Showing papers in "International Journal of Finance & Economics in 2006"
TL;DR: Using data from 72 countries for the period 1978-2000, the authors found that financial development has larger effect on GDP per capita when the financial system is embedded within a sound institutional framework.
Abstract: Using data from 72 countries for the period 1978–2000, we find that financial development has larger effects on GDPper capita when the financial system is embedded within a sound institutional framework Moreover, we find thatfinancial development is most potent in middle-income countries, where its effects are particularly large wheninstitutional quality is high Importantly, we also find that in low-income countries the influence of financialdevelopment is at its weakest; in these countries, more finance without sound institutions may not succeed in deliveringlong-run economic benefits Copyright # 2006 John Wiley & Sons, Ltd JEL CODE: G1; O1; O4 KEY WORDS: Financial development; institutional quality; economic development; pooled mean group estimation 1 INTRODUCTIONIt is now widely accepted that factor accumulation and technological change alone cannot adequatelyexplain differences in economic growth across countries Institutions and finance are separately emerging asthe key fundamental determinants of economic growth in recent literatureInstitutions are the rules of the game in a society by which the members of a society interact and shapethe economic behaviour of agents They may be treated as ‘social technologies’ in the operation ofproductive economic activities (Nelson and Sampat, 2001) When the rules change frequently or are notrespected, when corruption is widespread or when property rights are not well defined or enforced, marketswill not function well, uncertainty would be high, and, as a result, the allocation of resources would beadversely affected A number of recent papers provide empirical evidence that confirms the importance ofinstitutional quality for economic performance
313 citations
TL;DR: The use of technical analysis has gained importance over time and is now the most equally spread kind of analysis as mentioned in this paper, which has by far the greatest importance in FX dealing and is second in fund management, while flows dominate at the shortest-term and fundamentals at longer horizons.
Abstract: This work extends earlier survey studies on the use of technical analysis by considering flow analysis as a third form of information production. Moreover, the survey covers FX dealers and also the rising fund managers. Technical analysis has gained importance over time and is now the most equally spread kind of analysis. It has by far the greatest importance in FX dealing and is second in fund management. Charts are used for shorter-term forecasting horizons while flows dominate at the shortest-term and fundamentals at longer horizons. Preferred users of each kind of analysis exhibit different views about market frictions. Copyright # 2006 John Wiley & Sons, Ltd.
165 citations
TL;DR: In this paper, the authors provide a detailed, up-to-date description of the microstructure of the foreign exchange market and the behaviour of participant groups, highlighting shortcomings in existing theoretical models of market interaction and present an alternative model that marries theoretical prediction and current market practice.
Abstract: We provide a detailed, up-to-date description of the microstructure of the foreign exchange market and of the behaviour of participant groups. In the light of this, we highlight shortcomings in existing theoretical models of market interaction and present an outline alternative model that marries theoretical prediction and current market practice. Copyright © 2006 John Wiley & Sons, Ltd.
128 citations
TL;DR: The authors studied the communication by European central bankers during the first years of the European Economic and Monetary Union and found that comments by central bankers on interest rates, inflation and economic growth in the Eurozone have often been contradictory.
Abstract: This paper studies communication by European central bankers during the first years of the European Economic and Monetary Union. We find that comments by central bankers on interest rates, inflation and economic growth in the Eurozone have often been contradictory. However, over the years, interest rate statements have become more in line with each other. National central banks continue to dominate communication on monetary policy. The ECB Executive Board is the only group of central bankers to observe radio silence before ECB Governing Council meetings. Copyright (c) 2006 John Wiley & Sons, Ltd.
115 citations
TL;DR: In this paper, the authors take a comparative look at the patterns of capital flows from rich to poor countries in two eras of financial globalization and show that investment in developing countries was a central element of 19th century financial globalization, but plays only a minor role today.
Abstract: In this paper we take a comparative look at the patterns of capital flows from rich to poor countries in two eras of financial globalization. The paper extends recent research on the developmental effects of international financial integration, long-term trends in capital mobility and ‘globalization in historical perspective’. Analysing the patterns of international financial integration in the three decades of the classical gold standard and after 1990 we show that investment in developing countries was a central element of 19th century financial globalization, but plays only a minor role today. The Lucas paradox of capital failing to flow from rich to poor has grown much stronger. In historical perspective, today’s financial globalization is marked by massive diversification flows between high-income economies and a relative marginalization of less-developed economies. Copyright # 2006 John Wiley & Sons, Ltd.
81 citations
TL;DR: The authors developed a model for understanding end-user order flow in the FX market and found that order flow from segments traditionally thought to be liquidity-motivated actually has power to forecast exchange rates.
Abstract: This paper develops a model for understanding end-User order flow in the FX market. The model addresses several puzzling findings. First, the estimated price-impact of flow from different end-user segments is, dollar-for-dollar, quite different. Second, order flow from segments traditionally thought to be liquidity-motivated actually has power to forecast exchange rates. Third, about one-third of order flow's power to forecast exchange rates 1 month ahead comes from flow's ability to forecast future flow, whereas the remaining two-thirds applies to price components unrelated to Future flow. We show that all of these features arise naturally from end-User heterogeneity, in a setting where order flow provides timely information to market-makers about the state of the macro-economy. Copyright (c) 2006 John Wiley & Sons, Ltd.
70 citations
TL;DR: The authors investigated the determinants of each crisis separately and then estimated links between both crises employing instrumental variables techniques, finding that currency crises significantly increase the risk of contemporaneous debt crises and vice versa.
Abstract: Though currency and debt crises quite often occur simultaneously, the links between these two types of crises are not well understood. We review how currency and debt crises could be related due to common causes, contagion effects from one crisis to the other, and complementary budget financing aspects. In an empirical analysis based on a panel of 80 countries over the period 1975–2000, we first investigate the determinants of each crisis separately. Then we estimate links between both crises employing instrumental variables techniques. We find that, while there is a negative lagged influence of currency crises on debt crises, currency crises significantly increase the risk of contemporaneous debt crises and vice versa. Copyright © 2006 John Wiley & Sons, Ltd.
53 citations
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TL;DR: This paper examined the impact of contemporaneous feedback trading in the spot USD|EUR currency market and found that when data are sampled at the 1 and 5 minute frequencies, such trading strategies cause the price impact of order flow to be significantly larger than when feedback trading is ruled out.
Abstract: Order flow has been found to carry information to the market. When assessing how informative order flow is, the VAR methodology is typically employed, using impulse response functions. However, in such analyses, the direction of causality runs explicitly from order flow to asset return. If data are sampled at anything other than at the highest frequencies then any feedback trading may well appear contemporaneous; trading in period t depends on the asset return in that interval. The implications of contemporaneous feedback trading are examined in the spot USD|EUR currency market and we find that when data are sampled at the 1 and 5 minute frequencies, such trading strategies cause the price impact of order flow to be significantly larger than when feedback trading is ruled out. Copyright © 2006 John Wiley & Sons, Ltd.
41 citations
TL;DR: In this paper, the relationship between interventions and volatility at daily and intra-daily frequencies for the two major exchange rate markets was analyzed and it was shown that coordinated interventions tend to cause few, but large jumps.
Abstract: We analyse the relationship between interventions and volatility at daily and intra-daily frequencies for the two major exchange rate markets. Using recent econometric methods to estimate realized volatility, we employ bi-power variation to decompose this volatility into a continuously varying and jump component. Analysis of the timing and direction of jumps and interventions imply that coordinated interventions tend to cause few, but large jumps. Most coordinated operations explain, statistically, an increase in the persistent (continuous) part of exchange rate volatility. This correlation is even stronger on days with jumps. Copyright © 2007 John Wiley & Sons, Ltd.
40 citations
TL;DR: In this paper, the authors present four lessons for modeling short-run exchange-rate dynamics: currency flows are a key determinant of exchange rates, and models should have these flows fully in focus.
Abstract: Empirical research on the microeconomics of currency markets, an area known sometimes as ‘currency market microstructure,’ has taken off in the past decade. This paper extracts from this research four lessons for modelling short-run exchange-rate dynamics. First, currency flows are a key determinant of exchange rates, and models should have these flows fully in focus. The appropriate equilibrium condition may be flow-currency supply equals flow-currency demand. Second, the flows of first-order relevance include those of ‘financial’ traders, who use currencies essentially as a store of value, and ‘commercial’ traders, who use currencies as a medium of exchange. Financial flows and commercial flows should be negatively related to each other, meaning that financial demand tends to be met by commercial supply. Also, financial flows should be positively related to exchange rates. Third, financial traders are motivated by profits, rather than consumption, and behave as if risk averse. Fourth, commercial traders are motivated by exchange-rate levels and rationally choose not to speculate. The workhorse models of international macroeconomics do not fit most of these lessons, and these important lacunae in their microfoundations may help explain their limited empirical success. The paper sketches an optimizing model of currency flows that is consistent with the lessons and has an encouraging empirical record. Copyright © 2006 John Wiley & Sons, Ltd.
39 citations
TL;DR: In this article, a two-country dynamic general equilibrium model with sticky prices was proposed to account for international asymmetries in the price-setting behavior of the U.S. and the rest of the world.
Abstract: How does an unexpected domestic monetary expansion affect the foreign economy? Does it induce an increase or a decline in foreign production? In the traditional two-country Mundell-Fleming model, monetary policy has«beggar-thy-neighbor»effects. Yet, empirical evidence from VARs indicates that U.S. monetary policy has positive international transmission effects on both foreign (non-U.S. G-7) output and aggregate demand. In this paper, I will show that a two-country dynamic general equilibrium model with sticky prices can account for these «stylized facts» if we allow for international asymmetries in the price-setting behavior of firms. If U.S. firms set export prices in their own currency only (producer-currency pricing), whereas producers in the rest of the world price their exports to the U.S. in the local currency of the export market (local-currency pricing), a U.S. monetary expansion is found to increase output and aggregate demand abroad.
TL;DR: In this paper, the authors decompose a business cycle in a time-frequency framework, so that its components vary in importance and cyclical characteristics over time, and show that the inconclusive convergence results obtained so far appear because countries have some cycles in common, but diverge at others.
Abstract: The identification of an European business cycle has been inconclusive. Yet cyclical convergence is the key consideration for those countries that wish to be members of the currency union (e.g. UK). In general, countries will vary in the components and characteristics that make up their cycles at any moment, as well as in the state of their cycle at each moment. To take this into account, we show here how to decompose a business cycle in a time-frequency framework; so that its components vary in importance and cyclical characteristics over time. We show, the inconclusive convergence results obtained so far appear because countries have some cycles in common—but diverge at others. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this article, the authors investigate whether there is a case for asset prices in interest rates rules within a small econometric model of the Norwegian economy, modelling the interdependence of the real economy, credit and three classes of asset prices: housing prices, equity prices and the nominal exchange rate.
Abstract: We investigate whether there is a case for asset prices in interest rates rules within a small econometric model of the Norwegian economy, modelling the interdependence of the real economy, credit and three classes of asset prices: housing prices, equity prices and the nominal exchange rate. We compare the performance of simple interest rate rules that allow for additional response to movements in asset prices to the performance of more standard monetary policy rules. We find that including housing and/or equity prices in the policy rules improve macroeconomic performance in terms of both nominal and real economic stability. In contrast, responding to exchange rate fluctuations seems less effective to this end, mainly because the instrument must be used quite actively, which contributes to higher volatility in general. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this paper, the suitability of the following distributions is investigated: Normal, Frechet, Gumbel, Weibull, Generalized Extreme Value (GEV), Generalized Pareto and Generalized Logistic (GL).
Abstract: This paper seeks to characterize the distribution of extreme returns for US, UK and Japanese equity indices over the years 1963–2000. In particular, the suitability of the following distributions is investigated: Normal, Frechet, Gumbel, Weibull, Generalized Extreme Value (GEV), Generalized Pareto and Generalized Logistic (GL). Daily returns were obtained for each of the countries, and the minima over a variety of selection intervals were calculated. Plots of higher moment statistics for the minima on statistical distribution maps suggested that the best fitting distribution would be either the GEV or the GL. The results from fitting each of these distributions to extremes of a series of US, UK and Japanese share returns supported the preliminary evidence that the GL distribution best fitted the data in all three countries over the period of study. The GL distribution has fatter tails than the GEV distribution; hence this finding is of importance to investors who are concerned with assessing the risk of a portfolio. The paper highlights the important finance implications and in particular the potential for underestimation of risk if distributions without fat enough tails are employed. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this article, the effects of RBA intervention on the level and volatility of the Australian dollar exchange rate have been examined using daily exchange rate and official intervention data from January 1984 to December 2001.
Abstract: Since the Australian dollar was floated in December 1983, the Australian central bank (Reserve Bank of Australia) has actively intervened in the foreign exchange market. Using daily exchange rate and official intervention data from January 1984 to December 2001, this paper examines what effects, if any, foreign exchange operations by the Reserve Bank of Australia (RBA) have had on the level and volatility of the Australian dollar exchange rate. First, using an event study we evaluate the effectiveness of intervention by examining its direct effect on the level of the exchange rate. We find that over the period 1997–2001, the RBA has had some success in its intervention operations, by moderating the depreciating tendency of the Australian dollar. Second, we investigate the effects of RBA intervention policies on exchange rate volatility over the floating rate period. Our results indicate that intervention operations tend to be associated with an increase in exchange rate volatility, which suggests that official intervention may have added to market uncertainty. Overall, the effects of RBA intervention are quite modest on both the level and the volatility of the Australian dollar exchange rate. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this paper, an analysis of regime switching in volatility and out-of-sample forecasting of the Cyprus Stock Exchange by using daily data for the period 1996-2002 is provided.
Abstract: This paper provides an analysis of regime switching in volatility and out-of-sample forecasting of the Cyprus Stock Exchange by using daily data for the period 1996–2002. We first model volatility regime switching within a univariate Markov switching framework. Modelling stock returns within this context can be motivated by the fact that the change in regime should be considered as a random event and not predictable. The results show that linearity is rejected in favour of an MS specification, which forms statistically an adequate representation of the data. Two regimes are implied by the model, the high-volatility regime and the low-volatility one, and they provide quite accurately the state of volatility associated with the presence of a rational bubble in the capital market of Cyprus. Another implication is that there is evidence of regime clustering. We then provide out-of-sample forecasts of the CSE daily returns by using two competing nonlinear models, the univariate Markov switching model and the Artificial Neural Network Model. The comparison of the out-of-sample forecasts is done on the basis of forecast accuracy, using the Diebold and Mariano test and forecast encompassing, using the Clements and Hendry test. The results suggest that both nonlinear models are equivalent in forecasting accuracy and forecasting encompassing, and therefore on forecasting performance. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this paper, the authors demonstrate how to use over-the-counter option prices to recover the risk-neutral probability density function (PDF) for the future exchange rate, using the yen/dollar exchange rate as an example, to test whether intervention by the Japanese Ministry of Finance during the period 1996-2004 had any impact on the higher moments of the exchange rate.
Abstract: A vast literature on the effects of sterilized intervention by the monetary authorities in the foreign exchange markets concludes that intervention systematically moves the spot exchange rate only if it is publicly announced, coordinated across countries, and consistent with the underlying stance of fiscal and monetary policy. Over the past 15 years, researchers have also attempted to determine if intervention has any effects on the dispersion and directionality of market views concerning the future exchange rate. These studies usually focus on the variance around the expected future exchange rate}the second moment. In this paper we demonstrate how to use over-the-counter option prices to recover the risk-neutral probability density function (PDF) for the future exchange rate. Using the yen/dollar exchange rate as an example, we calculate measures of dispersion and directionality, such as variance and skewness, from estimated PDFs to test whether intervention by the Japanese Ministry of Finance during the period 1996–2004 had any impact on the higher moments of the exchange rate. We find little or no systematic effect, consistent with the findings of the literature on the spot rate as: Japanese intervention was not publicly announced prior to August 2000, and since that time only publicly announced after the fact, over the past 10 years rarely coordinated across countries and, in hindsight, probably inconsistent with the underlying stance of monetary policy. Copyright # 2007 John Wiley & Sons, Ltd.
TL;DR: This paper conducted a survey on central banks' FOREX intervention practices in industrialized countries over the last decade and found that interventions usually take place during normal working hours while central banks show some preference for dealing with major domestic banks.
Abstract: This paper presents the findings from a survey on central banks' FOREX intervention practices in industrialized countries over the last decade. The answers of responding monetary authorities are examined with respect to available data and literature. Our findings indicate that interventions usually take place during normal working hours while central banks show some preference for dealing with major domestic banks. Correction or prevention of long-term misalignments of exchange rates with their fundamental values and, to a lesser extent, the reduction of exchange rate volatility is the first motive given for intervention. The signalling effect of interventions is consistently put forward as the main channel through which interventions work. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this paper, the authors consider a standard present-value equity price formula with time-varying discount rates, and propose a state-space formulation that allows a decomposition of price 'uctuations into fundamental and non-fundamental components.
Abstract: This paper considers a standard present-value equity price formula with time-varying discount rates, and proposes a state-space formulation that allows a decomposition of price ‡uctuations into fundamental and non-fundamental components. By "fundamentals" we refer to dividends, interest rates and risk premia, both actual and expected; the "non-fundamental" price component is de…ned residually allowing for the possibility of a rational bubble. The empirical application uses annual US data, postulating a simple discount factor driven by the real return on short-term public debt. The stochastic factor explains part of the volatility in prices, but it is not su¢ cient to exclude the occurrence of near-exponential bubbles analogous to those found in the constant discount literature. On the contrary, de…nition and measurement of the fundamentals, and particularly of the dividend payout, prove to be crucial in this respect.
TL;DR: In this article, the existence of threshold cointegration between real exchange rates and real interest rate differentials was investigated for six of the countries in the Eurozone and the analysis revealed some evidence of a nonlinear long-run relationship.
Abstract: This paper investigates the existence of threshold cointegration between real exchange rates and real interest rate differentials. Unlike previous work, which generally fails to find evidence of a long-run relationship employing linear models, we employ tests of the null hypothesis of no cointegration derived from nonlinear bivariate models that allow for threshold cointegration under the alternative hypothesis. For six of the countries in our sample our analysis reveals some evidence of a nonlinear long-run relationship between real exchange rates and real interest rate differentials. Asymmetric mean reversion of the equilibrium error is found to be driven by the asymmetric short-run adjustment of the real exchange rate to dis-equilibrium. When threshold cointegration is found to exist, we find stronger mean reversion when the equilibrium error is negative relative to when it is positive. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this article, a model of weekly trades suggests that changes in momentum as well as the carry trade motives of interest differentials are significant explanatory factors for daily trade volume trend upward.
Abstract: Following the introduction of the euro in 1999, daily trade volume began a downward trend until early 2002, after which daily volume started to trend upward. A model of weekly trades suggests that changes in momentum as well as the carry trade motives of interest differentials are significant explanatory factors. Daily data examination reveals that Fridays have lower activity, and Tuesdays greater activity than average. At the intradaily level, trading is very low before and after London business hours. Within the London business day, trade activity is higher in 5-min intervals when a ‘big figure’ is breached. This is consistent with stop-loss or take-profit motives for trading. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this article, the existence of heterogeneous components in intra-day volatility has been confirmed using a conditional variance model which defines volatility components over differing time horizons, in which context the impact of high-frequency speculation and noise-trading are particularly apparent.
Abstract: Recent research has suggested that intra-day volatility may possess a component structure, resulting either from the arrival of heterogeneous information or the actions of heterogeneous market agents. This paper reports direct evidence for the existence of such components in S&P500 index and DM/$ exchange rate data. Estimation of a FIGARCH model supports the contention that volatility dynamics result from multiple sources. Using a HARCH conditional variance model which defines volatility components over differing time horizons, confirmatory evidence of heterogeneous components is reported, in which context the impact of high-frequency speculation and noise-trading are particularly apparent. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this paper, the relationship between the volatility of the credit risk premium of a plain vanilla bond and its credit rating was examined and it was shown that rating changes have a dynamic influence on spread volatilities.
Abstract: This article examines the relationship between the volatility of the credit risk premium of a plain vanilla bond and its credit rating. We calculate volatilities over different time windows and test for differences in the mean volatility depending on the bond rating. We check for the influence of further factors that are theoretically relevant for the explanation of the credit spread volatility. Moreover, we check the dynamic effect of rating changes on bond spread volatility. Finally, we test whether credit watchlistings influence credit spread volatility. We confirm prior studies in that, generally, credit ratings rank the risk of bonds according to credit spread volatility. We further find that rating changes have a dynamic influence on spread volatilities. Additionally it is shown that credit watchlistings significantly reduce the volatility. Thus, watchlistings are perceived to offer valuable information. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this paper, the authors discuss the dynamic response of employment, average hours, and real wages to macroeconomic policy shocks in the UK in the period 1970 Q1-2003 Q1.
Abstract: This paper discusses the dynamic response of employment, average hours, and real wages to macroeconomic policy shocks in the UK in the period 1970 Q1–2003 Q1. Following a monetary policy shock the adjustment of labour input is primarily along the extensive margin. However, there is also significant adjustment along the intensive margin 1 year after the shock. A government spending shock leads to a fall in employment and hours, whereas real wages rise. This is attributed to the wage bill component of government consumption. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this paper, a nonlinear long-memory model was used to forecast dynamically out-of-sample over the sample period for OECD countries, and the results showed clear evidence that the nonlinear model outperformed other estimated models.
Abstract: We consider a new time series model that can describe long memory and nonlinearity simultaneously and can be used to assess an extensive evaluation of the out-of-sample forecasting performance of the nonlinear long-memory model. Upon fitting it to the real exchange rate, we find that a parsimonious version of the model captures the salient features of the data rather well. We then use this nonlinear long-memory model to forecast dynamically out-of-sample over the sample period for OECD countries. Overall, we find clear evidence that favours the nonlinear long-memory model over any other estimated models. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this paper, a new way of extracting inflation information from the term structure, by setting the Fisher equation in the context of the stochastic discount factor (SDF) asset pricing theory, is proposed.
Abstract: We propose a new way of extracting inflation information from the term structure, by setting the Fisher equation in the context of the stochastic discount factor (SDF) asset pricing theory. We develop a multivariate estimation framework which models the term structure of interest rates in a manner consistent with the SDF theory while generating and including an often omitted time varying risk component in the Fisher equation. The joint distribution of excess bond returns and fundamental macroeconomic factors is modelled on the basis of the consumption CAPM, using multivariate GARCH with conditional covariances in the mean to capture the term premia. We apply this methodology to the US economy and find it offers substantial evidence in support of the Fisher equation, greatly improving its goodness of fit at horizons of up to one year. Copyright © 2006 John Wiley & Sons, Ltd.
TL;DR: In this article, a generalized Shleifer and Vishny (SV) model for central bank intervention is presented, which shows that increasing availability of arbitrage capital has a pronounced effect on the dynamic intervention strategy of the central bank.
Abstract: Shleifer and Vishny (SV) pointed out some of the practical and theoretical problems associated with assuming that rational risk-arbitrage would quickly drive asset prices back to long-run equilibrium. In particular, they showed that the possibility that asset price disequilibrium would worsen, before being corrected, tends to limit rational speculators. Uniquely, SV showed that ‘performance-based asset management’ would tend to reduce risk-arbitrage when it is needed most, when asset prices are furthest from equilibrium. We analyse a generalized SV model for central bank intervention. We show that increasing availability of arbitrage capital has a pronounced effect on the dynamic intervention strategy of the central bank. Intervention is reduced during periods of moderate misalignment and amplified at times of extreme misalignment. This pattern is consistent with empirical observation. Copyright © 2007 John Wiley & Sons, Ltd.