nep-ifn New Economics Papers
on International Finance
Issue of 2005‒09‒29
34 papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Can Information Heterogeneity Explain the Exchange Rate Determination? By Philippe Bacchetta; Eric van Wincoop
  2. Exchange-Rate Pass-Through to Import Prices in the Euro Area By José Manuel Campa; Linda S. Goldberg; José M. González-Mínguez
  3. The Exchange Rate Forecasting Puzzle By Francis Vitek
  4. Modeling Exchange Rate Passthrough After Large Devaluations By Burstein, Ariel Thomas; Eichenbaum, Martin; Rebelo, Sérgio
  5. Productivity Growth and the Exchange Rate Regime: The Role of Financial Development By Philippe Aghion; Philippe Bacchetta; Romain Rancière; Kenneth Rogoff
  6. Real Equilibrium Exchange Rate Estimates: To What Extent Applicable for Setting the Central Parity? By Roman Hotvath
  7. From World Banker to World Venture Capitalist: US External Adjustment and The Exorbitant Privilege By Gourinchas, Pierre-Olivier; Rey, Hélène
  8. How to cure the trade balance? Reducing budget deficits versus devaluations in the presence of J- and W-curves for Brazil By Ziesemer,Thomas
  9. Monetary Policy and Exchange Rate Volatility in a Small Open Economy By Jordi Galí; Tommaso Monacelli
  10. Currency crashes and bond yields in industrial countries By Joseph E. Gagnon
  11. Why Are Returns on Swiss Franc Assets So Low? Rare Events May Solve the Puzzle By Kugler, Peter; Weder, Beatrice
  12. Rational Inattention: A Solution to the Forward Discount Puzzle By Philippe Bacchetta; Eric van Wincoop
  13. Rational Inattention: A Solution to the Forward Discount Puzzle By Philippe Bacchetta; Eric van Wincoop
  14. Can a Rapidly-Growing Export-Oriented Economy Smoothly Exit an Exchange Rate Peg? Lessons for China from Japan's High-Growth Era By Barry Eichengreen; Mariko Hatase
  15. "Purchasing Power Parity Across Six British Colonies Versus Across the Same Six U.S. States, 1748-1811." By Farley Grubb 
  16. Level-ARCH Short Rate Models with Regime Switching: Bivariate Modeling of US and European Short Rates. By Christiansen, Charlotte
  17. Capital Flows and Controls in Brazil: What Have We Learned? By Ilan Goldfajn; André Minella
  18. Discrete Devaluations and Multiple Equilibria in a First Generation Model of Currency Crises By Fernando Broner
  19. Regional and Industry Cycles in Australasia: Implications for a Common Currency By Arthur Grimes
  20. The Stability of the Inter-war Gold Exchange Standard. Did Politics Matter? By Kirsten Wandschneider
  21. Flexible Exchange Rates as Shock Absorbers By Sebastian Edwards; Eduardo Levy Yeyati
  22. Determinants of Foreign Direct Investment in Iceland By Helga Kristjánsdóttir
  23. Recent developments in monetary macroeconomics and U.S. dollar policy By William T. Gavin
  24. Financial De-Dollarization: Is It for Real? By Alain Ize; Eduardo Levy Yeyati
  25. Monetary policy predictability in the euro area: An international comparison By Bjørn-Roger Wilhelmsen; Andrea Zaghini
  26. Determining Underlying Macroeconomic Fundamentals during Emerging Market Crises: Are Conditions as Bad as they Seem? By Mark Aguiar; Fernando Broner
  27. Trade Costs, Trade Balances and Current Accounts: An Application of Gravity to Multilateral Trade By Giorgio Fazio; Ronald MacDonald; Jacques Melitz
  28. Bubbles and Capital Flows By Jaume Ventura
  29. Bilateral FDI Flows: Threshold Barriers and Productivity Shocks By Assaf Razin; Efraim Sadka; Hui Tong
  30. Why are Capital Flows so much more Volatile in Emerging than in Developed Countries? By Fernando Broner; Roberto Rigobon
  31. Banking Sector Strength and the Transmission of Currency Crises By Bruinshoofd,Allard; Candelon,Bertrand; Raabe,Katharina
  32. International asset allocation under regime switching, skew and kurtosis preferences By Massimo Guidolin; Allan Timmerman
  33. A Resolution of the Fisher Effect Puzzle: A Comparison of Estimators By E.Panopoulou
  34. The US Trade Deficit: A Disaggregated Perspective By Catherine L. Mann; Katharina Plück

  1. By: Philippe Bacchetta (Study Center Gerzensee, University of Lausanne, FAME and CEPR); Eric van Wincoop (University of Virginia, NBER)
    Abstract: Empirical evidence shows that observed macroeconomic fundamentals have little explanatory power for nominal exchange rates (the exchange rate determination puzzle). On the other hand, the recent \microstructure approach to exchange rates" has shown that most exchange rate volatility at short to medium horizons is related to order flow. In this paper we introduce symmetric information dispersion about future fundamentals in a dynamic rational expectations model in order to explain these stylized facts. Consistent with the evidence the model implies that (i) observed fundamentals account for little of exchange rate volatility in the short to medium run, (ii) over long horizons the exchange rate is closely related to observed fundamentals, (iii) exchange rate changes are a weak predictor of future fundamentals, and (iv) the exchange rate is closely related to order flow over both short and long horizons.
    Keywords: Nominal Exchange Rates; Order Flow; Higher Order Expectations
    JEL: F3 F4 G0 G1 E0
    Date: 2005–08
  2. By: José Manuel Campa; Linda S. Goldberg; José M. González-Mínguez
    Abstract: This paper presents an empirical analysis of transmission rates from exchange rate movements to import prices, across countries and product categories, in the euro area over the last fifteen years. Our results show that the transmission of exchange rate changes to import prices in the short run is high, although incomplete, and that it differs across industries and countries; in the long run, exchange rate pass-through is higher and close to one. We find no strong statistical evidence that the introduction of the euro caused a structural change in this transmission. Although estimated point elasticities seem to have declined since the introduction of the euro, we find little evidence of a structural break in the transmission of exchange rate movements except in the case of some manufacturing industries. And since the euro was introduced, industries producing differentiated goods have been more likely to experience reduced rates of exchange rate pass-through to import prices. Exchange rate changes continue to lead to large changes in import prices across euro-area countries.
    JEL: F3 F4
    Date: 2005–09
  3. By: Francis Vitek (University of British Columbia)
    Abstract: We survey and update the empirical literature concerning the predictability of nominal exchange rates using structural macroeconomic models over the recent floating exchange rate period. In particular, we consider both flexible and sticky price versions of the monetary model of nominal exchange rate determination. In agreement with the existing empirical literature, we find that nominal exchange rate movements are difficult to forecast, with a random walk generally dominating the monetary model in terms of predictive accuracy conditional on observed monetary fundamentals at all horizons.
    Keywords: Exchange rate forecasting; Monetary model
    JEL: F31
    Date: 2005–09–14
  4. By: Burstein, Ariel Thomas; Eichenbaum, Martin; Rebelo, Sérgio
    Abstract: Large devaluations are generally associated with large declines in real exchange rates. We develop a model which embodies two complementary forces that account for the large declines in the real exchange rate that occur in the aftermath of large devaluations. The first force is sticky nontradable goods prices. The second force is the impact of real shocks that often accompany large devaluations. We argue that sticky nontradable goods prices generally play an important role in explaining post-devaluation movements in real exchange rates. However, real shocks can sometimes be primary drivers of real exchange rate movements.
    Keywords: devaluations; exchange rate; passthrough; sticky prices
    JEL: F31
    Date: 2005–09
  5. By: Philippe Aghion; Philippe Bacchetta; Romain Rancière; Kenneth Rogoff
    Abstract: This paper offers empirical evidence that a country's choice of exchange rate regime can have a signifficant impact on its medium-term rate of productivity growth. Moreover, the impact depends critically on the country's level of financial development, its degree of market regulation, and its distance from the global technology frontier. We illustrate how each of these channels may operate in a simple stylized growth model in which real exchange rate uncertainty exacerbates the negative investment e¤ects of domestic credit market constraints. The empirical analysis is based on an 83 country data set spanning the years 1960-2000. Our approach delivers results that are in striking contrast to the vast existing empirical exchange rate literature, which largely finds the effects of exchange rate volatility on real activity to be relatively small and insignificant.
    Keywords: Productivity growth; exchange rate
    JEL: O42 F30 F31 F43
    Date: 2005–05
  6. By: Roman Hotvath (Czech National Bank & Charles University)
    Abstract: The objective of this paper is twofold. First, we provide an introduction on estimation and methodology of the real equilibrium exchange rate. Second, we discuss to what extent are these estimates applicable for setting the central parity. Given the uncertainty surrounding the estimates, they are informative in the sign rather than the size of the misalignment of exchange rate, but may serve as useful consistency checks for the decision about setting the central parity. We argue that policy makers shall consider the estimates in their decision- making only if the real exchange rate is substantially misaligned (i.e. more than 10% as a rule of thumb).
    JEL: F3 F4
    Date: 2005–09–20
  7. By: Gourinchas, Pierre-Olivier; Rey, Hélène
    Abstract: Does the centre country of the International Monetary System enjoy an 'exorbitant privilege' that significantly weakens its external constraint as has been asserted in some European quarters? Using a newly constructed dataset, we perform a detailed analysis of the historical evolution of US external assets and liabilities at market value since 1952. We find strong evidence of a sizeable excess return of gross assets over gross liabilities. Interestingly, this excess return increased after the collapse of the Bretton Woods fixed exchange rate system. It is mainly due to a return discount: within each class of assets, the total return (yields and capital gains) that the US has to pay to foreigners is smaller than the total return the US gets on its foreign assets. We also find evidence of a composition effect: the US tends to borrow short and lend long. As financial globalization accelerated its pace, the US transformed itself from a World Banker into a World Venture Capitalist, investing greater amounts in high yield assets such as equity and FDI. We use these findings to cast some light on the sustainability of the current global imbalances.
    Keywords: dollar exchange rate; financial adjustment channel; gross positions; net foreign assets; sustainability; trade adjustment channel
    JEL: F3 N1
    Date: 2005–09
  8. By: Ziesemer,Thomas (MERIT)
    Abstract: We analyze empirically for Brazil a hypothesis by Stiglitz (2002) saying that devaluations may be more effective in reducing trade deficits than cuts in budget deficits. We find that the Ricardian equivalence does not hold. Devaluations have a stronger impact on the trade deficit than budget deficits when doing the analysis with yearly or monthly data even when the effect from a risk variable obtained from a TARCH estimate is subtracted. Devaluations have an effect that lasts 25 months. A J-or W-curve can be obtained from a polynomial distributed lag estimate. Devaluations can explain almost 19% of consumer price inflation. However, if inflation control is a task assigned to monetary policy rather than exchange rate policy, devaluations are available as an instrument to stabilize the trade balance under shocks rather than keeping exchange rates fixed through sales of reserves. This may avoid overvaluations, speculative attacks and currency crises. The results for the trade balance hold for several updates except for the last one, where budget deficits and exchange rate changes change signs. This suggests a role for imported investments and elasticity pessimism and casts doubts on the role of cutting budget deficits and devaluations in regard to the trade balance. Stability tests suggest that structural change seems to play a role. The change in signs of our estimates may have been caused by a change of exchange rate policies leading to appreciations since June 2004 and by an extraordinarily strong industrial recession in 2003 in some countries. If Ricardian equivalence for the trade balance is imposed by assumption we find a weakly significant N-curve for exchange rate risk jointly with a J-curve for devaluations.
    Keywords: economic development and growth ;
    Date: 2005
  9. By: Jordi Galí; Tommaso Monacelli
    Abstract: We lay out a small open economy version of the Calvo sticky price model, and show how the equilibrium dynamics can be reduced to simple representation in domestic inflation and the output gap. We use the resulting framework to analyze the macroeconomic implications of three alternative rule-based policy regimes for the small open economy: domestic inflation and CPI-based Taylor rules, and an exchange rate peg. We show that a key difference among these regimes lies in the relative amount of exchange rate volatility that they entail. We also discuss a special case for which domestic inflation targeting constitutes the optimal policy, and where a simple second order approximation to the utility of the representative consumer can be derived and used to evaluate the welfare losses associated with the suboptimal rules.
    Keywords: Small open economy, optimal monetary policy, sticky prices, exchange rate peg, exchange rate volatility
    JEL: E52 F41
    Date: 2004–07
  10. By: Joseph E. Gagnon
    Abstract: This paper examines episodes of sudden large exchange rate depreciations (currency crashes) in industrial countries and characterizes the behavior of government bond yields during and after these crashes. The most important determinant of changes in bond yields appears to be inflationary expectations. When inflation is high and rising at the time of a currency crash, bond yields tend to rise. Otherwise--and in every currency crash since 1985--bond yields tend to fall. Over the past 20 years, inflation rates have been remarkably stable in industrial countries after currency crashes.
    Keywords: Balance of payments ; Inflation (Finance) ; Foreign exchange rates
    Date: 2005
  11. By: Kugler, Peter; Weder, Beatrice
    Abstract: It is well known that the uncovered interest rate parity fails in the short run but usually holds in the long run. This paper analyses the long and short run interest rate parity of 10 major OECD currencies and finds that there is a long run failure of the uncovered interest rate parity condition for the Swiss franc. After correcting for exchange rate changes, mean returns on Swiss assets have been significantly lower than in other currencies, an anomaly not found in any other major currency. The long run return differential has been stable over the last 20 years, transitory structural breaks are only found in times of currency turmoil. We suggest that the return anomaly may be due to an insurance premium against very rare catastrophic events, such as a major war. Supporting evidence for this hypothesis comes from two empirical findings. First, we show that the return differential is negatively affected by large unexpected geo-political events. Second we examine historical data on interest rates differentials and show that the abnormally low level of Swiss returns arises after the First World War only.
    Keywords: asset prices; Swiss franc assets; uncovered interest rate parity
    JEL: E43 E44 G15
    Date: 2005–08
  12. By: Philippe Bacchetta (Study Center Gerzensee, University of Lausanne, FAME & CEPR); Eric van Wincoop (University of Virginia, NBER)
    Abstract: The uncovered interest rate parity equation is the cornerstone of most models in international macro. However, this equation does not hold empirically since the forward discount, or interest rate differential, is negatively related to the subsequent change in the exchange rate. This forward discount puzzle is one of the most extensively researched areas in international finance. It implies that excess returns on foreign currency investments are predictable. In this paper we propose a new explanation for this puzzle based on rational inattention. We develop a model where investors face a cost of collecting and processing information. Investors with low information processing costs trade actively, while other investors are inattentive and trade infrequently. We calibrate the model to the data and show that (i) inattention can account for most of the observed predictability of excess returns in the foreign exchange market, (ii) the benefit from frequent trading is relatively small so that few investors choose to be attentive, (iii) average expectational errors about future exchange rates are predictable in a way consistent with survey data for market participants, and (iv) the model can account for the puzzle of delayed overshooting of the exchange rate in response to interest rate shocks.
    Keywords: forward discount puzzle; excess return predictability; rational
    JEL: E44 F31 G1
    Date: 2005–09
  13. By: Philippe Bacchetta; Eric van Wincoop
    Abstract: The uncovered interest rate parity equation is the cornerstone of most models in international macro. However, this equation does not hold empirically since the forward discount, or interest rate differential, is negatively related to the subsequent change in the exchange rate. This forward discount puzzle is one of the most extensively researched areas in international finance. It implies that excess returns on foreign currency investments are predictable. In this paper we propose a new explanation for this puzzle based on rational inattention. We develop a model where investors face a cost of collecting and processing information. Investors with low information processing costs trade actively, while other investors are inattentive and trade infrequently. We calibrate the model to the data and show that (i) inattention can account for most of the observed predictability of excess returns in the foreign exchange market, (ii) the benefit from frequent trading is relatively small so that few investors choose to be attentive, (iii) average expectational errors about future exchange rates are predictable in a way consistent with survey data for market participants, and (iv) the model can account for the puzzle of delayed overshooting of the exchange rate in response to interest rate shocks.
    JEL: F3 G1 E4
    Date: 2005–09
  14. By: Barry Eichengreen; Mariko Hatase
    Abstract: We explore the parallels between Japanese currency policy after World War II and Chinese currency policy today. After two decades of pegging at 360 yen, Japan decoupled from the dollar on August 1971 and then repegged at a revalued rate of 308 yen. After stabilizing the exchange rate at this new level for about a year, greater flexibility was introduced. This phased adjustment - revaluation followed after a time by an increase in flexibility - bears more than a passing resemblance to recent Chinese policy initiatives. We analyze the impact of Japan's exit from its peg on exports and investment. The results point to sizeable effects of the yen's revaluation on both variables, especially investment. While our analysis suggests that a rapidly-growing, export-oriented economy can operate a heavily managed float despite the presence of capital controls and the absence of sophisticated foreign currency forward markets, it underscores the importance of managing the exchange rate with domestic conditions in mind and avoiding the kind of large real appreciation that would sharply compress profits and damage investment. For China this suggests starting with a modest band widening and a limited increase in flexibility, and not with a large step revaluation which could have a sharp negative impact on investment and growth. Our results thus provide support for the kind of measures taken at the end of July.
    JEL: F31 F33 N15 N65
    Date: 2005–09
  15. By: Farley Grubb  (Department of Economics,University of Delaware)
    Abstract: For the six major British North American colonies, five of whom independently issued their own fiat paper money, exchange rates between these colonies are constructed and combined with price indices to test purchasing power parity between these colonies. Purchasing power parity is then tested between these same six locations after they became states united politically and monetarily under a common currency with no trade barriers established by the U.S. Constitution. Even when using short spans of data and low powered tests, purchasing power parity cannot be rejected in either period, and if anything, holds with more confidence prior to political and monetary unification.
    Keywords: Monetary Policy
    JEL: N1
    Date: 2004
  16. By: Christiansen, Charlotte (Department of Accounting, Aarhus School of Business)
    Abstract: No abstract
    Keywords: Bivariate short-rate model; International short rates; Level-ARCH model; Regime switching
    Date: 2005–09–23
  17. By: Ilan Goldfajn; André Minella
    Abstract: This paper analyzes the relationship between capital account liberalization and macroeconomic volatility using Brazil as a case study. The paper provides several stylized facts regarding the evolution of capital flows and controls in Brazil in the last three decades. We conclude that, notwithstanding the financial crises and macroeconomic volatility of the recent past, capital account liberalization and the floating exchange regime have led to a more resilient economy. Further liberalization of the capital account is warranted and should be accompanied by a broad range of reforms to improve and foster stronger institutions.
    JEL: F21 F32 F40
    Date: 2005–09
  18. By: Fernando Broner
    Abstract: The first generation models of currency crises have often been criticized because they predict that, in the absence of very large triggering shocks, currency attacks should be predictable and lead to small devaluations. This paper shows that these features of first generation models are not robust to the inclusion of private information. In particular, this paper analyzes a generalization of the Krugman-Flood-Garber (KFG) model, which relaxes the assumption that all consumers are perfectly informed about the level of fundamentals. In this environment, the KFG equilibrium of zero devaluation is only one of many possible equilibria. In all the other equilibria, the lack of perfect information delays the attack on the currency past the point at which the shadow exchange rate equals the peg, giving rise to unpredictable and discrete devaluations.
    Keywords: Currency crises; First generation models; private information; discrete devaluations; multiple equilibria
    JEL: D8 E58 F31 F32
    Date: 2004–12
  19. By: Arthur Grimes (Motu Economic & Public Policy Research)
    Abstract: If two countries experience similar cycles, loss in monetary sovereignty following currency union may not be severe. Analysis of cyclical similarity is frequently carried out at the overall industry level, then interpreted with reference to regional industrial structures. By contrast, this paper explicitly incorporates regional industry structure into an examination of Australasian cycles. Since 1991, NZ and Australasian cycles have been highly correlated, but there is little evidence that the NZ cycle has been 'caused' by Australian regional or industry cycles. We test whether the NZDAUD exchange rate has insulated NZ from Australian shocks, but find it has not played a major buffering role in response to Australian industry shocks (including mining shocks). Instead, the strongest impacts on the NZDAUD stem from the NZ cycle. An important loss of monetary sovereignty under currency union may therefore arise in response to NZ-specific shocks.
    JEL: E32 E52 F36 R11
    Date: 2005–09–12
  20. By: Kirsten Wandschneider
    Abstract: The collapse of the inter-war gold standard has frequently been studied in economic his-tory. This paper proposes a discrete time duration model to analyze how economic and polit-ical indicators affected the length of time a country remained on the gold standard. We rely on a panel data set of 24 countries over the years 1922-1938, and incorporate new measures of political and institutional variables. The results of this study identify high per capita income growth, large foreign currency and gold reserves, trade with other countries on gold, interna-tional creditor status, and the prior experience of hyperinflation as factors that increased the probability that a country would remain on gold. In contrast, democratic regimes that were exposed to a relatively high percentage of left-wing representation in parliament left the gold standard early. We also offer predicted survival probabilities for selected key countries on the gold standard. These survival rates show that Britain abandoned the gold exchange standard at a much higher survival probability, compared with other countries in the system.
    Date: 2005
  21. By: Sebastian Edwards; Eduardo Levy Yeyati
    Abstract: This paper studies how institutional factors and systemic risks (driven by macroeconomic conditions) prevalent in emerging economies may impact market discipline among banks (traditionally understood as market responses to bank fundamentals). First, we discuss how certain institutional features of emerging economies (underdeveloped capital markets, pervasive government ownership of banks, greater guarantees, inadequate disclosure and transparency) may affect market responses to bank risk. Second, using the recent Argentine crisis as an illustration, we argue that systemic risks may exert an overwhelming impact on market behavior, overshadowing the link between the latter and bank fundamentals. Thus, market discipline, while missing in the traditional sense, may be indeed quite robust once systemic risks are factored in. We conclude that in emerging economies the analysis of market discipline should take into account the importance of institutional and systemic factors.
    Date: 2004
  22. By: Helga Kristjánsdóttir (University of Iceland)
    Abstract: This paper investigates whether the low foreign direct investment in Iceland can be explained by its geographical location together with market size measures. The effects of these factors on inward FDI are analyzed by means of the gravity model. The model is also applied to analyze sector, trade bloc and country specific effects. The research is based on panel data, running over countries, sectors and years. Results indicate that distance negatively affects FDI and that FDI appears to be more driven by wealth effects than market size effects.
    Keywords: foreign direct investment; gravity model
    JEL: F21 F23
    Date: 2005–09
  23. By: William T. Gavin
    Abstract: This paper summarizes recent developments in the theory and practice of monetary policy in a closed economy and explains what these developments mean for U.S. Dollar policy. There is no conflict between what is appropriate U.S. monetary policy at home or abroad because the dollar is the world's key currency country. Both at home and abroad, the main problem for U.S. policymakers is to provide an anchor for the dollar. Recent experience in other countries suggests that a solution is evolving in the use of inflation targets.
    Keywords: Dollar, American ; Monetary policy
    Date: 2005
  24. By: Alain Ize; Eduardo Levy Yeyati
    Abstract: De facto (unofficial) dollarization, defined as the holding by residents of assets and liabilities denominated in a foreign currency, is a policy concern in an increasing number of developing economies. This paper addresses the dollarization debate from this perspective, with the goal of setting the stage for a more detailed and focused discussion of whether de-dollarization should be a policy objective and, if so, how best to pursue this objective. We review existing theories of de facto dollarization and the extent to which they are supported by the available evidence, presents the main strategies for reform, and proposes a list of policy recommendations.
    Date: 2005
  25. By: Bjørn-Roger Wilhelmsen (Norges Bank); Andrea Zaghini (Banca d’Italia)
    Abstract: The paper evaluates the ability of market participants to anticipate monetary policy decisions in the euro area and in 13 other countries. First, by looking at the magnitude and the volatility of the changes in the money market rates we show that the days of policy meetings are special days for financial markets. Second, we find that the predictability of the ECB’s monetary policy is fully comparable (and sometimes slightly better) to that of the FED and the Bank of England. Finally, an econometric analysis of the ability of market participants to incorporate in the current money rates the expected changes in the key policy rate shows that in the euro area policy decisions are anticipated well in advance.
    Keywords: Monetary policy, Predictability, Money market rates
    JEL: E4 E5 G1
    Date: 2005–09–02
  26. By: Mark Aguiar; Fernando Broner
    Abstract: Emerging market crises are characterized by large swings in both macroeconomic fundamentals and asset prices. The economic significance of observed movements in macroeconomic variables is obscured by the brief and extreme nature of crises. In this paper we propose to study the macroeconomic consequences of crises by studying the behavior of “effective” fundamentals, constructed by studying the relative movements of stock prices during crises. We find that these effective fundamentals provide a different picture than that implied by observed fundamentals. First, asset prices often reflect expectations of improvement in fundamentals after the initial devaluations; specifically, effective depreciations are positive but not as large as the observed ones. Second, crises vary in their effect on credit market conditions, with investors expecting tightening of credit in some cases (Mexico 1994, Philippines 1997), but loosening of credit in others (Sweden 1992, Korea 1997, Brazil 1999).
    Keywords: Currency crises; emerging markets; stock prices; overshooting; credit markets
    JEL: E44 F31 F32 F41 G12 G14 G15
    Date: 2004–08
  27. By: Giorgio Fazio; Ronald MacDonald; Jacques Melitz
    Abstract: In this paper we test the well-known hypothesis of Obstfeld and Rogoff (2000) that trade costs are the key to explaining the so-called Feldstein-Horioka puzzle. Using a gravity framework in an intertemporal context, we provide strong support for the hypothesis and we reconcile our results with the so-called home bias puzzle. Interestingly, this requires a fundamental revision of Obstfeld and Rogoff’s argument. A further novelty of our work is in tying bilateral trade behavior to desired aggregate trade balances and desired intertemporal trade.
    Keywords: Feldstein-Horioka puzzle, trade costs, gravity model, home bias puzzle, current account, trade balance
    JEL: F10 F32
    Date: 2005
  28. By: Jaume Ventura
    Abstract: This paper presents a stylized model of international trade and asset price bubbles. Its central insight is that bubbles tend to appear and expand in countries where productivity is low relative to the rest of the world. These bubbles absorb local savings, eliminating inefficient investments and liberating resources that are in part used to invest in high productivity countries. Through this channel, bubbles act as a substitute for international capital flows, improving the international allocation of investment and reducing rate-of-return differentials across countries. This view of asset price bubbles has unexpected implications for the way we think about economic growth and fluctuations, and could eventually provide a simple account of some real world phenomenae that have been difficult to model before, such as the recurrence and depth of financial crises or their puzzling tendency to propagate across countries.
    Keywords: Asset price bubbles, international capital flows
    JEL: F21 F36 F43
    Date: 2004–01
  29. By: Assaf Razin; Efraim Sadka; Hui Tong
    Abstract: A positive productivity shock in the host country tends typically to increase the volume of the desired FDI flows to the host country, through the standard marginal profitability effect. But, at the same time, such a shock may lower the likelihood of making any new FDI flows by the source country, through a total profitability effect, derived from the a general-equilibrium increase in domestic input prices. This is the gist of the theory that we develop in the paper. For a sample of 62 OECD and Non-OECD countries over the period 1987-2000, we provide supporting evidence for the existence of such conflicting effects of productivity change on bilateral FDI flows. We also uncover sizeable threshold barriers in our data set and link the analysis to the Lucas Paradox.
    JEL: F2 F3
    Date: 2005–09
  30. By: Fernando Broner; Roberto Rigobon
    Abstract: The standard deviations of capital flows to emerging countries are 80 percent higher than those to developed countries. First, we show that very little of this difference can be explained by more volatile fundamentals or by higher sensitivity to fundamentals. Second, we show that most of the difference in volatility can be accounted for by three characteristics of capital flows: (i) capital flows to emerging countries are more subject to occasional large negative shocks (“crises”) than those to developed countries, (ii) shocks are subject to contagion, and (iii) – the most important one – shocks to capital flows to emerging countries are more persistent than those to developed countries. Finally, we study a number of country characteristics to determine which are most associated with capital flow volatility. Our results suggest that underdevelopment of domestic financial markets, weak institutions, and low income per capita, are all associated with capital flow volatility.
    Keywords: Capital flows, emerging countries, volatility, crises, contagion, persistence
    JEL: F21 F32 G15
    Date: 2004–10
  31. By: Bruinshoofd,Allard; Candelon,Bertrand; Raabe,Katharina (METEOR)
    Abstract: We show that, complementary to trade and financial linkages, the strength of the bankingsector helps explain the transmission of currency crises. Specifically, we demonstrate thatthe Mexican, Thai, and Russian crises predominantly spread to countries with weaknesses intheir banking sectors. At the same time, the role of banking sector strength varies per crisis;where the Mexican crisis spread to countries with a strong presence of foreign banks indomestic credit provision, the Thai crisis disproportionately contaminated countries wherethe banking sector was most sensitive to currency realignments, wh ile the Russian crisisspread to countries with inefficiencies in the banking sector.
    Keywords: macroeconomics ;
    Date: 2005
  32. By: Massimo Guidolin; Allan Timmerman
    Abstract: This paper proposes a new tractable approach to solving asset allocation problems in situations with a large number of risky assets which pose problems for standard numerical approaches. Investor preferences are assumed to be defined over moments of the wealth distribution such as its skewness and kurtosis. Time-variations in investment opportunities are represented by a flexible regime switching process. We develop analytical methods that only require solving a small set of difference equations and can be applied even in the presence of large numbers of risky assets. We find evidence of two distinct bull and bear states in the joint distribution of equity returns in five major regions with correlations that are much higher in the bear state. Ignoring regimes, an unhedged US investor's optimal portfolio is strongly diversified internationally. The presence of regimes in the return distribution leads to a large increase in the investor's optimal holdings of US stocks as does the introduction of predictability in returns from a short US interest rate. Our paper therefore offers a rational explanation of the strong home bias observed in US investors' asset allocation, based on regime switching, skew and kurtosis preferences and predictability from the short US interest rate.
    Keywords: Investments ; Assets (Accounting) - Prices ; International finance
    Date: 2005
  33. By: E.Panopoulou (National University of Ireland, Maynooth and University of Piraeus, Greece)
    Abstract: This paper attempts a resolution of the Fisher effect puzzle in terms of estimator choice. Using both short-term and long-term interest rates for 14 OECD countries, we find ample evidence supporting the existence of a long-run Fisher effect in which interest rates move oneto- one with inflation. Our results suggest that the reason why the Fisher effect has not found support internationally lies on the estimation method. When the hypothesis of a unit coefficient relating interest rates to expected inflation is tested within the Autoregressive Distributed Lag (ADL) framework, which is invariant to the integration properties of the data, the Fisher effect easily survives the empirical evidence. Similar, but less robust, results are reached on the grounds of the Pre-Whitened Fully Modified Least Squares (PW-FMLS) or the Johansen’s (JOH) estimators.
    Keywords: Cointegration Estimators,Fisher Effect,ADL; DOLS Small-sample properties
    JEL: E40 E50 C12
    Date: 2005–02
  34. By: Catherine L. Mann (Institute for International Economics); Katharina Plück (Institute for International Economics)
    Abstract: The paper prepares new estimates for the elasticity of US trade flows using bilateral, commodity-detailed trade data for 31 countries, using measures of expenditure and trade prices matched to commodity groups, and including a commodity-and-country specific proxy for global supply-cum-variety. Using the United Nations Commodity Trade Statistics Database (UN Comtrade) we construct bilateral trade flows for 31 countries in four categories of goods based on the Bureau of Economic Analysis’s “end-use” classification system—autos, industrial supplies and materials–excluding energy, consumer goods, and capital goods. We find that using expenditure matched to commodity category yields more plausible values for the demand elasticities than does using GDP as the measure of demand that drives trade flows. Controlling for country and commodity fixed effects, we find that industrial and developing countries have demand elasticities that are statistically significant and that generally differ between development groups and across product categories. Relative prices for the industrial countries have plausible parameter values, are statistically significant and differ across product groups, but the relative prices for developing countries are poorly estimated. We find that variety is an important variable for the behavior of capital goods trade. Because the commodity composition of trade and of trading partners has changed dramatically, particularly for imports, we find that the demand elasticity for imports is not constant. Comparing the in-sample performance of the disaggregated model against a benchmark that uses aggregated data and GDP as the expenditure variable, our disaggregated model predicts exports better in-sample but does not predict imports as well as the benchmark model.
    Keywords: US trade deficit, goods, trade, commodity composition, trade elasticities and sustainability
    JEL: F4 F1
    Date: 2005–09

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