nep-ifn New Economics Papers
on International Finance
Issue of 2010‒11‒20
twelve papers chosen by
Ajay Shah
National Institute of Public Finance and Policy

  1. Uncovering uncovered interest parity during the classical gold standard era, 1888-1905. By Andrew Coleman;
  2. The impact of population ageing on international capital flows By Narciso, Alexandre
  3. Foreign shareholding: A decomposition analysis. By Shah, Ajay; Patnaik, Ila
  4. Essays on financial crises in emerging markets By Komulainen, Tuomas
  5. The effects of capital market openness on exchange rate pass-through and welfare in an inflation-targeting small open economy By Sanchita Mukherjee
  6. The foreign exchange market: return distributions, multifractality, anomalous multifractality and Epps effect By Stanislaw Drozdz; Jaroslaw Kwapien; Pawel Oswiecimka; Rafal Rak
  7. International Capital Flows and Credit Market Imperfections: a Tale of Two Frictions By Alberto Martin; Filippo Taddei
  8. The term structure of interest rates, the expectations hypothesis and international financial integration: Evidence from Asian Economies By Mark J. Holmes; Theodore Panagiotidis; Jesus Otero
  9. Foreign Direct Investment and the Internationalisation of South African Mining Companies into Africa By John Luiz; Meshal Ruplal
  10. Modes of foreign direct investment and patterns of trade: Why do multinational enterprises come To China? By Park, Innwon; Park, Soonchan
  11. Why a diversified portfolio should include African assets By Paul Alagidede; Theodore Panagiotidis; Xu Zhang
  12. Exports Versus FDI Revisited: Does Finance Matter? By Claudia M. Buch; Iris Kesternich; Alexander Lipponer; Monika Schnitzer

  1. By: Andrew Coleman (Motu Economic and Public Policy Research);
    Abstract: This paper examines the uncovered interest parity hypothesis using the dollar-sterling exchange rate during the gold standard era. This period is interesting because the exchange rate was seasonal, because transactions costs were high, and because occasions when uncovered interest rate speculation did not occur can be identified. The paper shows UIP speculation frequently did not occur, that speculation occurred more in response to expected exchange rate changes than interest rate differentials, and that profitability varied systematically with interest rate differentials. The estimated UIP equations are substantially improved by distinguishing occasions when sterling was borrowed not lent.
    Keywords: Uncovered interest parity, gold standard
    JEL: N21 F31
    Date: 2010–02
  2. By: Narciso, Alexandre
    Abstract: This paper is oriented to study the relationship between demographical factors and international capital flows. We analyse the impact of ageing on foreign direct investments (FDI) and foreign portfolio investments (FPI) on a bilateral level. Firstly we present a theoretical foundation of the relationship and then we test it by an empirical model. Theoretical foundations are based on the lifecycle hypothesis and overlapping generations model in a demographic context. The bilateral FDI and FPI are modelled by using fixed effects balanced panel data. The results suggest that the current and future age structure of the nation has significant effect on current international capital flows.
    Keywords: International Capital Flows; Demography; Capital Mobility; FDI; Portfolio Investment
    JEL: G15 E00 F21 J20
    Date: 2010–11–04
  3. By: Shah, Ajay (National Institute of Public Finance and Policy); Patnaik, Ila (National Institute of Public Finance and Policy)
    Abstract: Stulz (2005) has emphasised that for home bias to decline, insiders have to reduce ownership so as to make purchase of shares by foreigners possible. We offer a decomposition in the ownership of shares by foreigners into three parts: the change in insider shareholding, the change in market capitalisation and the change in the fraction of outside shareholding that is held by foreigners. As an example, this decomposition is applied to help understand the sharp change in foreign ownership of Indian firms after 2001.
    Keywords: Home bias, Foreign investors
    JEL: G1 G15
    Date: 2010–10
  4. By: Komulainen, Tuomas (Bank of Finland Research)
    Abstract: The financial crises in emerging markets in 1997-1999 were preceded by financial liberalisation, rapid surges in capital inflows, increased levels of indebtedness, and then sudden capital outflows. The study contains four essays that extend the different generations of crisis literature and analyse the role of capital movements and borrowing in the recent crises. Essay 1 extends the first generation models of currency crises. It analyses bond financing of fiscal deficits in domestic and foreign currency, and compares the timing and magnitude of attack with the basic case where deficits are monetised. The essay finds that bond financing may not delay the crisis. But if the country’s indebtedness is low, the crisis is delayed by bond financing, especially if the borrowing is carried out with bonds denominated in foreign currency. Essay 2 extends the second generation model of currency crises by adding capital flows. If these depend negatively on crisis probability, there will be multiple equilibria. The range of country fundamentals for which self-fulfilling crises are possible is wider when capital flows are included, and thus more countries may end up in crisis. An application of the model shows that in 1996 in many emerging economies the fundamentals were inside the range of multiple equilibria and hence self-fulfilling crises were possible. Essay 3 studies financial contagion and develops a model of the international financial system. It uses a basic model of financial intermediation, but adds several local banks and an international bank. These banks are able to use outside borrowing, the amount of which is determined by the value of their collateral. The essay finds that the use of leverage by local and global banks and the fall in collateral prices comprise an important channel and reason for contagion. Essay 4 analyses the causes of financial crises in 31 emerging market countries in 1980–2001. A probit model is estimated using 23 macroeconomic and financial sector indicators. The essay finds that traditional variables (eg unemployment and inflation) and several indicators of indebtedness (eg private sector liabilities and banks' foreign liabilities) explain currency crises. When the sample was divided into pre- and post-liberalisation periods, the indicators of indebtedness became more important in predicting crisis in the postliberalisation period.
    Keywords: currency crises; banking crises; emerging markets; borrowing; collateral; contagion; liberalisation
    JEL: E50 E60 F00 N20 O10 O40
    Date: 2010–11–11
  5. By: Sanchita Mukherjee
    Abstract: This paper analyzes the impact of capital market openness on exchange rate pass-through and subsequently on the social loss function in an inflation-targeting small open economy under a pure commitment policy. Applying the intuition behind the macroeconomic trilemma, the author examines whether a more open capital market in an inflation-targeting country improves the credibility of the central bank and consequently reduces exchange rate pass-through. First, the effect of capital openness on exchange rate pass-through is empirically examined using a new Keynesian Phillips curve. The empirical investigation reveals that limited capital openness leads to greater pass-through from the exchange rate to domestic inflation, which raises the marginal cost of deviation from the inflation target. This subsequently worsens the inflation output-gap trade-off and increases the social loss of the inflation targeting central bank under pure commitment. However, the calibration results suggest that the inflation output-gap trade-off improves and the social loss decreases even in the presence of larger exchange rate pass-through if the capital controls are effective at insulating the exchange rate from interest rate and risk-premia shocks.
    Keywords: Monetary policy ; Inflation targeting ; Foreign exchange
    Date: 2010
  6. By: Stanislaw Drozdz; Jaroslaw Kwapien; Pawel Oswiecimka; Rafal Rak
    Abstract: We present a systematic study of various statistical characteristics of high-frequency returns from the foreign exchange market. This study is based on six exchange rates forming two triangles: EUR-GBP-USD and GBP-CHF-JPY. It is shown that the exchange rate return fluctuations for all the pairs considered are well described by the nonextensive statistics in terms of q-Gaussians. There exist some small quantitative variations in the nonextensivity q-parameter values for different exchange rates and this can be related to the importance of a given exchange rate in the world's currency trade. Temporal correlations organize the series of returns such that they develop the multifractal characteristics for all the exchange rates with a varying degree of symmetry of the singularity spectrum f(alpha) however. The most symmetric spectrum is identified for the GBP/USD. We also form time series of triangular residual returns and find that the distributions of their fluctuations develop disproportionately heavier tails as compared to small fluctuations which excludes description in terms of q-Gaussians. The multifractal characteristics for these residual returns reveal such anomalous properties like negative singularity exponents and even negative singularity spectra. Such anomalous multifractal measures have so far been considered in the literature in connection with the diffusion limited aggregation and with turbulence. We find that market inefficiency on short time scales leads to the occurrence of the Epps effect on much longer time scales. Although the currency market is much more liquid than the stock markets and it has much larger transaction frequency, the building-up of correlations takes up to several hours - time that does not differ much from what is observed in the stock markets. This may suggest that non-synchronicity of transactions is not the unique source of the observed effect.
    Date: 2010–10
  7. By: Alberto Martin; Filippo Taddei
    Abstract: The financial crisis of 2007-08 has underscored the importance of adverse selection in financial markets. This friction has been mostly neglected by macroeconomic models of financial frictions, however, which have focused almost exclusively on the effects of limited pledgeability. In this paper, we fill this gap by developing a standard growth model with adverse selection. Our main results are that, by fostering unproductive investment, adverse selection: (i) leads to an increase in the economy's equilibrium interest rate, and (ii) it generates a negative wedge between the marginal return to investment and the equilibrium interest rate. Under financial integration, we show how this translates into excessive capital inflows and endogenous cycles. We also explore how these results change when limited pledgeability is added to the model. We conclude that both frictions complement one another and argue that limited pledgeability exacerbates the effects of adverse selection.
    Keywords: Limited Pledgeability; Asymmetric Information; International Capital Flows; Credit Market Imperfections
    JEL: D53 D82 E22 F34
    Date: 2010
  8. By: Mark J. Holmes (Department of Economics, Waikato University Management School); Theodore Panagiotidis (Department of Economics, University of Macedonia); Jesus Otero (Facultad de Economia, Universidad del Rosario)
    Abstract: The validity of the expectations hypothesis of the term structure is examined for a sample of Asian countries. A panel stationarity testing procedure is employed that addresses both structural breaks and cross-sectional dependence. Asian term structures are found to be stationary and supportive of the expectations hypothesis. Further analysis suggests that international financial integration is associated with interdependencies between domestic and foreign term structures insofar as cross-term structures based on differentials between domestic (foreign) short- and foreign (domestic) long-rates are also stationary.
    Keywords: Heterogeneous dynamic panels, term structure, mean reversion, panel stationarity test
    JEL: C33 F31 F33 G15
    Date: 2010–11
  9. By: John Luiz; Meshal Ruplal
    Abstract: The paper investigates the factors influencing the internationalisation of mining firms into Africa and the strategies employed. We focus on the FDI of South African mining firms because of the dominance of this country in the extractive resources industry for over a century. A semi-structured interview survey process consisting of written questionnaires and one-on-one interviews that incorporated both structured as well as open-ended questions was used. The structured questionnaire attempted to identify the entry-mode characteristics of the mining firms as well as the importance of the factors influencing the internationalisation of mining firms. The open-ended questionnaire was designed to be probing in nature, in order to identify how mining companies manage the factors deemed present in an operational context. More than 80% of South African mining firms by market capitalisation provided responses to the survey. The research revealed that security of tenure, political stability and the availability of infrastructure were the three most important factors influencing the internationalisation of South African mining firms out of the nine factors tested in the survey. The most widespread strategies used to manage these factors were political lobbying, bargaining and negotiation.
    Keywords: Theory of FDI and the MNE (Ownership-Location-Internalization), Mining, Africa, Factor Analysis, Incorporating Country Variables
    JEL: F23 L72 O55
    Date: 2010
  10. By: Park, Innwon; Park, Soonchan
    Abstract: This paper investigates the link between patterns of trade and modes of foreign direct investment (FDI) by utilizing exports, imports, and inward FDI data for China over the period 1998 to 2007. We construct a modified gravity equation to find the main modes of inward FDI into China with considering spatially interdependent third country effect. The problem of endogeneity is controlled by applying the system generalized method of moments (GMM) estimation technique. We find that there is no evidence of statistically significant substitutability and complementarity between bilateral trade and FDI in the aggregate data. On the contrary, the trade-diverting third country effect of inward FDI is proven to be strong. As we decompose the aggregate trade goods into final and intermediate goods, we find that there is strong evidence of vertical FDI for importing intermediate goods from the home country and exporting final goods back to the home country. However, the motivation of vertical FDI has been diminishing and the modes of export-platform and complex vertical FDI have begun to emerge. This implies that China has imported intermediate inputs from the home country of FDI, produced final goods or parts and components, and exported them back to the home country. Recently, however, we have noticed that there has been a diversion trend of the vertical linkage from home country to third countries. This indicates that the main mode of inward FDI into China has been shifting from “home export base” to “third country export base”.
    Keywords: patterns of trade; foreign direct investment; multinational enterprises; China
    JEL: F23 F21
    Date: 2010–11–08
  11. By: Paul Alagidede (Department of Economics, University of Stirling); Theodore Panagiotidis (Department of Economics, University of Macedonia); Xu Zhang (Guosen Research Institute)
    Abstract: We employ parametric and non-parametric cointegration to investigate the extent of integration between African stock markets and the rest of the world. Long-run correlation estimates imply very low association between the two. The two distinct cointegration approaches confirm the latter through recursive estimation. The implication is that global market movements may have little impact on Africa. However, we argue that including African assets in a mean variance portfolio could be beneficial to international investors.
    Keywords: Correlation, Long-run correlation, Cointegration, Non-parametric cointegration, African Stock Markets.
    JEL: C22 C52 G10
    Date: 2010–11
  12. By: Claudia M. Buch (University of Tübingen); Iris Kesternich (University of Munich); Alexander Lipponer (Deutsche Bundesbank); Monika Schnitzer (University of Munich and CEPR)
    Abstract: This paper explores the impact of financial constraints on the internationalization strategies of firms. It contributes to the literature by focusing on three aspects: First, the paper studies the impact of financial constraints on exporting relative to FDI. Consistent with theory, the empirical results confirm that the impact of financial constraints is stronger for FDI than for exporting. Second, the paper analyzes the extensive and the intensive margins and finds that financial frictions matter for both. Third, the paper explores the impact on manufacturing as compared to service industries and shows that firms in service industries are affected more than firms in manufacturing. The paper also identifies a threshold effect: Financial constraints do not matter for small firms whose productivity seems to be too low to consider international expansions.
    Keywords: Multinational firms, exports versus FDI, financial constraints, heterogeneity, productivity
    JEL: F2 G2
    Date: 2010–11

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