nep-ifn New Economics Papers
on International Finance
Issue of 2015‒12‒08
six papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. Why Are Exchange Rates So Smooth? A Segmented Asset Markets Explanation By Chien, YiLi; Lustig, Hanno; Naknoi, Kanda
  2. The shocks matter: improving our estimates of exchange rate pass-through By Forbes, Kristin; Hjortsoe, Ida; Nenova, Tsvetelina
  3. China's Capital Flight: Pre- and Post-Crisis Experiences By Yin-Wong Cheung; Frank Westermann; Sven Steinkamp
  4. Has the Pricing of Stocks Become More Global? By Petzev, Ivan; Schrimpf, Andreas; Wagner, Alexander F
  5. The Forward Guidance Puzzle By Marc Giannoni; Christina Patterson; Marco Del Negro
  6. Squaring the cycle: capital flows, financial cycles, and macro-prudential policy in the euro area By Silvia Merler

  1. By: Chien, YiLi (Federal Reserve Bank of St. Louis); Lustig, Hanno (Stanford University); Naknoi, Kanda (University of Connecticut)
    Abstract: Empirical work on asset prices suggests that pricing kernels have to be almost perfectly correlated across countries. If they are not, real exchange rates are too smooth to be consistent with high Sharpe ratios in asset markets. However, the cross-country correlation of macro fundamentals is far from perfect. We reconcile these empirical facts in a two-country stochastic growth model with segmented markets. A large fraction of households either do not participate in the equity market or hold few equities, and these households drive down the cross-country correlation in aggregate consumption. Only a small fraction of households participate in international risk sharing by frequently trading domestic and foreign equities. These active traders are the marginal investors, who impute the almost perfect correlation in pricing kernels. In our calibrated economy, we show that this mechanism can quantitatively account for the excess smoothness of exchange rates in the presence of highly volatile stochastic discount factors.
    Keywords: asset pricing; market segmentation; exchange rate; international risk sharing
    JEL: F10 F31 G12 G15
    Date: 2015–11–27
  2. By: Forbes, Kristin (Monetary Policy Committee Unit, Bank of England); Hjortsoe, Ida (Monetary Policy Committee Unit, Bank of England); Nenova, Tsvetelina (Monetary Policy Committee Unit, Bank of England)
    Abstract: A major challenge for monetary policy has been predicting how exchange rate movements will impact inflation. We propose a new focus: incorporating the underlying shocks that cause exchange rate fluctuations when evaluating how these fluctuations ‘pass through’ into import and consumer prices. We show that in a standard open-economy model the relationship between exchange rates and prices depends on the shocks which cause the exchange rate to move. Then we develop an SVAR framework for a small open economy that relies on both short-run and long-run identification restrictions consistent with our theoretical model. Applying this framework to the United Kingdom, we find that the response of both import and consumer prices to exchange rate fluctuations depends on what caused the fluctuations. For example, exchange rate pass-through is relatively large in response to domestic monetary policy shocks, but smaller in response to domestic demand shocks. This framework helps explain why pass-through can change over time, including why sterling’s post-crisis depreciation caused a sharper increase in prices than expected and sterling’s recent appreciation has had a more muted effect.
    Keywords: Exchange rate pass-through; import prices; consumer prices; inflation; vector autoregression.
    JEL: E31 F41
    Date: 2015–12–01
  3. By: Yin-Wong Cheung (City University of Hong Kong); Frank Westermann (Universitaet Osnabrueck); Sven Steinkamp (Universitaet Osnabrueck)
    Abstract: Abstract: We study China’s illicit capital flow and document a change in its pattern. Specifically, we observe that China’s capital flight, especially the one measured by trade misinvoicing, exhibits a weakened response in the post-2007 period to the covered interest disparity, which is a theoretical determinant of capital flight. Further analyses indicate that the post-2007 behavior is influenced by quantitative easing and other factors including exchange rate variability, capital control policy and trade frictions. Our study confirms that China’s capital flight pattern and its determinants are affected by the crisis event. Further, both the canonical and additional explanatory variables have different effects on different measures of capital flight. These results highlight the challenges of managing China’s capital flight, which requires information on the period and the type of capital flight that the policy authorities would like to target.
    Keywords: World Bank Residual Method; Trade Misinvoicing; Quantitative Easing; Capital Controls; Covered Interest Disparity
    JEL: F3 F32 G15
    Date: 2015–11–25
  4. By: Petzev, Ivan; Schrimpf, Andreas; Wagner, Alexander F
    Abstract: We show that in recent years global factor models have been catching up significantly with their local counterparts in terms of explanatory power (R²) for international stock returns. This catch-up is driven by a rise in global factor betas, not a rise in factor volatilities, suggesting that the effect is likely to be permanent. Yet, there is no conclusive evidence for a global factor model catch-up in terms of pricing errors (alpha) or a convergence in country-specific factor premia. These findings suggest that global financial markets have progressed surprisingly little towards fully integrated pricing, different from what should be expected under financial market integration. We discuss alternative explanations for these patterns and assess implications for practice.
    Keywords: factor models; financial integration; international asset pricing; momentum; size; value
    JEL: F36 G12 G15
    Date: 2015–11
  5. By: Marc Giannoni (Federal Reserve Bank of New York); Christina Patterson (MIT); Marco Del Negro (Federal Reserve Bank of New York)
    Abstract: With short-term interest rates at the zero lower bound, forward guidance has become a key tool for central bankers and yet we know little about its effectiveness. We show that standard medium-scale DSGE models tend to grossly overestimate the impact of forward guidance on the macroeconomy, a phenomenon we call the "forward guidance puzzle," and explain why this is the case. We document the impact of forward guidance announcements on 1) a broad cross section of financial markets data, and 2) on the panel of Blue Chip forecasts. We find that this effect has been very heterogeneous across announcements and relate this heterogeneity to the type of forward guidance, whether delphic (news about the economy) or odyssean. We also discuss various explanations to the puzzle that have been advanced in the literature.
    Date: 2015
  6. By: Silvia Merler
    Abstract: Highlights Before the financial and economic crisis, monetary policy unification and interest rate convergence resulted in the divergence of euro-area countries’ financial cycles. This divergence is deeply rooted in the financial integration spurred by currency union and strongly correlated with intra-euro area capital flows. Macro-prudential policy will need to deal with potentially divergent financial cycles, while catering for potential cross-border spillovers from domestic policies, which domestic authorities have little incentive to internalise. The current framework is unfit to deal effectively with these challenges. The European Central Bank should be responsible for consistent and coherent application of macro-prudential policy, with appropriate divergences catering for national differences in financial conditions. The close link between domestic financial cycles and intra-euro area capital flows raises the question of whether macro-prudential policy in the euro area can be compatible with free flows of capital. Financial cycle divergence had its counterpart in the build-up of macroeconomic imbalances, so effective implementation of the Macroeconomic Imbalance Procedure would support and strengthen macro-prudential policy.
    Date: 2015–11

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