nep-ifn New Economics Papers
on International Finance
Issue of 2010‒11‒13
twelve papers chosen by
Ajay Shah
National Institute of Public Finance and Policy

  1. Home Bias in Currency Forecasts By Yu-chin Chen; Kwok Ping Tsang; Wen Jen Tsay
  2. Liquidity Crunch in Late 2008: High-Frequency Differentials between Forward-Implied Funding Costs and Money Market Rates By Matthew S. Yiu; Joseph K. W. Fung; Lu Jin; Wai-Yip Alex Ho
  3. Is exchange rate – customer order flow relationship linear? Evidence from the Hungarian FX market By Yuliya Lovcha; Alejandro Perez-Laborda
  4. Do Additional Bilateral Investment Treaties Boost Foreign Direct Investments? By Chang Hoon Oh; Michele Fratianni
  5. Adaptive Forecasting of Exchange Rates with Panel Data By Leonardo Morales-Arias; Alexander Dross
  6. External constraint and financial crises with balance sheet effects. By Meixing Dai
  7. The Risk of Sudden Depreciation of the Euro in the Sovereign Debt Crisis of 2009-2010 By Cho-Hoi Hui; Tsz-Kin Chung
  8. Locational determinants of acquisitions from China and India: The role of human capital By Filip De Beule
  9. Adjusting to Capital Account Liberalization By Kosuke Aoki; Gianluca Benigno; Nobuhiro Kiyotaki
  10. The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma By Joshua Aizenman; Hiro Ito; Menzie D. Chinna
  11. Do banks benefit from internationalization? Revisiting the market power-risk nexus By Buch, Claudia M.; Koch, Cathérine Tahmee; Koetter, Michael
  12. Compensation for Indirect Expropriation in International Investment Agreements: Implications of National Treatment and Rights to Invest By Emma Aisbett; Larry Karp; Carol McAusland

  1. By: Yu-chin Chen (University of Washington and Hong Kong Institute for Monetary Research); Kwok Ping Tsang (Virginia Tech and Hong Kong Institute for Monetary Research); Wen Jen Tsay (Academia Sinica)
    Abstract: The "home bias" phenomenon states that empirically, economic agents often under-utilize opportunities beyond their country borders, and it is well-documented in various international pricing and purchase patterns. This bias manifests in the forms of fewer exchanges of goods and net equity-holdings, as well as less arbitrage of price differences across borders than theoretically predicted to be optimal. Our paper documents another form of home bias, where market participants appear to under-weigh information beyond their borders when making currency forecasts. Using monthly data from 1995 to 2010 for seven major exchange rates relative to the US dollar, we show that excess currency returns and the errors in investors' consensus forecasts not only depend on the interest differentials between the pair of countries, but they depend more strongly on interest rates in a broader set of countries. A global short interest differential and a global long interest differential are driving the results.
    Keywords: Survey Data, Excess Currency Returns, Global Shock
    JEL: F31 G12 D84
    Date: 2010–10
  2. By: Matthew S. Yiu (Hong Kong Monetary Authority); Joseph K. W. Fung (Hong Kong Baptist University and Hong Kong Institute for Monetary Research); Lu Jin (Hong Kong Monetary Authority); Wai-Yip Alex Ho (Hong Kong Monetary Authority and Boston University)
    Abstract: The US Federal Reserve and the European Central Bank have adopted a number of measures, including aggressive policy rate cuts, to ease the liquidity crunch in the financial markets following the collapse of Lehman Brothers. Using high frequency spot and forward foreign exchange and interest rate quotes that are potentially executable for the period surrounding the 2008 global financial turmoil, this study examines the variations of intraday funding liquidity across the global financial markets that span different time zones. Moreover, the paper also tests how and to what extent policy actions undertaken by central banks affect the dynamics of market liquidity conditions. Similar to Hui et al. (2009), the paper uses the differential between the US dollar interest rate implied by the covered interest rate parity condition and the corresponding US dollar interest rate as a proxy for the liquidity (or the lack of it) in the US dollar money market. The study focuses on the EUR/USD exchange rate and compares the most stressful crisis period with other relatively less stressful periods. The intraday funding liquidity condition during the most tumultuous period shows that the pressures in the demand for US dollars through foreign exchange and forward markets spilled over to the Asian markets. The paper also examines how policy announcements by the central banks affect the dynamics of market liquidity. The study employs autoregressive models to capture the potential effects of monetary policy announcements on both the mean and volatility of the liquidity proxy. The empirical results show that the coordinated cuts of policy rates failed to stimulate lending in the short-term US money market, whereas the uncapped currency swap lines offered by the Federal Reserve to other central banks succeeded in easing the liquidity condition in the market. The policy is more effective and persistent for the very short end of the money market.
    Keywords: Financial Crisis, Intraday Liquidity, CIP Deviation, Monetary Policy
    JEL: G14 G15 E5
    Date: 2010–10
  3. By: Yuliya Lovcha (University of Alicante); Alejandro Perez-Laborda (University of Alicante)
    Abstract: over the last decade, the microstructure approach to exchange rates has become very popular. The underlying idea of this approach is that the order flows at different levels of aggregation contain valuable information to explain exchange rate movements. The bulk of empirical literature has focused on evaluating this hypothesis in a linear framework. This paper analyzes nonlinearities in the relation between exchange rates and customer order flows. We show that the relationship evolves over time and that it is different under different market conditions defined by exchange rate volatility. Further, we found that the nonlinearity can be captured successfully by the Threshold regression and Markov Switching models, which provide substantial explanatory power beyond the constant coefficients approach.
    Keywords: customer order flows, nonlinear models, microstructure, exchange rate
    JEL: C22 F31 G15
    Date: 2010
  4. By: Chang Hoon Oh (Brock University - Ontario (Canada), Faculty of Business); Michele Fratianni (Indiana University, Kelly School of Business, Bloomington US, Univ. Plitecnica Marche - Dept of Economics, MoFiR)
    Abstract: This paper finds that the stock of bilateral investment treaties (BIT) is subject to diminishing returns measured in terms of foreign direct investment flows. Diminishing returns are more pronounced among country-pairs that have not signed bilateral investment treaties but have their own BIT network than among country-pairs with their own bilateral investment treaties. For a given country's BIT network, a multinational enterprise finds more value in investing where a bilateral treaty is in place. This may suggest either stronger property-rights protection or greater latitude to use the host country as an export platform. Our subsidiary finding is that an index of a country's BIT network diversity appears to be a plausible explanation of the limiting force underlying the diminishing returns of the stock of BITs in a world where there is a mix between horizontally and vertically integrated multinational enterprises.
    Keywords: bilateral investment treaty, foreign direct investment, gravity equation, network diversity
    JEL: F21 F53
    Date: 2010–10
  5. By: Leonardo Morales-Arias; Alexander Dross
    Abstract: This article investigates the statistical and economic implications of adaptive forecasting of exchange rates with panel data and alternative predictors. The candidate exchange rate predictors are drawn from (i) macroeconomic ‘fundamentals’, (ii) return/volatility of asset markets and (iii) cyclical and confidence indices. Exchange rate forecasts at various horizons are obtained from each of the potential predictors using single market, mean group and pooled estimates by means of rolling window and recursive forecasting schemes. The capabilities of single predictors and of adaptive techniques for combining the generated exchange rate forecasts are subsequently examined by means of statistical and economic performance measures. The forward premium and a predictor based on a Taylor rule yield the most promising forecasting results out of the macro ‘fundamentals’ considered. For recursive forecasting, confidence indices and volatility in-mean yield more accurate forecasts than most of the macro ‘fundamentals’. Adaptive forecast combinations techniques improve forecasting precision and lead to better market timing than most single predictors at higher horizons
    Keywords: Exchange rate forecasting, panel data, forecast combinations, market timing
    JEL: C20 F31 G12
    Date: 2010–10
  6. By: Meixing Dai
    Abstract: This paper investigates the dynamic implications of Krugman’s (1999) model of financial crises with balance-sheet effects, which has a considerable impact on the literature of international financial crisis. Considering explicitly the wealth-accumulation constraint and the external equilibrium condition, I describe an emerging-market financial crisis as a jump from an unstable dynamic trajectory to a stable one, instead of a jump from a “good” to a “bad” equilibrium with zero investment and zero foreign debt. By discriminating the financial crises according to the severity of the negative impacts of some internal and external factors, this paper also adds some insights into the anti-crisis policy.
    Keywords: Currency crisis, balance sheet effect, external solvency constraint, financial crisis.
    JEL: F31 F32 F41
    Date: 2010
  7. By: Cho-Hoi Hui (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research); Tsz-Kin Chung (Hong Kong Monetary Authority)
    Abstract: The economic-political instability of a country, which is tied to its credit risk, often leads to sharp depreciation and heightened volatility in its currency. This paper shows that not only the creditworthiness of the euro-area countries with weaker fiscal positions but also that of the member countries with more sound fiscal positions are important determinants of the deep out-of-the-money euro put option prices, which embedded information on the euro crash risk during the sovereign debt crisis of 2009-2010. Using information on the option prices under the stochastic-volatility jump-diffusion model, the euro's crash probability of 11% in a year with crash size of 14% is estimated at the end of April 2010. However, during the period of the global financial crisis between the Lehman default and September 2009 before the debt crisis began, the estimated crash size reflects the potential sharp devaluation of the US dollar that might result from quantitative easing in the US.
    Keywords: European Sovereign Debt Crisis, Currency Options, Credit Default Swaps, Currency Crash
    JEL: F31 G13
    Date: 2010–10
  8. By: Filip De Beule
    Abstract: The article analyses the locational determinants of Chinese and Indian mergers and acquisitions (M&As). Existing literature often indicate that Chinese and Indian multinationals are motivated by access to local markets, natural resources and intangible assets . These determinants will be used to analyze the relevant determinants of Chinese and Indian acquisitions. On the basis of several macro-economic determinants the article will analyze the relevant host country characteristics that drive the locational choices of Chinese and Indian M&A, as well as the similarities and differences between these two so-called BRIC countries.
    Keywords: locational determinants, mergers and acquisitions, M&As, Chinese mergers and acquisitions, Indian mergeres and acquisitions, natural resources, intangible assets, BRIC countries, International finance, Economics
    Date: 2010
  9. By: Kosuke Aoki; Gianluca Benigno; Nobuhiro Kiyotaki
    Abstract: We study theoretically how the adjustment to liberalization of international financialtransaction depends upon the degree of domestic financial development. Using a model withdomestic and international borrowing constraints, we show that, when the domestic financialsystem is underdeveloped, capital account liberalization is not necessarily beneficial becauseTFP stagnates in the long-run or employment decreases in the short-run. Government policy,including allowing foreign direct investment, can mitigate the possible loss of employment,but cannot eliminate it unless the domestic financial system is improved.
    Keywords: credit frictions, capital account liberalization
    JEL: F32
    Date: 2010–10
  10. By: Joshua Aizenman; Hiro Ito; Menzie D. Chinna
    Abstract: This paper extends their previous paper (Aizenman, Chinn, and Ito 2008) and explores some of the unexplored questions. First, they examine the channels through which the trilemma policy configurations affect output volatility. Secondly, they investigate how trilemma policy configurations affect the output performance of the economies under severe crisis situations. Thirdly, they look into how trilemma configurations have evolved in the aftermath of economic crises in the past. They find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. [ADBI Working Paper 213]
    Keywords: trilemma, policy, performance, economic, finances
    Date: 2010
  11. By: Buch, Claudia M.; Koch, Cathérine Tahmee; Koetter, Michael
    Abstract: Recent developments on international financial markets have called the benefits of bank globalization into question. Large, internationally active banks have acquired substantial market power, and international activities have not necessarily made banks less risky. Yet, surprisingly little is known about the actual link between bank internationalization, bank risk, and market power. Analyzing this link is the purpose of this paper. We jointly estimate the determinants of risk and market power of banks, and we analyze the effects of changes in terms of the number of foreign countries (the extensive margin) and the volume of foreign assets (the intensive margin). Our paper has four main findings. First, there is a strong negative feedback effect between risk and market power. Second, banks with higher shares of foreign assets, in particular those held through foreign branches, have higher market power at home. Third, holding assets in a large number of foreign countries tends to increase bank risk. Fourth, the impact of internationalization differs across banks from different banking groups and of different size. --
    Keywords: market power-risk nexus,international banking,micro-data,Germany
    JEL: F3 G21
    Date: 2010
  12. By: Emma Aisbett; Larry Karp; Carol McAusland
    Abstract: International investment agreements in bilateral treaties or free trade agreements allow investors to bring compensation claims when their investments are hurt by new regulations addressing environmental or other social concerns. Compensation rules such as expropriation clauses in international treaties help solve post-investment moral hazard problems such as hold-ups, thereby helping to prevent inefficient over-regulation and encouraging foreign investment. However, when social or environmental harm is uncertain preinvestment, compensation requirements can interact with National Treatment clauses in a manner that reduces host government welfare and makes them less likely to admit investment. A police powers carve-out from the definition of compensable expropriation can be Pareto-improving and can increase the level of foreign investment.
    Keywords: foreign direct investment, regulatory takings, expropriation, international investment agreements, National Treatment, environment
    JEL: K3 Q58 F21
    Date: 2010–11

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