is a nearly decomposable system which comprises hierarchic subsystems. This work also presents results from the analysis of a network derived from a large data set of stock prices. This network analysis technique is a new promising approach to analyze and classify stocks based on price interactions and to decompose the complex system embodied in the stock market.
    Date: 2004–12
  21. By: Hélène Hamisultane (EconomiX - [CNRS : UMR7166] - [Université de Paris X - Nanterre])
    Abstract: Since the underlying of the weather derivatives is not a traded asset, these contracts cannot be evaluated by the traditional financial theory. Cao and Wei (2004) price them by using the consumption-based asset pricing of Lucas (1978) and by assuming different values for the constant relative risk aversion coefficient. Instead of taking this coefficient as given, we suggest in this paper to estimate it by using the consumption data and the quotations of one of the most transacted weather contracts which is the New York weather futures on the Chicago Mercantile Exchange (CME). We will apply the well-known generalized method of moments (GMM) introduced by Hansen (1982) to estimate it as well as the simulated method of moments (SMM) attributed to Lee and Ingram (1991) and Duffie and Singleton (1993). This last method is studied since we think that it can give satisfactory results in the case of the weather derivatives for which the prices are simulated. We find that the estimated coefficient from the SMM approach must have improbably high values in order to have the calculated weather futures prices matching the observations. This finding is in accordance with the results of the prior works which have shown the empirical failures of the consumption-based asset pricing model.
    Keywords: weather derivatives; consumption-based asset pricing model; constant relative risk aversion utility function; generalized method of moments; simulated method of moments; HAC matrix; Monte-Carlo simulations; periodic variance; GARCH
    Date: 2006–08–03
  22. By: Simon Gilchrist; Masashi Saito
    Abstract: This paper studies the implications of financial market imperfections represented by a countercyclical external finance premium and the gradual recognition of changes in the drift of technology growth for the design of an interest rate rule. Asset price movements induced by changes in trend growth influence balance-sheet conditions that determine the external finance premium. Such movements are magnified when the private sector is imperfectly informed regarding the trend growth rate of technology. The presence of financial market imperfections provides a motivation for responding to the gap between the observed asset prices and the potential level of asset prices in addition to responding strongly to inflation. This is because the asset price gap represents distortions in the resource allocation induced by financial market imperfections more distinctly than inflation. The policymaker's imperfect information about the drift of technology growth renders imprecise the calculation of the potential and thus reduces the benefit of responding to the asset price gap. A policy that responds to the level of asset prices which does not take into account changes in potential tends to be welfare reducing.
    JEL: E44 E52 O41
    Date: 2006–08
  23. By: Stefania Albanesi
    Abstract: This paper studies optimal taxation of entrepreneurial capital and financial assets in economies with private information. Returns to entrepreneurial capital are risky and depend on entrepreneurs' hidden effort. It is shown that the idiosyncratic risk in capital returns implies that the intertemporal wedge on entrepreneurial capital that characterizes constrained-efficient allocations can be positive or negative. The properties of optimal marginal taxes on entrepreneurial capital depend on the sign of this wedge. If the wedge is positive, the optimal marginal capital tax is decreasing in capital returns, while the opposite is true when the wedge is negative. Optimal marginal taxes on other assets depend on their correlation with idiosyncratic capital returns. The optimal tax system equalizes after tax returns on all assets, thus reducing the variance of after tax returns on capital relative to other assets. If entrepreneurs are allowed to sell shares of their capital to outside investors, returns to externally owned capital are subject to double taxation- at the level of the entrepreneur and at the level of the outside investors. Even if entrepreneurs can purchase private insurance against their idiosyncratic risk, optimal asset taxes are essential to implement the constrained-efficient allocation if entrepreneurial portfolios are private information.
    JEL: D82 E22 E62 G18 H2 H21 H25 H3
    Date: 2006–08
  24. By: Stanley Fischer
    Abstract: In this paper I reflect on my first year as Governor of the Bank of Israel, which I joined in May 2005. I start by describing the current state of the Israeli economy and monetary policy and economic developments during the past year. I then review a series of issues that have arisen during the past year. Among them are: the monetary mechanism, which is unusual because exchange rate changes have a very rapid impact on prices; the role of inflation and interest rate expectations in policy decisions; the role of the interest rate gap with the US; the role of the Governor as chief economic adviser to the Government; banking supervision; and management and political issues.
    JEL: E50 E65
    Date: 2006–08
  25. By: M. Ayhan Kose (International Monetary Fund); Eswar S. Prasad (International Monetary Fund and IZA Bonn); Marco E. Terrones (International Monetary Fund)
    Abstract: The influential work of Ramey and Ramey (1995) highlighted an empirical relationship that has now come to be regarded as conventional wisdom – that output volatility and growth are negatively correlated. We reexamine this relationship in the context of globalization – a term typically used to describe the phenomenon of growing international trade and financial integration that has intensified since the mid-1980s. Using a comprehensive new dataset, we document that, while the basic negative association between growth and volatility has been preserved during the 1990s, both trade and financial integration significantly weaken this negative relationship. Specifically, we find that the estimated coefficient on the interaction between volatility and trade integration is significantly positive. We find a similar, although less significant, result for the interaction of financial integration with volatility.
    Keywords: globalization, international trade and financial linkages, macroeconomic volatility and growth
    JEL: F41 F36 F15
    Date: 2006–08
  26. By: Kenneth Kuttner
    Abstract: This paper addresses the possible role of bond prices as operating or intermediate targets for monetary policy. The paper begins with a brief review of the mechanisms through which a central bank could, in theory, influence long-term interest rates, and continues with a brief narrative overview of debt management policies in the U.S., tracing their effects on the maturity distribution of outstanding publicly-held Treasury debt and the composition of the assets held by the Federal Reserve System. The empirical section presents new econometric evidence on the effects of these policies on expected excess holding returns (“term premia”), demonstrating that changes in the Fed’s holdings of long-term securities have had statistically significant and economically meaningful effects on the term premia associated with Treasury securities with maturities in the two- to five-year range.
    JEL: E43 E58 E63
    Date: 2006–08
  27. By: Stephen Satchel (School of Finance and Economics, University of Technology, Sydney); Wei Xia (Birbeck College, University of London)
    Abstract: This paper constructs and compares various total return world stock indices based on daily data. Due to diversification these indices are noticeably similar. A diversification theorem identifies any diversified portfolio as a proxy for the growth optimal portfolio. The paper constructs a diversified world stock index that outperforms a number of other indices and argues that it is a good proxy for the growth optimal portfolio. This has applications to derivative pricing and investment management.
    Keywords: validation; credit analysis; rating model; ROC; Basel II
    Date: 2006–08–01
  28. By: Jayati Ghosh
    Abstract: This paper considers the main elements of the standard pattern of financial liberalization that has become widely prevalent in developing countries. The theoretical arguments in favour of such liberalization are considered and critiqued, and the political economy of such measures is discussed. The problems for developing countries, with respect to financial fragility and the greater propensity to crisis, as well as the negative deflationary and developmental effects, are discussed. It is concluded that there is a strong case for developing countries to ensure that their own financial systems are adequately regulated with respect to their own specific requirements.
    Keywords: financial liberalization, development banking, financial fragility, financial crisis, deflation.
    JEL: F41 F43 G15
    Date: 2005–10
  29. By: Yuanhua Feng (Department of Mathematics and Statistics, University of Konstanz)
    Abstract: This paper considers simultaneous modelling of seasonality, slowly changing un- conditional variance and conditional heteroskedasticity in high-frequency financial returns. A new approach, called a seasonal SEMIGARCH model, is proposed to perform this by introducing multiplicative seasonal and trend components into the GARCH model. A data-driven semiparametric algorithm is developed for estimating the model. Asymptotic properties of the proposed estimators are investigated brie y. An approximate significance test of seasonality and the use of Monte Carlo confidence bounds for the trend are proposed. Practical performance of the proposal is investigated in detail using some German stock price returns. The approach proposed here provides a useful semiparametric extension of the GARCH model.
    Keywords: High-frequency financial data, nonparametric regression, seasonality in volatility, semiparametric GARCH model, trend in volatility
  30. By: Wolfgang Eggert (University of Konstanz and CESifo); Martin Kolmar (University of G¨ottingen and CESifo)
    Abstract: This paper examines information sharing between governments in an optimaltaxation framework. We present a taxonomy of alternative systems of international capital-income taxation and characterize the choice of tax rates and information exchange. The model reproduces the conclusion of the previous literature that integration of international capital markets may lead to the under-provision of publicly provided goods. However, different to the existing literature under-provision occurs because of inefficiently coordinated expectations. We show that there exists a second equilibrium with an efficient level of public-good provision and complete and voluntary information exchange between national tax authorities.
    Keywords: tax competition, information exchange
    JEL: F42 F20 H21
  31. By: Thomas Philippon
    Abstract: I propose a new implementation of the q-theory of investment using corporate bond yields instead of equity prices. In q-theory, the optimal investment rate is a function of risk-adjusted discount rates and of future marginal profitability. Corporate bond prices also depend on these variables. I show that, when aggregate shocks are small, aggregate q is a linear combination of risk free rates and average yields on risky corporate debt. The yield-theory of investment, unlike its equity-based counter part, is empirically successful: it can account for more than half of the volatility of investment in post-war US data, it drives out cash flows from the investment equation, and it delivers sensible estimates for the parameters of the adjustment cost function.
    JEL: E0 E44 G31
    Date: 2006–08
  32. By: Olivia S. Mitchell; John Piggott; Michael Sherris; Shaun Yow
    Abstract: Over the last half-century, around the world, many nations have seen plummeting fertility rates and mounting life expectancies. These two factors are the engine behind unprecedented global aging. In this paper, we explore how the demographic transition may influence financial markets and, in turn, how financial market innovation might help resolve concerns flowing from global aging trends. We first provide context by reviewing the economics, finance, and insurance-related literature on how global aging patterns may influence capital markets. We then turn to insurance markets, and discuss a range of products and policies, including both retail and wholesale financial offerings for various forms of life annuities, long-term care benefits, reverse mortgages, securitization of longevity risk, inflation-protected assets, reinsurance, guarantees, derivative contracts on residential property price indices, mortality swaps and longevity derivative contracts. We also indicate how new public-private partnerships might be beneficial in enhancing the future environment for old-age risk management.
    JEL: G22 G23 J11 J14 J18 J21 J26 N2
    Date: 2006–08
  33. By: Günter Franke (Department of Economics, University of Konstanz); Erik Lüders (Pinehill Capital and Laval University)
    Abstract: This paper analyzes the e¤ect of non-constant elasticity of the pricing kernel on asset return characteristics in a rational expectations model. It is shown that declining elasticity of the pricing kernel can lead to predictability of asset returns and high and persistent volatility. Also, declining elasticity helps to motivate technical analysis and to explain stock market crashes. Moreover, based on a general characterization of the pricing kernel, we propose analytical asset price processes which can be tested empirically. The numerical analysis reveals strong deviations from the geometric Brownian motion which are caused by declining elasticity of the pricing kernel.
    Keywords: Pricing Kernel, Viable asset price processes, Serial correlation, Heteroskedasticity, Stock market crashes
    JEL: G12
    Date: 2005–08–18
  34. By: Jens Carsten Jackwerth (Department of Economics, University of Konstanz); George M. Constantinaides (University of Chicago and NBER); Stylianos Perrakis (Concordia University)
    Abstract: We document widespread violations of stochastic dominance in the one-month S&P 500 index options market over the period 1986-2002. These violations imply that a trader can improve her expected utility by engaging in a zero-net-cost trade. We allow the market to be incomplete and also imperfect by introducing transactions costs and bid-ask spreads. There is higher incidence of violations by OTM than by ITM calls, contradicting the common inference drawn from the observed implied volatility smile that the problem lies with the left-hand tail of the index return distribution. Even though pre-crash option prices conform to the BSM model reasonably well, they are incorrectly priced. Over 1997-2002, many options, particularly OTM calls, are overpriced irrespective of which time period is used to determine the index return distribution. These results do not support the hypothesis that the options market is becoming more rational over time. Finally, our results dispel another common misconception, that the observed smile is too steep after the crash: most of the violations by post-crash options are due to the options being either underpriced over 1988-1995, or overpriced over 1997-2002.
    Keywords: Derivative pricing; volatility smile, incomplete markets, transactions costs, index options, stochastic dominance bounds
    Date: 2005–10–10
  35. By: Klaus Abberger (IFO Munich)
    Abstract: The CAPM model assumes stock returns to be a linear function of the market return. However, there is considerable evidence that the beta stability assumption commonly used when estimating the model is invalid. Nonparametric regression methods are used to examine the stability of beta coefcients in German stock returns. Since local polynomial regression is used for estimation, known methods for testing the stability and for bandwidth choice can be used. For some returns the test indicates time-varying betas. For these returns conditionally parametric fits are calculated.
    Keywords: CAPM, time-varying betas, conditionally parametric fits, nonparametric regression
  36. By: Rajnish Mehra
    Abstract: In this article we examine the Equity Premium in the Indian context and review the related literature. The equity premium is the returned earned by a well-diversified stock portfolio in excess of that earned by a risk free security such as a Treasury Bill. Consistent with U.S. experience we find that the Indian equity premium has been quite high in the post 1991 period, averaging 9.7% above the corresponding risk free security. It is difficult to justify such a premium based on theoretical considerations. The article is an entry prepared for the Oxford Companion to Economics in India edited by Kaushik Basu
    JEL: E21 G1 G12
    Date: 2006–08
  37. By: Weibach, Rafael; Sibbertsen, Philipp
    Abstract: Lending is associated with credit risk. Modelling the loss stochastically, the cost of credit risk is the expected loss. In credit business the probability that the debtor will default in payments within one year, often is the only reliable quantitative parameter. Modelling the time to default as continuous variable corresponds to an exponential distribution. We calculate the expected loss of a trade with several cash flows, even if the distribution is not exponential. Continuous rating migration data show that the exponential distribution is not adequate in general. The distribution can be calibrated using rating migrations without a parametric model. A practitioner, however, will model time as a discrete variable. We show that the expected loss in the discrete model is a linear approximation of the expected loss in the continuous model and discuss the consequences. Finally, as costs for the expected loss cannot be charged up-front, the credit spread over risk-free interest is derived.
    Keywords: Point process, credit valuation, hazard rate, kernel smoothing test
    JEL: C19 C29
    Date: 2006–08
  38. By: Bong-Chan Kho; René M. Stulz; Francis E. Warnock
    Abstract: Despite the disappearance of formal barriers to international investment across countries, we find that the average home bias of U.S. investors towards the 46 countries with the largest equity markets did not fall from 1994 to 2004 when countries are equally weighted but fell when countries are weighted by market capitalization. This evidence is inconsistent with portfolio theory explanations of the home bias, but is consistent with what we call the optimal insider ownership theory of the home bias. Since foreign investors can only own shares not held by insiders, there will be a large home bias towards countries in which insiders own large stakes in corporations. Consequently, for the home bias to fall substantially, insider ownership has to fall in countries where it is high. Poor governance leads to concentrated insider ownership, so that governance improvements make it possible for corporate ownership to become more dispersed and for the home bias to fall. We find that the home bias of U.S. investors decreased the most towards countries in which the ownership by corporate insiders is low and countries in which ownership by corporate insiders fell. Using firm-level data for Korea, we find that portfolio equity investment by foreign investors in Korean firms is inversely related to insider ownership and that the firms that attract the most foreign portfolio equity investment are large firms with dispersed ownership.
    JEL: F36 F30 G32 G30 G11 G15
    Date: 2006–07
  39. By: Roberto Chang
    Abstract: I study a small open economy in which elections affect and are affected by capital inflows. Two candidates, one favoring workers and another favoring entrepreneurs, run for office; the winner chooses taxes, which affect investment returns. A pro labor victory results in a "sudden stop" in investment and capital flows, reflecting a time inconsistency problem. The pro business candidate is free from time inconsistency but becomes less attractive to voters if the foreign debt is larger. Hence electoral outcomes depends on the size of the debt, which itself depends on expectations about the election. The model's politico economic equilibria has several implications. Politico economic links exacerbate the responses of financial variables to exogenous shocks. Self fulfilling equilibria may exist. Policies that alleviate the pro labor candidate's commitment problem contribute to financial stability but also, and perhaps more surprisingly, to the chances of a pro labor victory in the elections. A redistribution of wealth has ambiguous although predictable effects on politico economic outcomes.
    JEL: F34 F41
    Date: 2006–08
  40. By: Wolfgang Eggert (Department of Economics, University of Konstanz)
    Abstract: This paper analyzes the choice of taxes and international information exchange by governments in a capital tax competition model. We explain situations where countries can choose tax rates on tax savings income and exchange information about the domestic savings of foreigners, implying that the decentralized equilibrium is efficient. However, we also identify situations with adverse welfare properties in which information exchange is compatible with zero taxes on capital income. The model helps to identify the linkage between voluntary information exchange and the choice of tax rates. It is shown that the recent development in information exchange treaties may not be useful to overcome the inefficiencies caused by decentralized tax setting.
    Keywords: withholding tax, tax credit, international tax competition, information exchange
    JEL: H77 H87 F42
    Date: 2005–06
  41. By: Josef Lakonishok; Louis Chan; Stephen G. Dimmock
    Abstract: Academic and practitioner research yields a proliferation of methods using size and value/growth attributes or factors to evaluate portfolio performance. We assess the relative merits of several of the most widely-used procedures, including variants of matched-characteristic benchmark portfolios and time-series return regressions, by applying them to a sample of active money managers and passive indexes. Estimated abnormal returns display large variation across approaches. The benchmarks most widely used in academic research --- attribute-matched portfolios from independent sorts, the conventional three-factor time series model, and cross-sectional regressions of returns on stock characteristics --- have poor ability to track returns. Simple alterations are provided that improve the performance of the methods.
    JEL: G11 G12 G14 G23
    Date: 2006–08
  42. By: Jinhui H. Bai; Ingolf Schwarz (Department of Economics, Georgetown University)
    Abstract: The general equilibrium model with incomplete financial markets (GEI) is extended by adding fiat money, fiscal and monetary policy and a cash-in-advance constraint. The central bank either pegs the interest rate or money supply while the fiscal authority sets a Ricardian or a non-Ricardian fiscal plan. We prove the existence of equilibria in all four scenarios. In Ricardian economies, the conditions required for existence are not more restrictive than in standard GEI. In non-Ricardian economies, the sufficient conditions for existence are more demanding. In the Ricardian economy, neither the price level nor the equivalent martingale measure is determinate. Classification-JEL Codes: D52; E40; E50
    Keywords: Money; Incomplete Markets; Fiscal Policy; Indeterminacy
  43. By: James L. Smith; Rex Thompson
    Abstract: Conventional wisdom holds that dependence among geological prospects increases exploration risk. However, dependence also creates the option to truncate exploration if early results are discouraging. We show that the value of this option creates incentives for explorationists to plunge into dependence; i.e., to assemble portfolios of highly correlated exploration prospects. Risk-neutral and risk-averse investors are distinguished not by the plunging phenomenon, but by the threshold level of dependence that triggers such behavior. Aversion to risk does not imply aversion to dependence. Indeed the potential to plunge may be larger for risk-averse investors than for risk-neutral investors.
    Date: 2005–04
  44. By: Gábor Orbán (Magyar Nemzeti Bank); Zoltán Szalai (Magyar Nemzeti Bank)
    Abstract: The most important mechanism through which monetary policy affects the real economy in Hungary is the exchange rate channel. With euro adoption, this mechanism will largely disappear and the impact of monetary policy will be transmitted via the interest rate channel, presently seen as rather weak. This has raised concerns that the influence of monetary policy on the real economy in Hungary could be very limited after euro adoption. On top of this, other concerns have been voiced as regards potential asymmetries in the wage-setting behaviour, the exchange rate and credit channels. Based on the experience of today’s euro area participating countries and the structural characteristics of the Hungarian economy, this paper argues that after euro adoption 1) we may expect a broadening of the scope of the interest rate channel of monetary policy after euro adoption, 2) there are no institutional obstacles in the way of the effective functioning of the expectations channel in Hungary 3) substantially different monetary conditions from that in the euro area as a result of a different trade orientation are unlikely, and, finally 4) some asymmetries in the balance sheet channel may continue to exist for some time between Hungary and the core euro area countries but its effect will be significantly smaller after euro zone entry.
    Keywords: monetary transmission mechanism, transmission channels, EMU participation.
    JEL: E52 E58
    Date: 2005
  45. By: Richard Deaves (McMaster University); Erik Lüders (Pinehill Capital and Laval University); Michael Schröder (Center for European Economic Research (ZEW))
    Abstract: As a group, market forecasters are egregiously overconfident. In conformity to the dynamic model of overconfidence of Gervais and Odean (2001), successful forecasters become more overconfident. What’s more, more experienced forecasters have “learned to be overconfident,” and hence are more susceptible to this behavioral flaw than their less experienced peers. It is not just individuals who are affected. Markets also become more overconfident when market returns have been high.
    Date: 2005–10–07
  46. By: Gergely Kiss (Magyar Nemzeti Bank); Gábor Vadas (Magyar Nemzeti Bank)
    Abstract: As part of the monetary transmission studies of the Magyar Nemzeti Bank, this paper attempts to analyse the role of the housing market in the monetary transmission mechanism of Hungary. The housing market can influence monetary transmission through three channels, namely, the nature of the interest burden of mortgage loans, asset (house) prices, and the credit channel. The study first summarises the experiences of developed countries, paying special attention to issues arising from the monetary union. It then examines the developments in the Hungarian housing and mortgage markets in the last 15 years, as well as the expected developments and changes attendant to the adoption of the euro. Using panel econometric techniques, the study investigates the link between macroeconomic variables and house prices in Hungary, and the effect of monetary policy on housing investment and consumption through the wealth effect and house equity withdrawal.
    Keywords: Housing, Monetary transmission, Mortgage market, Panel econometrics.
    JEL: E52
    Date: 2005
  47. By: Roberto S. Mariano (School of Economics and Social Sciences, Singapore Management University); Delano Villanueva (School of Economics and Social Sciences, Singapore Management University)
    Abstract: High ratios of external debt to GDP in selected Asian countries have contributed to the initiation, propagation, and severity of the financial and economic crises in recent years, reflecting runaway fiscal deficits and excessive foreign borrowing by the private sector. More importantly, the servicing of large debt stocks has diverted scarce resources from investment and long-term growth. Applying and calibrating the formal framework proposed by Villanueva (2003) to Philippine data, we explore the joint dynamics of external debt, capital accumulation, and growth. The relative simplicity of the model makes it convenient to analyze the links between domestic adjustment policies, foreign borrowing, and growth. We estimate the optimal domestic saving rate that is consistent with maximum real consumption per unit of effective labor in the long run. As a by-product, we estimate the steady-state ratio of net external debt to GDP that is associated with this optimal outcome. The framework is an extension of the standard neoclassical growth model that incorporates endogenous technical change and global capital markets. The major policy implications are that in the long run, fiscal adjustment and the promotion of private saving are critical; reliance on foreign saving in a globalized financial world has limits; and when risk spreads are highly and positively correlated with rising external debt levels, unabated foreign borrowing depresses long run welfare.
    JEL: F34 F43 O41
    Date: 2005–03
  48. By: Shin-ichi Fukuda; Masanori Ono
    Abstract: The purpose of this paper is to investigate why the choice of invoice currency under exchange rate uncertainty depends not only on expectations but also on history. The analysis is motivated by the fact that the U.S. dollar has historically been the dominant vehicle currency in developing countries. The theoretical analysis is based on an open economy model of monopolistic competition. When the market is competitive enough, the exporting firms tend to set their prices not to deviate from those of the competitors. As a result, a coordination failure can lead the third currency to be a less efficient equilibrium invoice currency. The role of expectations is important in selecting the equilibrium in the static framework. However, in the dynamic model with staggered price-setting, the role of history becomes another key determinant of the equilibrium currency pricing. The role of history may dominate the role of expectations when the firms are myopic, particularly in the competitive local market. It also becomes dominant in the staggered price setting when a small fraction of the new price setters are backward-looking. The result suggests the importance of history in explaining why the firm tends to choose the US dollar as vehicle currency.
    JEL: F12 F31 F33
    Date: 2006–08
  49. By: Elsas, Ralf; Hackethal, Andreas; Holzhaeuser, Markus
    Abstract: We use panel data from nine countries over the period 1996 to 2003 to test how revenue diversi-fication in conjunction with increasing bank size affects bank value. Using a comprehensive framework for bank performance measurement, we find no evidence for a conglomerate discount, unlike studies concerned with industrial firms. Rather, revenue diversification increases bank profitability and is associated with higher market valuation. This performance effect does not depend on whether diversification was achieved through organic growth or through M&A activity.
    Keywords: Bank diversification; organic growth; M&A
    JEL: G21
    Date: 2006–06
  50. By: Joshua Aizenman; Jorge Fernández-Ruiz
    Abstract: This paper evaluates the challenges facing developing countries when there is uncertainty about the policy maker type. We consider a country characterized by volatile output, inelastic demand for fiscal outlays, high tax collection costs, and sovereign risk, where future output depends on the type of policymaker in place today. There are two policymakers -- type T chooses debt and international reserves to smooth tax collection costs; type S has higher discount factor, aiming at obtaining current resources for narrow interest groups, and preferring not to undertake costly reforms that may enhance future output. Financial markets do not know the type of policymaker in place and try to infer its type by looking at its financial choices. We show that various adverse shocks (lower output, higher real interest rate, etc.) can induce a switch from an equilibrium where each policy maker chooses its preferred policy to another where T distorts its policies in order to separate itself from S in the least costly way. This is accomplished by type T reducing both international reserves and external debt. Further decline in output would induce type T to lower debt, and reserves would fall at a higher rate than otherwise expected.
    JEL: F31 F34 F36
    Date: 2006–08
  51. By: Nicolas Magud (University of Oregon Economics Department); Carmen Reinhart (University of Maryland and NBER); Kenneth Rogoff (Harvard University and NBER)
    Abstract: The literature on capital controls has (at least) four very serious apples-to-oranges problems: (i) There is no unified theoretical framework to analyze the macroeconomic consequences of controls; (ii) there is significant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple definitions of what constitutes a “success” and (iv) the empirical studies lack a common methodology-furthermore these are significantly “overweighted” by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by: being very explicit about what measures are construed as capital controls. Also, given that success is measured so differently across studies, we sought to “standardize” the results of over 30 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Effectiveness Index (CCE Index), and Weighted Capital Control Effectiveness Index (WCCE Index). The difference between them lies only in that the WCCE controls for the differentiated degree of methodological rigor applied to draw conclusions in each of the considered papers. Inasmuch as possible, we bring to bear the experiences of less well known episodes than those of Chile and Malaysia. Then, using a portfolio balance approach we model the effects of imposing short-term capital controls. We find that there should exist country-specific characteristics for capital controls to be effective. From these simple perspective, this rationalizes why some capital controls were effective and some were not. We also show that the equivalence in effects of price- vs. quantity-capital control are conditional on the level of short–term capital flows.
    Keywords: Capital controls
    JEL: F30
    Date: 2005–01–11
  52. By: Roberto Rigobon; Brian Sack
    Abstract: The current literature has provided a number of important insights about the effects of macroeconomic data releases on monetary policy expectations and asset prices. However, one puzzling aspect of that literature is that the estimated responses are quite small. Indeed, these studies typically find that the major economic releases, taken together, account for only a small amount of the variation in asset prices—even those closely tied to near-term policy expectations. In this paper we argue that this apparent detachment arises in part from the difficulties associated with measuring macroeconomic news. We propose two new econometric approaches that allow us to account for the noise in measured data surprises. Using these estimators, we find that asset prices and monetary policy expectations are much more responsive to incoming news than previously believed. Our results also clarify the set of facts that should be captured by any model attempting to understand the interactions between economic data, monetary policy, and asset prices.
    JEL: E44 E47 E52
    Date: 2006–08
  53. By: Carl Schwartz (Reserve Bank of Australia); Tim Hampton (Reserve Bank of Australia); Christine Lewis (Reserve Bank of Australia); David Norman (Reserve Bank of Australia)
    Abstract: Over the past decade or so, aggregate data suggest a trend increase in housing equity withdrawal in Australia, potentially stimulating household spending. However, there has been little disaggregated information on how equity is being withdrawn and injected, the characteristics of households altering housing equity, and how funds from withdrawn equity are being used. This paper uses a survey of 4 500 households commissioned by the Reserve Bank of Australia (RBA) to address these questions. The results suggest that, during 2004, the most common method of withdrawing equity was for a household to increase the level of debt secured against a property they already owned. In contrast, most of the value of equity withdrawn was associated with property transactions, with the typical property transaction resulting in a net equity withdrawal. Turnover in the property market is therefore likely to be an important driver of cycles in aggregate housing equity withdrawal. Bivariate and logit analysis suggests a significant life-cycle influence, with the bulk of equity withdrawal being undertaken by older households, while younger households typically inject, primarily through mortgage repayments or deposits for property purchase. Finally, the results suggest that the bulk of the value of withdrawn equity was used to increase non-housing assets, although a significant proportion of households used the funds for consumption expenditure.
    Keywords: housing equity withdrawal; housing turnover; household debt
    JEL: E21 E51
    Date: 2006–08
  54. By: Bertram Düring (Department of Mathematics and Informatics, University of Mainz); Ansgar Jüngel (Department of Mathematics and Informatics, University of Mainz)
    Abstract: We consider a quasilinear parabolic equation with quadratic gradient terms. It arises in the modelling of an optimal portfolio which maximizes the expected utility from terminal wealth in incomplete markets consisting of risky assets and non-tradable state variables. The existence of solutions is shown by extending the monotonicity method of Frehse. Furthermore, we prove the uniqueness of weak solutions under a smallness condition on the derivatives of the covariance matrices with respect to the solution. The influence of the non-tradable state variables on the optimal value function is illustrated by a numerical example.
    Keywords: Quasilinear PDE, quadratic gradient, existence and uniqueness of solutions, optimal portfolio, incomplete market
  55. By: Truc Le (School of Finance and Economics, University of Technology, Sydney); Eckhard Platen (School of Finance and Economics, University of Technology, Sydney)
    Abstract: In this paper, the authors use the concept of the population ROC curve to build analytic models of ROC curves. Information about the population properties can be used to gain greater accuracy of estimation relative to the non-parametric methods currently in vogue. If used properly this is particularly helpful in some situations where the number of sick loans is rather small; a situation frequently met in periods of benign macro-economic background.
    Keywords: world stock index; growth optimal portfolio; diversification; mean-variance portfolio selection; enhanced index fund
    JEL: G10 G13
    Date: 2006–08–01
  56. By: Iris Claus
    Abstract: This paper develops an open economy model to assess the long-run effects of taxation where firms are finance constrained. Finance constraints arise because of imperfect information between borrowers and lenders. Only borowers (firms) can costlessly observe actual returns from production. Imperfect information and finance constraints magnify the effects of taxation. A reduction (rise) in income taxation increases (lowers) firms' internal funds and their ability to assess external finance to expand production. The findings thus underline the importance of incorporating access to finance into models that assess the impact of taxation.
    JEL: H2 E44 F41
    Date: 2006–08
  57. By: Roberto Frenkel; Lance Taylor
    Abstract: The exchange rate affects the economy through many channels and, consequently, has diverse macroeconomic and development impacts. Five are analysed in this paper: resource allocation, economic development, finance, external balance and inflation. The use of the exchange rate as a developmental tool in conjunction with its other uses (often in coordination with monetary policy) is at the focus of the discussion.
    Keywords: exchange rate, development policy
    JEL: F3 F4 O2
    Date: 2006–02
  58. By: Günter Franke (Department of Economics, University of Konstanz); Harris Schlesinger (University of Alabama); Richard C. Stapleton (University of Manchester and University of Melbourne)
    Abstract: Although there has been much attention in recent years on the effects of additive background risks, the same is not true for its multiplicative counterpart. We consider random wealth of the multiplicative form xy, where x and y are statistically independent random variables. We assume that x is endogenous to the economic agent, but that y is an exogenous and nontradable background risk, which represents a type of market incompleteness. Our main focus is on how the presence of the multiplicative background risk y affects risk-taking behavior for decisions on the choice of x. We characterize conditions on preferences that lead to more cautious behavior.
    Keywords: multiplicative risks, background risk, incomplete markets, standard risk aversion, affiliated utility function, multiplicative risk vulnerability
    JEL: D81
    Date: 2005–05
  59. By: Chen, Jie (The Institute for Housing and Urban Research, Uppsala University)
    Abstract: This paper extends the VECM cointegration model and PT (permanent-transitory) variance decomposition framework proposed by Lettau & Ludvigson (2004) and applies them on the Swedish data spanning from 1980q1 to 2004q4. There are strong statistical evidences that the movements of aggregate consumption, disposable income, housing wealth and financial wealth are tied together. However, it also suggests that the short run variations in the Swedish housing market are largely dissociated with consumer spending. Meanwhile, it is shown that the strength of the linkage between consumption and housing wealth is not sensitive to different model specifications and various measures of key variables.
    Keywords: housing wealth; consumption; wealth effect; VECM; PT decomposition
    JEL: E21 E32 E44 R31
    Date: 2006–06–10
  60. By: Ole E Barndorff-Nielsen; Peter Hansen; Asger Lunde; Neil Shephard
    Abstract: This paper shows how to use realised kernels to carry out efficient feasible inference on the ex-post variation of underlying equity prices in the presence of simple models of market frictions. The issue is subtle with only estimators which have symmetric weights delivering consistent estimators with mixed Gaussian limit theorems. The weights can be chosen to achieve the best possible rate of convergence and to have an asymptotic variance which is close to that of the maximum likelihood estimator in the parametric version of this problem. Realised kernels can also be selected to (i) be analysed using endogenously spaced data such as that in databases on transactions, (ii) allow for market frictions which are endogenous, (iii) allow for temporally dependent noise. The finite sample performance of our estimators is studied using simulation, while empirical work illustrates their use in practice.
    JEL: C13 C22
    Date: 2006
  61. By: Jens Carsten Jackwerth (Department of Economics, University of Konstanz); James E. Hodder (Finance Department, University of Wisconsin-Madison)
    Abstract: Previous papers have argued that trading restrictions can result in a typical employee stock option having a subjective value (certainty equivalent value) that is substantially less than its Black-Scholes value. However, these analyses ignore the manager’s ability to (at least partially) control the risk level within the firm. In this paper, we show how managerial control can lead to such options having much larger certainty equivalent values for employees who can exercise control. We also show that the potential for early exercise is substantially less valuable with managerial control. The certainty equivalent value for a European option with managerial control can easily exceed the Black-Scholes value for a comparable option without control. However, it is questionable whether Black-Scholes is an appropriate benchmark for an option where the underlying process exhibits controlled volatility. We show how to obtain a risk-neutral valuation for such an option. That risk-neutral value can be substantially greater or less than the Black- Scholes value. Furthermore, the option’s certainty equivalent value can also be greater or less than its risk-neutral value.
    Date: 2005–02–28
  62. By: Jens Carsten Jackwerth (Department of Economics, University of Konstanz); James E. Hodder (Finance Department, University of Wisconsin-Madison)
    Abstract: This paper investigates dynamically optimal risk-taking by an expected-utility maximizing manager of a hedge fund. We examine the effects of variations on a compensation structure that includes a percentage management fee, a performance incentive for exceeding a specified highwater mark, and managerial ownership of fund shares. In our basic model, there is an exogenous liquidation barrier where the fund is shut down due to poor performance. We also consider extensions where the manager can voluntarily choose to shut down the fund as well as to enhance the fund’s Sharpe Ratio through additional effort. We find managerial risk-taking which differs considerably from the optimal risk-taking for a fund investor with the same utility function. In some portions of the state space, the manager takes extreme risks. In another area, she pursues a lock-in style strategy. Indeed, the manager’s optimal behavior even results in a trimodal return distribution. We find that seemingly minor changes in the compensation structure can have major implications for risk-taking. Additionally, we are able to compare results from our more general model with those from several recent papers that turn out to be focused on differing parts of the larger picture.
    Date: 2005–05–23
  63. By: Anindya Ghose (NYU, Leonard Stern School of Business)
    Abstract: A series of recent papers have investigated the nature of trading and sorting induced by the dynamic price mechanism in a competitive durable good market with adverse selection and exogenous entry of traders over time. These models are dynamic versions of Akerlof’s (1970) seminal work. The general set up consist of identical cohorts of durable goods, whose quality is known only to potential sellers, enter the market over time and a common result is that there exists a cyclical equilibrium where all goods are traded within a finite number of periods after entry. Market failure is reflected in the relationship between product quality (and product reliability) and the length of waiting time before trade as well as on the relationship between average price decline and extent of trade of used goods. Based on a unique 9-month dataset collected from Amazon’ secondary market across multiple countries, and multiple product categories we provide empirical evidence of trade patterns and the presence of adverse selection. We show how used good quality and product reliability aect resale turnaround times in an electronic secondary market. We find some empirical evidence that is consistent with theoretical predictions existing in the literature.
    Date: 2005–10
  64. By: Peter Bofinger (University of Wuerzburg)
    Abstract: The paper provides an analysis of the first three years of the European Monetary Union. It discusses the changeover to Euro notes, the performance of monetary policy in terms of price stability and real growth, the establishment of credibility for the ECB, and the two pillar strategy. The weakness of the euro's exchange value during the first three years is explained. Some aspects of the eastern enlargement of the eurozone are examined especially the problems that may be associated with the lack of real convergence. Other issues such as the importance of a Balassa-Samuelson effect and the need for appropriate fiscal policies are discussed.
    Keywords: European Monetary Union, European Central Bank, Euro, monetary policy
    JEL: E42 E58 E60
  65. By: Günter Franke (Department of Economics, University of Konstanz); Richard C. Stapleton (University of Manchester and University of Melbourne); Marti G. Subrahmanyam (Stern School of Business, New York University)
    Abstract: We present a necessary and sufficient condition on an agent’s utility function for a simple mean preserving spread in an independent background risk to increase the agent’s risk aversion (incremental risk vulnerability). Gollier and Pratt (1996) have shown that declining and convex risk aversion as well as standard risk aversion are sufficient for risk vulnerability. We show that these conditions are also sufficient for incremental risk vulnerability. In addition, we present sufficient conditions for a restricted set of stochastic increases in an independent background risk to increase risk aversion.
    Date: 2005–09–23
  66. By: Carl Bonham (Department of Economics, University of Hawaii at Manoa); Richard Cohen (College of Business and Public Policy, University of Alaska Anchorage); Shigeyuki Abe (Center for Contemporary Asian Studies, Doshisha University)
    Abstract: This paper examines the rationality and diversity of industry-level forecasts of the yen-dollar exchange rate collected by the Japan Center for International Finance. In several ways we update and extend the seminal work by Ito (1990). We compare three specifications for testing rationality: the ”conventional” bivariate regression, the univariate regression of a forecast error on a constant and other information set variables, and an error correction model (ECM). We find that the bivariate specification, while producing consistent estimates, suers from two defects: first, the conventional restrictions are sucient but not necessary for unbiasedness; second, the test has low power. However, before we can apply the univariate specification, we must conduct pretests for the stationarity of the forecast error. We find a unit root in the six-month horizon forecast error for all groups, thereby rejecting unbiasedness and weak eciency at the pretest stage. For the other two horizons, we find much evidence in favor of unbiasedness but not weak eciency. Our ECM rejects unbiasedness for all forecasters at all horizons. We conjecture that these results, too, occur because the restrictions test suciency, not necessity. In our systems estimation and micro- homogeneity testing, we use an innovative GMM technique (Bonham and Cohen (2001)) that allows for forecaster cross-correlation due to the existence of common shocks and/or herd eects. Tests of micro-homogeneity uniformly reject the hypothesis that forecasters across the four industries exhibit similar rationality characteristics.
    Keywords: Rational Expectations, Heterogeneity, Exchange Rate, Survey Forecast
    Date: 2006
  67. By: Klaus Abberger (IFO Munich)
    Abstract: For a bivariate data set the dependence structure can not only be measured globally, for example with the Bravais-Pearson correlation coefficient, but the dependence structure can also be analyzed locally. In this article the exploration of dependencies in the tails of the bivariate distribution is discussed. For this a graphical method which is called chi-plot and which was introduced by Fisher and Switzer (1985, 2001) is used. Examples with simulated data sets illustrate that the chi-plot is suitable for the exploration of dependencies. This graphical method is then used to examine stock-return pairs. The kind of tail-dependence between returns has consequences, for example, for the calculation of the Value at Risk and should be modelled carefully. The application of the chi-plot to various daily stock-return pairs shows that different dependence structures can be found. This graph can therefore be an interesting aid for the modelling of returns.
    Keywords: Association, bivariate distribution, chi-plot, copula, correlation, local dependence, tail-dependence
  68. By: Bertram Düring (Department of Mathematics and Informatics, University of Mainz); Michel Fournié (Laboratoire MIP, Université Paul Sabatier, Toulouse); Ansgar Jüngel (Department of Mathematics and Informatics, University of Mainz)
    Abstract: A high-order compact finite difference scheme for a fully nonlinear parabolic differential equation is analyzed. The equation arises in the modeling of option prices in financial markets with transaction costs. It is shown that the finite difference solution converges locally uniformly to the unique viscosity solution of the continuous equation. The proof is based on a careful study of the discretization matrices and on an abstract convergence result due to Barles and Souganides.
    Keywords: High-order compact finite differences, numerical convergence, viscosity solution, financial derivatives
  69. By: Steven N. Kaplan; Bernadette Minton
    Abstract: We study CEO turnover – both internal (board driven) and external (through takeover and bankruptcy) – from 1992 to 2005 for a sample of large U.S. companies. Annual CEO turnover is higher than that estimated in previous studies over earlier periods. Turnover is 14.9% from 1992 to 2005, implying an average tenure as CEO of less than seven years. In the more recent period since 1998, total CEO turnover increases to 16.5%, implying an average tenure of just over six years. Internal turnover is significantly related to three components of firm performance – performance relative to industry, industry performance relative to the overall market, and the performance of the overall stock market. Also in the more recent period since 1998, the relation of internal turnover to performance is more strongly related to all three measures of performance in the contemporaneous year. External turnover is not significantly related to any of the measures of stock performance over the entire sample period, nor over the two sub-periods. We discuss the implications of these findings for various issues in corporate governance.
    JEL: G3 L2
    Date: 2006–08
  70. By: Rhys T. Dale; Wallce E. Tyner (Department of Agricultural Economics, College of Agriculture, Purdue University)
    Abstract: Using the DM model is not complex: the user changes input values of interest (plant size, conversion rates, etc.) and examines the effect of these changes on output values (annual profits, feed stock requirements, etc.). There are nine worksheets in four modules in the excel workbook- assumptions, process, economics, and technology assessment. All user inputs are entered in the assumptions module of the model, which consists of three worksheets denoted with bright yellow tabs: process assumptions, economic assumptions and physical assumptions. The values that are entered on this page are then used in each of the subsequent modules to calculate hourly flow rates, equipment size and cost, total costs, loan terms, and annual profits. At the top of each page is a title bar which describes the page, the color coding of the cells, and pertinent information from the other pages. Before each of the pages is discussed, an explanation of the different types of cells in the model is in order.
    Keywords: model user's manual
    Date: 2006–04
  71. By: Todd Moss
    Abstract: The British proposal to create an International Finance Facility in order to ‘frontload’ $50 billion in aid per year until 2015 has generated a lot of attention and will likely be a major topic at the G8 meeting this July. But the IFF has also been shrouded in confusion and misconceptions. This paper explains the IFF proposal and highlights some of the common misunderstandings surrounding it, including the mechanics of the scheme itself, the potential for a U.S. role, and the expectations of aid which underlie the IFF’s premise. The UK deserves plaudits for elevating global poverty on the international agenda and for seeking ways to better harness the power of private capital markets for development. But the IFF, as currently conceived, is an idea that merits more scrutiny and a healthy dose of skepticism.
    Keywords: development aid, International Finance Facility (IFF), poverty, private capital market
    JEL: F33 F35 F4 O12
  72. By: Patrick Bajari; Han Hong; Ahmed Khwaja
    Abstract: Theoretical models predict asymmetric information in health insurance markets may generate inefficient outcomes due to adverse selection and moral hazard. However, previous empirical research has found it difficult to disentangle adverse selection from moral hazard in health care. We empirically study this question by using data from the Health and Retirement Study to estimate a structural model of the demand for health insurance and medical care. Using a two-step semi-parametric estimation strategy we find significant evidence of moral hazard, but not of adverse selection.
    JEL: C14 D82 I11
    Date: 2006–08
  73. By: Günter Franke (Department of Economics, University of Konstanz); Christian Hopp (Department of Economics, University of Konstanz)
    Date: 2005–07–18
  74. By: Pablo A. Guerron (Department of Economics, North Carolina State University)
    Abstract: The interest semi-elasticity of money demand has been a long standing puzzle in the monetary economics literature. Researchers consistently have estimated low short-run semi-elasticities, usually around 1, and high long-run semi-elasticities of 10. Given the crucial role of interest semi-elasticity in determining the welfare costs of inflation and the effectiviness of tax cuts, we must understand why these short- and long-run estimates are so different. To explore this issue, I formulate and estimate a model of the demand for money that simultaneously accounts for low short- and high long-run semi-elasticities. In my formulation, re-balancing money holdings between money for purchases and money for financial investment is costly. I model this re-balancing cost by assuming that households re-optimize their money holdings subject to an exogenous probability. In the log-linearized version of my model, velocity depends on both its own past value and households' present and future expectations of the interest rate. I use this equilibrium condition to estimate my model's parameters by employing generalized method of moments. My estimates for the short-run and long-run interest semi-elasticities are 0.96 and 12.62, respectively. When I apply my model of money demand to explain the increase in the volatility of real balances after 1980, my model indicates that the late-1970s financial innovations, which facilitated portfolio re-balancing, lie behind this rise.
    Keywords: Interest Semi-Elasticity of Money Demand, Time-Dependent Portfolio Adjustment, Volatility, GMM.
    JEL: C32 E41 E47
    Date: 2006–01
  75. By: Alexander Harin (MODERN UNIVERSITY FOR THE HUMANITIES - Modern University for the Humanities - [Modern University for the Humanities])
    Abstract: A man is a key subject of economics. “A man is irrational” - this opinion can be made from Allais paradox, risk aversion and other well-known fundamental problems. For a long time, this opinion was a barrier to proper solution of these problems and the development of the economics. A radically new way is proposed to solve them and remove this barrier. The way is the generalization of a breach of a term of contract.
    Keywords: contract; business; bank; trade; industry; development; risk; “ideal” economics; investment; choice
    Date: 2006–08–10
  76. By: OCDE
    Abstract: Le système de financement particulier adopté par la Nouvelle-Zélande accorde une grande autonomie aux établissements d’enseignement publics en matière de gestion de leurs actifs par rapport à ce qui se passe dans la plupart des autres pays. Les écoles peuvent prétendre à un budget prédéterminé qui leur est versé par les trois « sources » de la structure de financement des actifs des établissements d’enseignement. Le recours original du gouvernement à la méthode de la comptabilité d’exercice, associé à un nouvel accord sur les Plans quinquennaux de gestion des actifs, permet aux établissements de connaître avec une grande précision le montant du financement des actifs dont ils disposent. En outre, ces derniers jouissent d’une grande autonomie dans la prise de décision concernant la modernisation de leurs bâtiments.
    Keywords: gestion, financement
    Date: 2004–10
  77. By: Kyoji Fukao; Keiko Ito; Hyeog Ug Kwon; Miho Takizawa
    Abstract: Using Japanese firm-level data for the period from 1994-2002, this paper examines whether a firm is chosen as an acquisition target based on its productivity level, profitability and other characteristics and whether the performance of Japanese firms that were acquired by foreign firms improves after the acquisition. In our previous study for the Japanese manufacturing sector, we found that M&As by foreigners brought a larger and quicker improvement in total factor productivity (TFP) and profit rates than M&As by domestic firms. However, it may argued that firms acquired by foreign firms showed better performance simply because foreign investors acquired more promising Japanese firms than Japanese investors did. In order to address this potential problem of selection bias problem, in this study we combine a difference-in-differences approach with propensity score matching. The basic idea of matching is that we look for firms that were not acquired by foreign firms but had similar characteristics to firms that were acquired by foreigners. Using these firms as control subjects and comparing the acquired firms and the control subjects, we examine whether firms acquired by foreigners show a greater improvement in performance than firms not acquired by foreigners. Both results from unmatched samples and matched samples show that foreign acquisitions improved target firms’ productivity and profitability significantly more and quicker than acquisitions by domestic firms. Moreover, we find that there is no positive impact on target firms’ profitability in the case of both within-group in-in acquisitions and in-in acquisitions by domestic outsiders. In fact, in the manufacturing sector, the return on assets even deteriorated one year and two years after within-group in-in acquisition, while the TFP growth rate was higher after within-group in-in acquisitions than after in-in acquisitions by outsiders. Our results imply that in the case of within-group in-in acquisitions, parent firms may be trying to quickly restructure acquired firms even at the cost of deteriorating profitability.
    JEL: C14 D24 F21 F23
    Date: 2006–08
  78. By: Yuzo Honda (School of Economics, Osaka University); Kazuyuki Suzuki (Meiji University)
    Abstract: The literature maintains the statistical significance of cash flow in the investment equation. One criticism against the financing constraint interpretation of cash flow is that cash flow may be picking up information on the future profitability of a firm which Tobinfs Q fails to capture. We confine ourselves to the investment behavior of unlisted automobile parts suppliers, and use the sales of large automobile makers as an exogenous instrument. Despite the various criticisms against the financing constraint interpretation of cash flow, our statistical evidence does not disagree with the hypothesis.
    Keywords: Tobinfs Q, Investment Equation, Cash Flow, Financing Constraint, Japanese Unlisted Firms
    JEL: E22 G31
    Date: 2006–08

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