nep-fmk New Economics Papers
on Financial Markets
Issue of 2008‒06‒21
sixteen papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. A Methodological Note on Measuring the Functional Efficiency of Capital Markets By Eklund, Johan E; Desai, Sameeksha
  2. A new Model for Stock Price Movements By Venier, Guido
  3. Stochastic Behavioral Asset Pricing Models and the Stylized Facts By Thomas Lux
  4. Model-based Estimation of High Frequency Jump Diffusions with Microstructure Noise and Stochastic Volatility By Charles S. Bos
  5. The forint interest rate swap market and the main drivers of swap spreads By Csaba Csávás; Lóránt Varga; Csaba Balogh
  7. Estimating yield curves from swap, BUBOR and FRA data By Zoltán Reppa
  8. The Anatomy of Banking Crises By Paul Cashin; Rupa Duttagupta
  9. Do IMF Programs Improve Economic Governance? By Jiro Honda
  10. An eclectic third generation model of financial and exchange rate crises By Joaquin Novella Izquierdo; Joan Ripoll i Alcon
  11. Real exchange rate volatility and disconnect: an empirical investigation By Riccardo Cristadoro; Andrea Gerali; Stefano Neri; Massimiliano Pisani
  12. Exchange Rate Regimes and Capital Mobility: How Much of the Swoboda Thesis Survives? By Eichengreen, Barry
  13. What are borders made of? An analysis of barriers to European banking integration By Massimiliano Affinito; Matteo Piazza
  14. The Procyclical Effects of Basel II By Repullo, Rafael; Suarez, Javier
  15. The Rise and Fall of the Dollar, or When did the Dollar Replace Sterling as the Leading Reserve Currency? By Eichengreen, Barry; Flandreau, Marc
  16. The Effect of Exchange Rate Volatility on International Trade: The Implication for Production Networks in East Asia By Hayakawa, Kazunobu; Kimura, Fukunari

  1. By: Eklund, Johan E (JIBS and CESIS); Desai, Sameeksha (Max Planck Institute of Economics)
    Abstract: We apply the accelerator principle to measure the functional efficiency of capital markets. We estimate the elasticity of capital with respect to output using a panel of firms across 44 countries, and compare the results with existing approaches. Furthermore, we correlate our measure with corporate governance institutions.
    Keywords: Allocation of capital; accelerator principle; functional efficiency
    JEL: C00 G32 P00
    Date: 2008–06–09
  2. By: Venier, Guido
    Abstract: A new alternative diffusion model for asset price movements is presented. In contrast to the popular approach of Brownian motion it proposes deterministic diffusion for the modelling of stock price movements. These diffusion processes are a new area of physical research and can be created by the chaotic behaviour of rather simple piecewise linear maps, but can also occur in chaotic deterministic systems like the famous Lorenz system. The reason for the investigation on deterministic diffusion processes as suitable model for the behaviour of stock prices is, that their time series can obey certain stylized facts of real world stock market time series. For example they can show fat tails of empirical log returns in union with varying volatility i.e. heteroscedacity as well as slowly decaying autocorrelations of squared log returns. These phenomena could not be explained by a simple Brownian motion and have been the most criticism to the lognormal random walk. The scope is to show that deterministic diffusion models can explain the occurrence of those empirical observed stylized facts and to discuss the implications for economic theory with respect to market efficiency and option pricing.
    Keywords: stock pricing;chaos theory;deterministic diffusion; heteroscedasticity;fat tails;long range dependence;stylized facts of economic time series;fractional brownian motion;levy stable distributions;brownian motion;black scholes;option pricing;CAPM;market efficiency
    JEL: G14 D58 G13 C32 D53 G12 Z0 D79
    Date: 2007–08–10
  3. By: Thomas Lux
    Abstract: High-frequency financial data are characterized by a set of ubiquitous statistical properties that prevail with surprising uniformity. While these 'stylized facts' have been well-known for decades, attempts at their behavioral explanation have remained scarce. However, recently a new branch of simple stochastic models of interacting traders have been proposed that share many of the salient features of empirical data. These models draw some of their inspiration from the broader current of behavioral finance. However, their design is closer in spirit to models of multi-particle interaction in physics than to traditional asset-pricing models. This reflects a basic insight in the natural sciences that similar regularities like those observed in financial markets (denoted as 'scaling laws' in physics) can often be explained via the microscopic interactions of the constituent parts of a complex system. Since these emergent properties should be independent of the microscopic details of the system, this viewpoint advocates negligence of the details of the determination of individuals' market behavior and instead focuses on the study of a few plausible rules of behavior and the emergence of macroscopic statistical regularities in a market with a large ensemble of traders. This chapter will review the philosophy of this new approach, its various implementations, and its contribution to an explanation of the stylized facts in finance
    Keywords: Agent-based models, speculation, stylized facts, group dynamics
    JEL: C15 D84 G12
    Date: 2008–06
  4. By: Charles S. Bos (VU University Amsterdam)
    Abstract: When analysing the volatility related to high frequency financial data, mostly non-parametric approaches based on realised or bipower variation are applied. This article instead starts from a continuous time diffusion model and derives a parametric analog at high frequency for it, allowing simultaneously for microstructure effects, jumps, missing observations and stochastic volatility. Estimation of the model delivers measures of daily variation outperforming their non-parametric counterparts. Both with simulated and actual exchange rate data, the feasibility of this novel approach is shown. The parametric setting is used to estimate the intra-day trend in the Euro/U.S. Dollar exchange rate.
    Keywords: High frequency; integrated variation; intra-day; jump diffusions; microstructure noise; stochastic volatility; exchange rates
    JEL: C11 C14 D53 E44
    Date: 2008–01–22
  5. By: Csaba Csávás (Magyar Nemzeti Bank); Lóránt Varga (Magyar Nemzeti Bank); Csaba Balogh (Magyar Nemzeti Bank)
    Abstract: In our paper we present the most important characteristics of the forint interest rate swap market, as well as examine the determinants and the information content of the forint interest rate swap spreads. The turnover of the forint interest rate swap market has grown dynamically in recent years, and now it may reach, or even exceed, the turnover of the government bond market. Due to the hedging activity of interest rate swap market makers, there is a close linkage between the forint interest rate swap market and the government bond market. In terms of investors, the interest rate swap and government bond markets are strongly segmented. Consequently, the spillover from one market segment to the other is not perfect. Our analyses suggest that long-term forint interest rate swap spreads are exposed to the common impact of several factors. The strongest effects are attributed to government bond purchases by residents, the Maggie A spread, the slope of the yield curve and the forint/euro forward yield spread. In the developments of swap spreads, the impact of those trading strategies employing interest rate swaps can be detected. These are widespread in the domestic market, as is confirmed by anecdotal information. The results indicate that in certain cases the swap yields, while at other times the government bond yields carry additional information about long-term yield expectations. The values of the 5-year HUF/EUR forward spread 5 years ahead calculated from the swap yields and from the treasury yields differ markedly, and this difference is driven practically by the same factors that influence the interest rate swap spreads.
    Keywords: forint interest rate swap market, government securities market, interest rate swap spread, swap spread model.
    JEL: G12 G14 G15
    Date: 2008
  6. By: Vink, D.; Thibeault, A. (Vlerick Leuven Gent Management School)
    Abstract: The capital market in which the asset-backed securities are issued and traded is composed of three main categories: ABS, MBS and CDOs. We were able to examine a total number of 3,951 loans (worth €730.25 billion) of which 1,129 (worth €208.94 billion) have been classified as ABS. MBS issues represent 2,224 issues (worth €459.32 billion) and 598 are CDO issues (worth €61.99 billion). We have investigated how common pricing factors compare for the main classes of securities. Due to the differences in the assets related to these securities, the relevant pricing factors for these securities should differ, too. Taking these three classes as a whole, we have documented that the assets attached as collateral for the securities differ between security classes, but that there are also important univariate differences to consider. We found that most of the common pricing characteristics between ABS, MBS and CDO differ significantly. Furthermore, applying the same pricing estimation model to each security class revealed that most of the common pricing characteristics associated with these classes have a different impact on the primary market spread exhibited by the value of the coefficients. The regression analyses we performed demonstrated econometrically that ABS, MBS, and CDOs are in fact different financial instruments.
    Keywords: asset securitization, asset-backed securitisation, bank lending, default risk, risk management, spreads, leveraged financing
    JEL: G21 G24 G32
    Date: 2008–06–02
  7. By: Zoltán Reppa (Magyar Nemzeti Bank)
    Abstract: In this paper we estimate yield curves from Hungarian interest rate swap and money market data. Following general practice, we experiment with several models-differing in the functional form and objective function-and chose the model which performs best according to standard evaluation criteria. We find that the methods perform equally well in terms of residuals and out-of-sample fit; however, the smoothing spline method stands out when we consider the ability to fit the short end of the maturity spectrum, stability of estimation and plausibility of the estimated curves.
    Keywords: yield curve, interest rate swaps.
    JEL: E43 G12
    Date: 2008
  8. By: Paul Cashin; Rupa Duttagupta
    Abstract: This paper uses a Binary Classification Tree (BCT) model to analyze banking crises in 50 emerging market and developing countries during 1990-2005. The BCT identifies key indicators and their threshold values at which vulnerability to banking crisis increases. The three conditions identified as crisis-prone-(i) very high inflation, (ii) highly dollarized bank deposits combined with nominal depreciation or low liquidity, and (iii) low bank profitability-highlight that foreign currency risk, poor financial soundness, and macroeconomic instability are key vulnerabilities triggering banking crises. The main results survive under alternative robustness checks, confirming the importance of the BCT approach for monitoring banking system vulnerabilities.
    Date: 2008–04–22
  9. By: Jiro Honda
    Abstract: This paper examines the effects of IMF financial assistance on economic governance in developing countries, based on panel data analyses of perceived governance indicators. It uses a two-stage approach to address possible endogeneity issues. The results show that successful implementation of IMF programs is associated with improvements in the quality of economic governance. Specifically, the paper finds statistically robust results that IMF concessional programs through the Poverty Reduction and Growth Facility tend to enhance the rule of law and strengthen control of corruption. Through this exercise, however, no statistically significant effect is observed for assistances under the General Resource Account.
    Date: 2008–05–05
  10. By: Joaquin Novella Izquierdo; Joan Ripoll i Alcon (Universitat de Barcelona)
    Abstract: This paper presents an eclectic model that systematizes the dynamics of self-fulfilling crises, using the main aspects of the three typologies of third generation models, to describe the stylized facts that hasten the withdrawal of a pegged exchange rate system. The most striking contributions are the implications for economic policy as well the vanishing role of exchange rate as an instrument of macroeconomic adjustment, when balance-sheet effects are a real possibility.
    Keywords: speculative attack, financial liberalization, financial panic, financial and exchange rate crisis
    JEL: F41 F43 E44 F31 F32 F34 F36 E52
    Date: 2008
  11. By: Riccardo Cristadoro (Bank of Italy, Economic Outlook and Monetary Policy Research Department); Andrea Gerali (Bank of Italy, Economic Outlook and Monetary Policy Research Department); Stefano Neri (Bank of Italy, Economic Outlook and Monetary Policy Research Department); Massimiliano Pisani (Bank of Italy, Economic Outlook and Monetary Policy Research Department)
    Abstract: A two-country model that incorporates many features proposed in the New Open Economy Macroeconomics literature is developed in order to replicate the volatility of the real exchange rate and its disconnect with macroeconomic variables. The model is estimated using data for the euro area and the U.S. and Bayesian methods. The analysis delivers the following results: (a) international price discrimination, home bias and shocks to the uncovered interest rate parity (UIRP) condition are key features to replicate the variance of the real exchange rate; (b) home bias, shocks to the UIRP condition and to production technologies help replicating the disconnect;(c) distribution services intensive in local nontradeables are an important source of international price discrimination.
    Keywords: International business cycle, Exchange rate volatility, Exchange rate pass-through, International transmission.
    JEL: F32 F33 F41 C11
    Date: 2008–04
  12. By: Eichengreen, Barry
    Abstract: Alexander Swoboda is one of the originators of the bipolar view that capital mobility creates pressure for countries to abandon intermediate exchange rate arrangements in favor of greater flexibility and harder pegs. This paper takes another look at the evidence for this hypothesis using two popular de facto classifications of exchange rate regimes. That evidence supports the bipolar view for the advanced countries, the sample for which it was originally developed, but not obviously for emerging markets and other developing countries. One interpretation of the contrast is that there is a tendency to move away from intermediate regimes in the course of economic and financial development, implying that emerging markets and other developing countries will eventually abandon intermediate regimes as well. Another interpretation is that the advanced countries have been faster to abandon soft pegs because they have been faster to develop attractive alternatives, notably Europe’s monetary union. In this view, other countries are unlikely to abandon soft pegs because of the absence of the distinctive political conditions that have made the European alternative feasible. A final interpretation is that the advanced countries have been able to abandon soft peg because of their success in substituting inflation targeting for exchange rate targeting as the anchor for monetary policy. The paper presents some evidence for this view, which suggests the feasibility of further movement by emerging markets and developing countries in the direct of greater exchange rate flexibility.
    Keywords: exchange rate regimes; exchange rates
    JEL: F30 F31
    Date: 2008–06
  13. By: Massimiliano Affinito (Banca d'Italia); Matteo Piazza (Banca d'Italia)
    Abstract: Linguistic and cultural differences, different legal and supervisory frameworks, relationship lending have been repeatedly mentioned as barriers to European retail banking integration. We investigate whether these barriers have affected integration within national boundaries, using an index of localism of regional banking systems as a measure of market integration. If local banks are established and flourish because asymmetric information makes entry difficult for non-incumbents (DellÂ’Ariccia, 2001) or regulatory and governance rules prevent entry from outside (Berger et al., 1995), we should find a significant relationship between indicators of these barriers and measures of the localism of banking systems. Our results show that this is indeed the case for asymmetric information, while findings are more blurred for supervisory practices.
    Keywords: banking integration, barriers, asymmetric information
    JEL: G21 G28
    Date: 2008–04
  14. By: Repullo, Rafael; Suarez, Javier
    Abstract: We analyze the cyclical effects of moving from risk-insensitive (Basel I) to risk-sensitive (Basel II) capital requirements in the context of a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period. Banks anticipate that shocks to their earnings as well as the cyclical position of the economy can impair their capacity to lend in the future and, as a precaution, hold capital buffers. We find that the new regulation changes the behavior of these buffers from countercyclical to procyclical. Yet, the higher buffers maintained in expansions are insufficient to prevent a significant contraction in the supply of credit at the arrival of a recession. We show that cyclical adjustments in the confidence level behind Basel II can reduce its procyclical effects without compromising banks' long-run solvency.
    Keywords: banking regulation; Basel II; business cycles; capital requirements; credit crunch; loan defaults; relationship banking
    JEL: E43 G21 G28
    Date: 2008–06
  15. By: Eichengreen, Barry; Flandreau, Marc
    Abstract: We present new evidence on the currency composition of foreign exchange reserves in the 1920s and 1930s. Contrary to the presumption that the pound sterling continued to dominate the U.S. dollar in central bank reserves until after World War II, we show that the dollar first overtook sterling in the mid-1920s. This suggests that the network effects thought to lend inertia to international currency status and to create incumbency advantages for the dominant international currency do not apply in the reserve currency domain. Our new evidence is similarly incompatible with the notion that there is only room in the market for one dominant reserve currency at a point in time. Our findings have important implications for our understanding of interwar monetary history but also for the prospects of the dollar and the euro as reserve currencies.
    Keywords: international currency; international reserves; reserve currency
    JEL: F31 F33
    Date: 2008–06
  16. By: Hayakawa, Kazunobu; Kimura, Fukunari
    Abstract: This paper is an empirical investigation of the relationship between exchange rate volatility and international trade, focusing on East Asia. It finds that intra-East Asian trade is discouraged by exchange rate volatility more seriously than trade in other regions because intermediate goods trade in production networks, which is quite sensitive to exchange rate volatility compared with other types of trade, occupies a significant fraction of trade. In addition, this negative effect of volatility is mainly induced by the unanticipated volatility and has an even greater impact than that of tariffs.
    Keywords: Exchange rate volatility, Trade, East Asia, International trade, Foreign exchange
    JEL: F10 F31 N75
    Date: 2008–05

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