nep-ifn New Economics Papers
on International Finance
Issue of 2014‒11‒22
two papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. From tapering to tightening : the impact of the fed's exit on India By Basu, Kaushik; Eichengreen, Barry; Gupta, Poonam
  2. The Term Structures of Co-entropy in International Financial Markets By Chabi-Yo, Fousseni; Colacito, Riccardo

  1. By: Basu, Kaushik; Eichengreen, Barry; Gupta, Poonam
    Abstract: The"tapering talk"starting on May 22, 2013, when Federal Reserve Chairman Ben Bernanke first spoke of the possibility of the U.S. central bank reducing its security purchases, had a sharp negative impact on emerging markets. India was among those hardest hit. The rupee depreciated by 18 percent at one point, causing concerns that the country was heading toward a financial crisis. This paper contends that India was adversely impacted because it had received large capital flows in prior years and had large and liquid financial markets that were a convenient target for investors seeking to rebalance away from emerging markets. In addition, India's macroeconomic conditions had weakened in prior years, which rendered the economy vulnerable to capital outflows and limited the policy room for maneuver. The paper finds that the measures adopted to handle the impact of the tapering talk were not effective in stabilizing the financial markets and restoring confidence, implying that there may not be any easy choices when a country is caught in the midst of rebalancing of global portfolios. The authors suggest putting in place a medium-term policy framework that limits vulnerabilities in advance, while maximizing the policy space for responding to shocks. Elements of such a framework include a sound fiscal balance, sustainable current account deficit, and environment conducive to investment. In addition, India should continue to encourage relatively stable longer-term flows and discourage volatile short-term flows, hold a larger stock of reserves, avoid excessive appreciation of the exchange rate through interventions with the use of reserves and macroprudential policy, and prepare the banks and firms to handle greater exchange rate volatility.
    Keywords: Debt Markets,Emerging Markets,Currencies and Exchange Rates,Economic Theory&Research,Macroeconomic Management
    Date: 2014–10–01
  2. By: Chabi-Yo, Fousseni (OH State University); Colacito, Riccardo (University of NC)
    Abstract: We propose a new entropy-based correlation measure (co-entropy) to evaluate the performance of international asset pricing models. Co-entropy summarizes in a single number the extent of co-dependence between two variables beyond normality. We document that the co-entropy of international stochastic discount factors (SDFs) can be decomposed into a series of entropy-based correlations of permanent and transitory components of the SDFs. We derive bounds and restrictions on co-entropies of these components, which we then use to analyze the composition of co-dependence of international SDFs. A large cross-section of countries is employed to provide empirical evidence on the entropy-based correlations at various horizons. We find that the co-entropy of the transitory components is always sizably smaller than the co-entropy of the permanent components, with the latter usually being very close to one. Furthermore, the entropy based correlation of transitory components of SDFs increases with the investment horizon, which features an upward sloping term structure of co-entropies. We confront several state-of-the-art international finance models with these empirical regularities, and find that existing models cannot account for the composition of codependence at all horizons.
    JEL: C62 F31 G12
    Date: 2013–11

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