nep-ifn New Economics Papers
on International Finance
Issue of 2016‒11‒20
two papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. Crisis severity and the international trade network By Endrész, Marianna; Skudelny, Frauke
  2. Do Individual Behavioral Biases Affect Financial Markets and the Macroeconomy? By Raman Uppal; Harjoat Bhamra

  1. By: Endrész, Marianna; Skudelny, Frauke
    Abstract: In this paper we analyse the role of the international trade network for the strength of the global recession across countries. The novelty of our paper is the use of value-added trade data to capture the importance of trade network structure. We estimate with BMA techniques how far network indicators measuring interlinkages in terms of value added trade has explanatory power both for the length and the depth of the recent crisis once we control for pre-crisis macroeconomic fundamentals. Our main findings are that the macroeconomic control variables with the strongest explanatory power for the length and the depth of the crisis are the growth rates of credit and of the real effective exchange rate in the pre-crisis period and, though to a lesser extent, GDP and inflation growth over the same period and pre-crisis foreign exchange reserves. Government debt, the GVC participation index and net foreign assets have very little explanatory power in the BMA estimations. The models’ performance increases when we introduce interaction terms of credit growth with other vulnerability measures. The results demonstrate that the coincidence of vulnerabilities matters a lot. Credit growth deepens the crisis mainly if accompanied with pre-crisis GDP growth or low reserves, while the crisis tends to be longer if credit growth has led to large leverage or the accumulation of net foreign liabilities. Finally, we find evidence that value added trade linkages have an impact on the severity of the crisis. While the increasing connectivity or openness of the country makes the crisis longer, the same characteristics of the neighbours makes it also deeper. The tendency to interact with already connected countries lowers or increases the impact of the crisis depending on the position of the country. Altogether we have mixed results on the direct trade channel, but we demonstrate the importance of network structure beyond the countries’ own openness. In addition, we are also able to improve results by using gross value added instead of gross trade data. JEL Classification: F14, C45, C52, C67
    Keywords: Bayesian model averaging, crisis indicators, network indicators, value added trade, WIOD
    Date: 2016–10
  2. By: Raman Uppal (Edhec Business School); Harjoat Bhamra (Imperial College Business School)
    Abstract: A common criticism of behavioral economics is that it has not shown that individual investors' biases lead to aggregate long-run effects on both asset prices and macroeconomic quantities. Our objective is to address this criticism in a production economy where individual portfolio biases cancel when summed across investors, but still have an effect on aggregate quantities in the long-run. We solve in closed form a model of a stochastic general-equilibrium production economy with a large number of heterogeneous firms and investors. Investors are ambiguity averse, so they hold portfolios biased toward familiar assets. We specify this bias to be unsystematic - it cancels out when aggregated across investors. However, each investor bears more risk than necessary, which distorts the consumption of all investors in the same direction. Hence, distortions in consumption do not cancel out in aggregate and increasing the price of risk and distorting aggregate investment and growth. The increased risk from holding biased portfolios, which increases the demand for the risk-free asset, leading to a higher equity risk premium and lower risk-free rate that match empirical values. Our analysis illustrates that idiosyncratic behavioral biases can have long-run distortionary effects on both financial markets and the macroeconomy
    Date: 2016

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