nep-ifn New Economics Papers
on International Finance
Issue of 2011‒02‒05
twenty-two papers chosen by
Ajay Shah
National Institute of Public Finance and Policy

  1. Euroisation in Serbia By Alexandre Chailloux; Franziska Ohnsorge; David Vavra
  2. Role of the U.S. Dollar in International Financial System By Mária Vojtková
  3. Foreign currency lending in emerging Europe: bank-level evidence By Martin Brown; Ralph De Haas
  4. Monetary Policy in Emerging Markets: A Survey By Frankel, Jeffrey
  5. What can EMU countries' sovereign bond spreads tell us about market perceptions of default probabilities during the recent financial crisis? By Niko Dotz; Christoph Fisher
  6. Addressing private sector currency mismatches in emerging Europe By Jeromin Zettelmeyer; Piroska M. Nagy; Stephen Jeffrey
  7. The Impact of Monetary Policy on Financial Markets in Small Open Economies: More or Less Effective During the Global Financial Crisis? By Pennings, Steven; Ramayandi, Arief; Tang, Hsiao Chink
  8. Financial integration and growth - Is emerging Europe different? By Christian Friedrich; Isabel Schnabel; Jeromin Zettelmeyer
  9. Global banking and international business cycles By Robert Kollmann; Zeno Enders; Gernot J. Mueller
  10. Globalization, Governance, and the Returns to Cross-Border Acquisitions By Ellis, Jesse; Moeller, Sara B.; Schlingemann, Frederick P.; Stulz, Rene M.
  11. The home bias in equities and distribution costs By Harms, Philipp; Hoffmann, Mathias; Ortseifer, Christina
  12. Economic Factors Contributing to Time-Varying Conditional Correlations in Stock Returns By Nagayasu, Jun
  13. Determinants of the Exchange Rate in Colombia under Inflation Targeting By Fredy Alejandro Gamboa Estrada
  14. End of the line: Exchange Rate and Monetary Policy for Sustainable Post-conflict Transition By Ibrahim Elbadawi; Raimundo Soto Author-X-Name-First: Raimundo
  15. Chinese monetary policy and the dollar peg By Reade, J. James; Volz, Ulrich
  16. Price Discovery in Currency Markets By Carol Osler; Alexander Mende; Lukas Menkhoff
  17. Global crisis and Financial destabilization in ASEAN countries. A microstructural perspective By Céline Gimet; Thomas Lagoarde-Segot
  18. Cross-country causes and consequences of the crisis: an update By Andrew K. Rose; Mark M. Spiegel
  19. Extreme Returns: The Case of Currencies By Carol Osler; Tanseli Savaser
  20. A Balancing-Process Approach to Firm Internationalization By Kim, Min-Young; Mahoney, Joseph T.; Tan, Danchi
  21. Should Argentina Be Welcomed Back by the Capital Markets? By Porzecanski, Arturo C.
  22. Financial Spillovers Across Countries: The Case of Canada and the United States By Kimberly Beaton; Brigitte Desroches

  1. By: Alexandre Chailloux (IMF); Franziska Ohnsorge (EBRD); David Vavra (OGResearch)
    Abstract: Euroisation in Serbia is rooted in a long history of macroeconomic instability. Extreme inflation volatility has undermined trust in the dinar and discouraged dinar savings. At the same time, an abundant supply of foreign capital inflows has provided easy access to foreign currency lending at low interest rates in an environment of perceived exchange rate stability – a perception reinforced by the choice of exchange rate regime. As a result, both the asset and the liability side of banks’ balance sheets, and even those of the non-bank sector, is heavily foreign currency-denominated. This paper documents the forces that promote euroisation in Serbia. The paper argues that, in the wake of the global crisis, a window of opportunity has emerged that could foster a process of de-euroisation. The lack of foreign funding and recent exchange rate volatility has tilted borrower incentives towards local currency borrowing. If disinflationary macroeconomic policies gain credibility, with the possible support of regulatory options, euroisation could drop sharply.
    JEL: O1 P2 P5
    Date: 2010–10
  2. By: Mária Vojtková (University of Economics in Bratislava, Faculty of National Economy, Department of Banking and International Finance)
    Abstract: In the study we focus on theoretical and practical aspects of the role of the U.S. dollar in current international monetary system. We shortly describe the historical evolution of monetary system when it comes to the dollar position in it. Subsequently, we assess current status of the U.S. dollar in financial markets and its share on international foreign exchange reserves. In the application part, we examine how changes in the U.S. dollar exchange rate affect countries operating in the pegged exchange regime. At the same time, we focus on the problem of current account deficit of the U.S. balance of payments and its relationship to the export-oriented countries pegged to the U.S. dollar.
    Keywords: Bretton-Wood monetary system, U.S. dollar, pegged exchange regime, fixed exchange regime, balance of payment, terms of trade
    JEL: E42 E52 F30 F33
    Date: 2011–01–28
  3. By: Martin Brown (Swiss National Bank, Tilburg University); Ralph De Haas (EBRD)
    Abstract: Based on survey data from 193 banks in 20 countries we provide the first bank-level analysis of the determinants of foreign currency (FX) lending in emerging Europe. We find that FX lending by all banks, regardless of their ownership structure, is strongly determined by the macroeconomic environment. We find no evidence of foreign banks ‘pushing’ FX loans indiscriminately because of easier access to wholesale funding in foreign currency. In fact, while foreign banks do lend more in FX to corporate clients, they do not do so to retail clients. We also find that after a take-over by a foreign bank, the acquired bank does not increase its FX lending any faster than a bank which remains in domestic hands.
    JEL: O1 P2 P5
    Date: 2010–12
  4. By: Frankel, Jeffrey (Harvard Kennedy School)
    Abstract: The characteristics that distinguish most developing countries, compared to large industrialized countries, include: greater exposure to supply shocks in general and trade volatility in particular, procyclicality of both domestic fiscal policy and international finance, lower credibility with respect to both price stability and default risk, and other imperfect institutions. These characteristics warrant appropriate models. Models of dynamic inconsistency in monetary policy and the need for central bank independence and commitment to nominal targets apply even more strongly to developing countries. But because most developing countries are price-takers on world markets, the small open economy model, with nontraded goods, is often more useful than the two-country two-good model. Contractionary effects of devaluation are also far more important for developing countries, particularly the balance sheet effects that arise from currency mismatch. The exchange rate was the favored nominal anchor for monetary policy in inflation stabilizations of the late 1980s and early 1990s. After the currency crises of 1994-2001, the conventional wisdom anointed Inflation Targeting as the preferred monetary regime in place of exchange rate targets. But events associated with the global crisis of 2007-09 have revealed limitations to the choice of CPI for the role of price index. The participation of emerging markets in global finance is a major reason why they have by now earned their own large body of research, but it also means that they remain highly prone to problems of asymmetric information, illiquidity, default risk, moral hazard and imperfect institutions. Many of the models designed to fit emerging market countries were built around such financial market imperfections; few economists thought this inappropriate. With the global crisis of 2007-09, the tables have turned: economists should now consider drawing on the models of emerging market crises to try to understand the unexpected imperfections and failures of advanced-country financial markets.
    JEL: E00 E50 F41 O16
    Date: 2011–01
  5. By: Niko Dotz; Christoph Fisher
    Abstract: This paper presents a new approach to analysing recent movements of EMU sovereign bond spreads. Based on a GARCH-in-mean model originally used in the exchange rate target zone literature, spreads are decomposed into a risk premium, an expected loss component and a liquidity premium. Time-varying probabilities of default are derived. The results suggest that the rise in sovereign spreads during the recent financial crisis mainly reflects an increased expected loss component. In addition, the rescue of Bear Stearns in March 2008 seems to mark a change in market perceptions of sovereign bond risk. The government bonds of some countries lost their former role as a safe haven. While price competitiveness always helps to explain sovereign spreads, it increasingly moved into investors’ focus as financial sector soundness weakened.
    Keywords: Liquidity (Economics) ; Default (Finance) ; Bonds - Prices
    Date: 2011
  6. By: Jeromin Zettelmeyer (EBRD); Piroska M. Nagy (EBRD); Stephen Jeffrey (University of Warwick)
    Abstract: This paper provides a survey of the theoretical and empirical literature on the dollarisation of corporate and household liabilities; presents evidence on the causes of FX lending specifically in transition economies; and proposes a set of criteria to help decide on the right policy response based on country characteristics. These criteria particularly affect the extent to which regulation should be part of the policy response. Regulation to contain FX mismatches is useful in relatively advanced countries in which small market size and/or proximity to the euro make it difficult to fully develop local currency capital markets. In contrast, regulatory responses could be counterproductive in less advanced countries with high macroeconomic volatility. In these countries, the route to de-dollarisation first and foremost requires the strengthening of macroeconomic institutions.
    JEL: O1 P2 P5
    Date: 2010–06
  7. By: Pennings, Steven (Department of Economics); Ramayandi, Arief (Asian Development Bank); Tang, Hsiao Chink (Asian Development Bank)
    Abstract: This paper estimates the impact of monetary policy on exchange rates and stock markets for eight small open economies: Australia, Canada, the Republic of Korea, New Zealand, the United Kingdom, Indonesia, Malaysia and Thailand. On average across these countries, a one percentage point surprise rise in official interest rates leads to a 1% appreciation of the exchange rate and a 1% fall in stock market indices. The effect on exchange rates is notably weaker in the non-Organization for Economic Cooperation and Development (OECD) countries with a managed float. For the OECD countries, there is no robust evidence of a change in the effect of policy during the global financial crisis. For the non-OECD countries, there is some evidence of a stronger effect of policy on stock markets during the crisis, although further research is needed to investigate whether this is a result of measurement issues.
    Keywords: Monetary policy effectiveness; exchange rate; stock prices; crisis; Asian economies
    JEL: E44 E52 G14
    Date: 2011–01–01
  8. By: Christian Friedrich (Graduate Institute for International and Development Studies, Geneva); Isabel Schnabel (Johannes Gutenberg University, Mainz); Jeromin Zettelmeyer (EBRD)
    Abstract: Using industry-level data, this paper shows that the European transition region benefited much more strongly from financial integration in terms of economic growth than other developing countries in the years preceding the current crisis. We analyse several factors that may explain this finding: financial development, institutional quality, trade integration, political integration, and financial integration itself. The explanation that stands out is political integration. Within the group of transition countries, the effect of financial integration is strongest for countries that are politically closest to the European Union. This suggests that political and financial integration are complementary and that political integration can considerably increase the benefits of financial integration.
    JEL: O1 P2 P5
    Date: 2010–12
  9. By: Robert Kollmann; Zeno Enders; Gernot J. Mueller
    Abstract: This paper incorporates a global bank into a two-country business-cycle model. The bank collects deposits from households and makes loans to entrepreneurs, in both countries. It has to finance a fraction of loans using equity. We investigate how such a bank capital requirement affects the international transmission of productivity and loan default shocks. Three findings emerge. First, the bank's capital requirement has little effect on the international transmission of productivity shocks. Second, the contribution of loan default shocks to business cycle fluctuations is negligible under normal economic conditions. Third, an exceptionally large loan loss originating in one country induces a sizeable and simultaneous decline in economic activity in both countries. This is particularly noteworthy, as the 2007–09 global financial crisis was characterized by large credit losses in the US and a simultaneous sharp output reduction in the U.S. and the euro Area. Our results thus suggest that global banks may have played an important role in the international transmission of the crisis.
    Keywords: Equity ; Bank capital ; Productivity ; Default (Finance) ; Loans
    Date: 2011
  10. By: Ellis, Jesse (University of Pittsburgh); Moeller, Sara B. (University of Pittsburgh); Schlingemann, Frederick P. (University and Pittsburgh and Erasmus University); Stulz, Rene M. (Ohio State University)
    Abstract: Using a sample of control cross-border acquisitions from 61 countries from 1990 to 2007, we find that acquirers from countries with better governance gain more from such acquisitions and their gains are higher when targets are from countries with worse governance. Other acquirer country characteristics are not consistently related to acquisition gains. For instance, the anti-self-dealing index of the acquirer has opposite associations with acquirer returns depending on whether the acquisition of a public firm is paid for with cash or equity. Strikingly, global effects in acquisition returns are at least as important as acquirer country effects. First, the acquirer's industry and the year of the acquisition explain more of the stock-price reaction than the country of the acquirer. Second, for acquisitions of private firms or subsidiaries, acquirers gain more when acquisition returns are high for acquirers from other countries. We find strong evidence that better alignment of interests between insiders and minority shareholders is associated with greater acquirer returns and weaker evidence that this effect mitigates the adverse impact of poor country governance.
    JEL: G31 G32 G34
    Date: 2011–01
  11. By: Harms, Philipp; Hoffmann, Mathias; Ortseifer, Christina
    Abstract: We show that including distribution costs into a general equilibrium model of international portfolio choice contributes to explaining the 'home bias' in international equity investment. Our model is able to replicate observed investment positions for a wide range of parameter values, even if agents have an incentive to hedge labor income risk by purchasing foreign equity. This is because the existence of a retail sector affects both the correlation of domestic returns with the domestic price level and the correlation between financial and nonfinancial income. --
    Keywords: International Financial Market Integration,International Risk Sharing,Home Bias
    JEL: F41 G11 G15
    Date: 2010
  12. By: Nagayasu, Jun
    Abstract: This paper attempts to find economic and financial factors contributing to the changing correlations of stock returns. Time-varying correlations were documented in previous studies, but a few attempts have been made to investigate their evolution. Using daily data from the Asia-Pacific region, this paper provides evidence that return correlations are negatively correlated with the distance between the markets. Furthermore, correlations tend to be higher in advanced countries and increase at times of the active trading (e.g., around the Lehman shock). Instead, the level of correlations declines among pairs of countries with less financial integration.
    Keywords: Conditional correlations; DCC
    JEL: G15 F36
    Date: 2010–12–01
  13. By: Fredy Alejandro Gamboa Estrada
    Abstract: This research studies the forecasting performance of conventional and more recent exchange rate models in Colombia. The purpose is to explain which have been the main exchange rate determinants under an Inflation Targeting regime and a completely floating exchange rate scheme. Compared to similar studies, this paper includes conventional specifications and Taylor rule approaches that assume exogenous and endogenous monetary policy respectively. Based on the Johansen multivariate cointegration methodology, the results provide evidence for the existence of cointegration in all specifications except in the Sticky-Price Monetary Model and the Taylor Rule model that includes the real exchange rate. In addition, out of sample forecasting performance is analyzed in order to compare if all specifications outperform the drift less random walk model. All models outperform the random walk at one month horizon. However, the Flexible Price Monetary Model and the Uncovered Interest Parity Condition have superior predictive power for longer horizons.
    Date: 2011–01–23
  14. By: Ibrahim Elbadawi; Raimundo Soto Author-X-Name-First: Raimundo
    Abstract: This paper asks the question as to whether the choice of the exchange rate regime matters for post-conflict economic recovery and macro stabilization. Though an important aspect of the macroeconomic agenda for post-conflict, it has however, been largely ignored by the literature. We identify three main exchange rate regimes (fixed, managed floating and free float) and estimate their marginal contributions to post-conflict economic recovery and macro stabilization in the context of fully specified models of four pivotal macroeconomic variables: per capita GDP and export growth, the demand for money balances and inflation. The paper estimates extended versions of these models in a panel over 1970-2008 covering 132 countries, including the 38 post-conflict countries and 94 peaceful ones as a control group. The evidence suggests that the managed floating regime appears to have an edge on some critical areas of economic performance for post-conflict reconstruction.
    Keywords: Monetary Policy, Civil Wars, Transition, Economic Growth.
    JEL: E52 O43 N40
    Date: 2011
  15. By: Reade, J. James; Volz, Ulrich
    Abstract: This paper investigates to what extent Chinese monetary policy is constrained by the dollar peg. To this end, we use a cointegration framework to examine whether Chinese interest rates are driven by the Fed's policy. In a second step, we estimate a monetary model for China, in which we include also other monetary policy tools besides the central bank interest rate, namely reserve requirement ratios and open market operations. Our results suggest China has been relatively successful in isolating its monetary policy from the US policy and that the interest rate tool has not been effectively made use of. We therefore conclude that by employing capital controls and relying on other instruments than the interest rate China has been able to exert relatively autonomous monetary policy. --
    Keywords: Chinese monetary policy,monetary independence,cointegration
    JEL: C32 E52 F33
    Date: 2010
  16. By: Carol Osler (International Business School, Brandeis University); Alexander Mende (Leibniz Universität); Lukas Menkhoff (Leibniz Universität)
    Abstract: This paper examines the price discovery process in currency markets, basing its analysis on the pivotal distinction between the customer (end-user) market and the interdealer market. It first provides evidence that the price discovery process cannot be based on adverse selection between dealers and end users, as postulated in standard equity-market models, because the spreads dealers quote to their customers are not positively related to a trade’s likely information content. The paper then highlights three hypotheses from the literature – fixed operating costs, market power, and strategic dealing – that may explain the cross-sectional variation in customers spreads. The paper finishes by proposing a price discovery process relevant to liquid two-tier markets and providing preliminary evidence that this process applies to currencies.
    Keywords: Bid-ask spreads, foreign exchange, asymmetric information, microstructure, price discovery, interdealer, inventory, market order, limit order
    JEL: F31 G14 G15
    Date: 2010–06
  17. By: Céline Gimet (Université de Lyon, Lyon, F-69003, France ; CNRS, GATE Lyon St Etienne,F-69130 Ecully, France); Thomas Lagoarde-Segot (Euromed Management, School of Management, Marseille & DEFI ; University of Aix-Marseille, France)
    Abstract: This paper investigates wether the ongoing financial crisis has destabilized the microstructures of ASEAN stock market. Using daily stock market data from 2007 to 2010, we first develop a set of monthly country-level liquidity, efficiency, international integration and volatility indicators. We then analyze the impact of global market volatility shocks on those indicators, using a set of Bayesian S-VAR models. Finally, forecast error variance decomposition analysis and impulse response function permits to identify the magnitude and the symmetry of ASEAN financial systems’ exposures to international shocks. Our results uncover significant and asymmetrical schock transmission channels. We draw implications for the design of future integration initiatives.
    Keywords: microstructures, regional integration,schok vulnerability, SVAR
    JEL: F32 F36 G15 C32
    Date: 2011
  18. By: Andrew K. Rose; Mark M. Spiegel
    Abstract: We update Rose and Spiegel (2010a, b) and search for simple quantitative models of macroeconomic and financial indicators of the "Great Recession" of 2008-09. We use a cross-country approach and examine a number of potential causes that have been found to be successful indicators of crisis intensity by other scholars. We check a number of different indicators of crisis intensity, and a variety of different country samples. While countries with higher income and looser credit market regulation seemed to suffer worse crises, we find few clear reliable indicators in the pre-crisis data of the incidence of the Great Recession. Countries with current account surpluses seemed better insulated from slowdowns.
    Keywords: Financial crises ; Econometric models
    Date: 2011
  19. By: Carol Osler (International Business School, Brandeis University); Tanseli Savaser (Department of Economics, Williams College)
    Abstract: This paper investigates how active price-contingent trading contributes to extreme returns even in the absence of news. Price-contingent trading, which is common across financial markets, includes algorithmic trading, technical trading, and dynamic option hedging. The paper highlights four properties of such trading that increase the frequency of extreme returns, and then estimates the relative of these properties using data from the foreign exchange market. The four key properties we consider are: (1) high kurtosis in the distribution of order sizes; (2) clustering of trades within the day; (3) clustering of trades at certain prices; and (4) positive and negative feedback between trading and returns. Calibrated simulations indicate that interactions among these properties are at least as important as any single one. Among individual properties, the orders’ size distribution and feedback effects have the strongest influence. Price-contingent trading could account for over half of realized excess kurtosis in currency returns.
    Keywords: Crash, Fat Tails,Kurtosis,Exchange Rates,Order Flow,High-Frequency,Microstructure,Jump Process,Value-At-Risk,Risk Management
    JEL: G1 F3
    Date: 2010–11
  20. By: Kim, Min-Young (University of Illinois); Mahoney, Joseph T. (University of Illinois); Tan, Danchi (National Chengchi University)
    Abstract: Drawing on the resource-based view of the firm, this paper develops a balancing-process approach to explain the motivations and location choices of foreign direct investment (FDI). In this approach, FDI is viewed as a means to balance a firm's portfolio of resources and capabilities through utilizing foreign strategic factor markets with the ultimate goal of achieving growth and sustainable competitive advantage. This approach joins exploitative and explorative FDI in a single framework and helps explain why a firm can conduct both types of FDI simultaneously.
    Date: 2010
  21. By: Porzecanski, Arturo C.
    Abstract: Argentina has been making its way back to the international capital markets after being shunned for almost a decade following a catastrophic default and devaluation. The question of whether financial intermediaries and institutional investors in the U.S. and Europe should welcome Argentina back to the global capital markets is certainly relevant –- especially for those with short memories who may be tempted by the high yields on offer to rush in without a full understanding of the significant risks involved. At first sight, it would appear that Argentina has come a long way from its troubled past: it has recorded major gains in real GDP, employment growth, and various financial ratios that usually buttress creditworthiness (e.g., tax revenues, export earnings and international reserves). However, it would be naïve to rush to the conclusion that Argentina is a creditworthy or relatively safe place in which to invest. Notwithstanding an impressive economic recovery, the country’s ability to service its financial obligations remains quite limited, and the government’s attitude toward official and private creditors, as well as toward court judgments and arbitral awards, remains one of contempt. The country is ranked uniformly low in various measures of the business climate, competitiveness, transparency, corruption and economic liberty. Therefore, Argentina –- including its sovereign, sub-sovereign and most corporate issuers –- is classified correctly as a very risky, single-B credit by the leading rating agencies. Indeed, the country remains an outlier in the community of nations. It is the only nation in the G-20 group of countries that is in protracted default on its financial obligations to its fellow members. It is the only country in the G-20 that refuses to abide by its treaty obligations to the International Monetary Fund. It is the only member of the G-20 to have received a "thumbs down" from the leading governmental organization that sets and monitors standards to combat transnational financial crimes. And it is the G-20 member with by far the most investor claims against it in the world’s premier dispute resolution center.
    Keywords: Argentina; soveriegn; default; creditworthiness; emerging markets
    JEL: F34 F30 O54
    Date: 2010–12–17
  22. By: Kimberly Beaton; Brigitte Desroches
    Abstract: The authors investigate financial spillovers across countries with an emphasis on the effect of shocks to financial conditions in the United States on financial conditions and economic activity in Canada. These questions are addressed within a global vector autoregression model. The framework links individual country vector autoregression models in which the domestic variables are related to the country-specific foreign variables. The authors' results highlight the importance of financial variables in the transmission of shocks to real activity and financial conditions in the United States to Canada. First, they show that shocks to U.S. output are transmitted quickly to Canada, with important implications for financial conditions. Second, they show that the most important source of financial transmission between the United States and Canada is through shocks to U.S. equity prices. Financial transmission through movements in the quantity of U.S. credit is also important for Canada.
    Keywords: Business fluctuations and cycles; Economic models; Financial stability; International topics
    JEL: E27 E32 F36 F40
    Date: 2011

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