Modelling Interbank Relations during the International Financial Crisis

This paper examines the effects of the current financial crisis on the correlations of four international banking stocks. We find that in the beginning of the crisis banks generally show a transition to a higher correlation followed by a dramatic decline towards the end of 2008. These findings are consistent with both traditional contagion theory and the more recent network theory of contagion. JEL classifications: C51; G15 Keywords: Financial Crises; Contagion; Interbank Markets.

A compositional statistical analysis of capital stock

Most of economic literature has presented its analysis under the assumption of homogeneous capital stock.However, capital composition differs across countries. What has been the pattern of capital compositionassociated with World economies? We make an exploratory statistical analysis based on compositional datatransformed by Aitchinson logratio transformations and we use tools for visualizing and measuring statisticalestimators of association among the components. The goal is to detect distinctive patterns in the composition.As initial findings could be cited that:1. Sectorial components behaved in a correlated way, building industries on one side and , in a lessclear view, equipment industries on the other.2. Full sample estimation shows a negative correlation between durable goods component andother buildings component and between transportation and building industries components.3. Countries with zeros in some components are mainly low income countries at the bottom of theincome category and behaved in a extreme way distorting main results observed in the fullsample.4. After removing these extreme cases, conclusions seem not very sensitive to the presence ofanother isolated cases

Modelling world investment markets using threshold conditional correlation models

In this paper we propose a parsimonious regime-switching approach to model the correlations between assets, the threshold conditional correlation (TCC) model. This method allows the dynamics of the correlations to change from one state (or regime) to another as a function of observable transition variables. Our model is similar in spirit to Silvennoinen and Teräsvirta (2009) and Pelletier (2006) but with the appealing feature that it does not suffer from the course of dimensionality. In particular, estimation of the parameters of the TCC involves a simple grid search procedure. In addition, it is easy to guarantee a positive definite correlation matrix because the TCC estimator is given by the sample correlation matrix, which is positive definite by construction. The methodology is illustrated by evaluating the behaviour of international equities, govenrment bonds and major exchange rates, first separately and then jointly. We also test and allow for different parts in the correlation matrix to be governed by different transition variables. For this, we estimate a multi-threshold TCC specification. Further, we evaluate the economic performance of the TCC model against a constant conditional correlation (CCC) estimator using a Diebold-Mariano type test. We conclude that threshold correlation modelling gives rise to a significant reduction in portfolio´s variance.

Sovereign Risk, Anonymous Markets, and the Effects of Globalization

The goal of this paper is to study the e¤ects of globalization on the workings of financial markets. We adopt a "technological" view of globalization, which consists of an exogenous reduction in the cost of shipping goods across di¤erent regions of the world. We model financial markets where agents anonymously trade securities issued by every other agent in the world. In the absence of frictions, we show how globalization creates trade opportunities among residents of different regions of the world, thereby raising welfare. In the presence of sovereign risk, however, there emerge two crucial interactions between trade among residents within a region and trade among residents of di¤erent regions. First, the more residents within a region trade with each other, the more they can trade with residents of other regions. Second, the possibility of trade with residents of other regions sometimes leads a government to not enforce payments by its residents, destroying trade opportunities among residents within the region. The net effect on welfare of this process of creation and destruction of trade opportunities is ambiguous. We argue that there are no policies governments can take to avoid the negative effects of globalization on trade among domestic residents. In a dynamic extension, we analyze how our results are a¤ected by reputational considerations.

Free Flows, Limited Diversification: Explaining the Fall and Rise of Stock Market Correlations, 1890-2001

Using a new dataset on capital account openness, we investigate why equity return correlations changed over the last century. Based on a new, long-run dataset on capital account regulations in a group of 16 countries over the period 1890-2001, we show that correlations increase as financial markets are liberalized. These findings are robust to controlling for both the Forbes-Rigobon bias and global averages in equity return correlations. We test the robustness of our conclusions, and show that greater synchronization of fundamentals is not the main cause of increasing correlations. These results imply that the home bias puzzle may be smaller than traditionally claimed.

Equilibrium asset prices and savings of heterogeneous agents in the presence of incomplete markets and portfolio constraints

We study the quantitative properties of a dynamic general equilibrium model in which agents face both idiosyncratic and aggregate income risk, state-dependent borrowing constraints that bind in some but not all periods and markets are incomplete. Optimal individual consumption-savings plans and equilibrium asset prices are computed under various assumptions about income uncertainty. Then we investigate whether our general equilibrium model with incomplete markets replicates two empirical observations: the high correlation between individual consumption and individual income, and the equity premium puzzle. We find that, when the driving processes are calibrated according to the data from wage income in different sectors of the US economy, the results move in the direction of explaining these observations, but the model falls short of explaining the observed correlations quantitatively. If the incomes of agents are assumed independent of each other, the observations can be explained quantitatively.

Debt and deficit fluctuations and the structure of bond markets

This paper tests for the market environment within which US fiscal policyoperates, that is we test for the incompleteness of the US government bondmarket. We document the stochastic properties of US debt and deficits andthen consider the ability of competing optimal tax models to account forthis behaviour. We show that when a government pursues an optimal taxpolicy and issues a full set of contingent claims, the value of debthas the same or less persistence than other variables in the economyand declines in response to higher deficit shocks. By contrast, ifgovernments only issue one-period risk free bonds (incomplete markets),debt shows more persistence than other variables and it increases inresponse to expenditure shocks. Maintaining the hypothesis of Ramseybehavior, US data conflicts.

Launching prices for new pharmaceuticals in heavily regulated and subsidized markets

This paper provides empirical evidence on the explanatory factorsaffecting introductory prices of new pharmaceuticals in a heavilyregulated and highly subsidized market. We collect a data setconsisting of all new chemical entities launched in Spain between1997 and 2005, and model launching prices. We found that, unlike inthe US and Sweden, therapeutically "innovative" products are notoverpriced relative to "imitative" ones. Price setting is mainly used asa mechanism to adjust for inflation independently of the degree ofinnovation. The drugs that enter through the centralized EMAapproval procedure are overpriced, which may be a consequence ofmarket globalization and international price setting.

Determining underlying macroeconomic fundamentals during emerging market crises: Are conditions as bad as they seem?

Emerging market crises are characterized by large swings in both macroeconomic fundamentalsand asset prices. The economic significance of observed movements in macroeconomicvariables is obscured by the brief and extreme nature of crises. In this paper we propose to study the macroeconomic consequences of crises by studying the behavior of effective fundamentals, constructed by studying the relative movements of stock prices during crises. We find that these effective fundamentals provide a different picture than that implied by observed fundamentals. First, asset prices often reflect expectations of improvement in fundamentals after the initial devaluations; specifically, effective depreciations are positive but not as large as the observed ones. Second, crises vary in their effect on credit market conditions, with investors expecting tightening of credit in some cases (Mexico 1994, Philippines 1997), but loosening of credit in others (Sweden 1992, Korea 1997, Brazil 1999).

Labor markets and monetary policy: A new-Keynesian model with unemployement

We construct a utility-based model of fluctuations, with nominal rigidities andunemployment, and draw its implications for the unemployment-inflation trade-off and for the conduct of monetary policy.We proceed in two steps. We first leave nominal rigidities aside. We show that,under a standard utility specification, productivity shocks have no effect onunemployment in the constrained efficient allocation. We then focus on theimplications of alternative real wage setting mechanisms for fluctuations in un-employment. We show the role of labor market frictions and real wage rigiditiesin determining the effects of productivity shocks on unemployment.We then introduce nominal rigidities in the form of staggered price setting byfirms. We derive the relation between inflation and unemployment and discusshow it is influenced by the presence of labor market frictions and real wagerigidities. We show the nature of the tradeoff between inflation and unemployment stabilization, and its dependence on labor market characteristics. We draw the implications for optimal monetary policy.

Convertibility, currency controls and the cost of capital in Western Europe, 1950-1999

For most of the post-war period, Europe s capital markets remained largely closed to international capital flows. Thispaper explores the costs of this policy. Using an event-study methodology, I examine the extent to which restrictions ofcurrent and capital account convertibility affected stock returns. The delayed introduction of full currency convertibilityincreased the cost of capital. Also, a string of measures designed to reduce capital mobility before the ultimate collapseof the Bretton Woods System had considerable negative effects. These findings offer an explanation for the mountingevidence suggesting that capital account liberalization facilitates growth.

Enforcement problems and secondary markets

There is a large and growing literature that studies the effects of weak enforcement institutions on economic performance. This literature has focused almost exclusively on primary markets, in which assets are issued and traded to improve the allocation of investment and consumption. The general conclusion is that weak enforcement institutions impair the workings of these markets, giving rise to various inefficiencies.But weak enforcement institutions also create incentives to develop secondary markets, in which the assets issued in primary markets are retraded. This paper shows that trading in secondary markets counteracts the effects of weak enforcement institutions and, in the absence of further frictions, restores efficiency.

Disability, capacity for work and the business cycle: An international perspective

An important policy issue in recent years concerns the number of people claimingdisability benefits for reasons of incapacity for work. We distinguish between workdisability , which may have its roots in economic and social circumstances, and healthdisability which arises from clear diagnosed medical conditions. Although there is a linkbetween work and health disability, economic conditions, and in particular the businesscycle and variations in the risk of unemployment over time and across localities, mayplay an important part in explaining both the stock of disability benefit claimants andinflows to and outflow from that stock. We employ a variety of cross?country andcountry?specific household panel data sets, as well as administrative data, to testwhether disability benefit claims rise when unemployment is higher, and also toinvestigate the impact of unemployment rates on flows on and off the benefit rolls. Wefind strong evidence that local variations in unemployment have an importantexplanatory role for disability benefit receipt, with higher total enrolments, loweroutflows from rolls and, often, higher inflows into disability rolls in regions and periodsof above?average unemployment. Although general subjective measures of selfreporteddisability and longstanding illness are also positively associated withunemployment rates, inclusion of self?reported health measures does not eliminate thestatistical relationship between unemployment rates and disability benefit receipt;indeed including general measures of health often strengthens that underlyingrelationship. Intriguingly, we also find some evidence from the United Kingdom and theUnited States that the prevalence of self?reported objective specific indicators ofdisability are often pro?cyclical that is, the incidence of specific forms of disability arepro?cyclical whereas claims for disability benefits given specific health conditions arecounter?cyclical. Overall, the analysis suggests that, for a range of countries and datasets, levels of claims for disability benefits are not simply related to changes in theincidence of health disability in the population and are strongly influenced by prevailingeconomic conditions. We discuss the policy implications of these various findings.

Incomplete markets, labor supply and capital accumulation

In this paper we explore the accumulation of capital in the presence oflimited insurance against idiosyncratic shocks, borrowing constraintsand endogenous labor supply. As in the exogenous labor supply case(e.g. Aiyagari 1994, Huggett 1997), we find that steady states arecharacterized with an interest rate smaller than the rate of timepreference. However,wealsofind that when labor supply is endogenous thepresence of uncertainty and a borrowing limit are not enough to giverise to aggregate precautionary savings .

Sovereign risk and secondary markets

Conventional wisdom views the problem of sovereign risk as one of insufficient penalties.Foreign creditors can only be repaid if the government enforces foreign debts. And this will onlyhappen if foreign creditors can effectively use the threat of imposing penalties to the country.Guided by this assessment of the problem, policy prescriptions to reduce sovereign risk havefocused on providing incentives for governments to enforce foreign debts. For instance, countriesmight want to favor increased trade ties and other forms of foreign dependence that make themvulnerable to foreign retaliation thereby increasing the costs of default penalties.