Contagion or Interdependence in the recent Global Financial Crisis? An application to the stock markets using unconditional cross-market correlations

We consider stock market contagion as a significant increase in cross-market linkages after a shock to one country or group of countries. Under this definition we study if contagion occurred from the U.S. Financial Crisis to the rest of the major stock markets in the world by using the adjusted (unconditional) correlation coefficient approach (Forbes and Rigobon, 2002) which consists of testing if average crossmarket correlations increase significantly during the relevant period of turmoil. We would not reject the null hypothesis of interdependence in favour of contagion if the increase in correlation only suggests a continuation of high linkages in all state of the world. Moreover, if contagion occurs, this would justify the intervention of the IMF and the suddenly portfolio restructuring during the period under study.

How did the Financial Crisis affect the Real Interest Rate Dynamics in Europe?

We investigate the effects of the financial crisis on the stationarity of real interest rates in the Euro Area. We use a new unit root test developed by Peseran et al. (2013) that allows for multiple unobserved factors in a panel set up. Our results suggest that while short-term and long-term real interest rates were stationary before the financial crisis, they became nonstationary during the crisis period likely due to persistent risk that characterized financial markets during that time. JEL codes: E43, C23. Keywords: Real interest rates, Euro Area, financial crisis, panel unit root tests, cross-sectional dependence.

The Generational contract in the family : explaining regime differences in financial transfers from parents to children in Europe

The exchange of social and economic support between the generationsis one of the main pillars of both family life and welfare systems. Thedebate on how to reform the generational contract is still truncated, however, by focusing on its public dimension only, especially on pensions and health care provisions. For a full account, the transfer of resources between adult generations in the family needs to be included as well. In our previous research we have shown that intergenerationalexchange is more likely to take place but less intense in the Nordicwelfare regime than in the Continental and Southern ones. In thepresent paper we analyze the social mechanisms that create and explain this nexus between patterns of intergenerational transfers and welfare regimes. The notion that Southern European family support networksare stronger and more effective than those of Continental and Northern European countries is only partially confirmed. In Southern (and partly in Continental) countries, children are mostly supported by means of co-residence with their parents till their complete economicindependence. However, once they have left the parental home thereare fewer transfers; support tends to be restricted to children who have special needs (such as for the formation of their own family), and depends more on their parents’ resources. In the Nordic countries, in contrast, transfers are less driven by children’s needs and parentalresources.

Endogenous Credit Cycles and Financial Dampening in an Adverse Selection Economy

We propose an adverse selection framework in which the financial sector has a dual role. It amplifies or dampens exogenous shocks and also generates endogenous fluctuations. We fully characterize constrained optimal contracts in a setting in which entrepreneurs need to borrow and are privately informed about the quality of their projects. Our characterization is novel in analyzing pooling and separating allocations in a context of multi-dimensional screening: specifically, the amounts of investment undertaken and of entrepreneurial net worth are used to screen projects. We then embed these results in a dynamic competitive economy. First, we show how endogenous regime switches in financial contracts may generate fluctuations in an economy that exhibits no dynamics under full information. Unlike previous models of endogenous cycles, our result does not rely on entrepreneurial net worth being counter-cyclical or inconsequential for determining investment. Secondly, the model shows the different implications of adverse selection as opposed to pure moral hazard. In particular, and contrary to standard results in the macroeconomic literature, the financial system may dampen exogenous shocks in the presence of adverse selection.

Financial Development, Financial Fragility, and Growth

This paper studies the apparent contradiction between two strands of the literature on the effects of financial intermediation on economic activity. On the one hand, the empirical growth literature finds a positive effect of financial depth as measured by, for instance, private domestic credit and liquid liabilities (e.g., Levine, Loayza, and Beck 2000). On the other hand, the banking and currency crisis literature finds that monetary aggregates, such as domestic credit, are among the best predictors of crises and their related economic downturns (e.g., Kaminski and Reinhart 1999). The paper accounts for these contrasting effects based on the distinction between the short- and long-run impacts of financial intermediation. Working with a panel of cross-country and time-series observations, the paper estimates an encompassing model of short- and long-run effects using the Pooled Mean Group estimator developed by Pesaran, Shin, and Smith (1999). The conclusion from this analysis is that a positive long-run relationship between financial intermediation and output growth co-exists with a, mostly, negative short-run relationship. The paper further develops an explanation for these contrasting effects by relating them to recent theoretical models, by linking the estimated short-run effects to measures of financial fragility (namely, banking crises and financial volatility), and by jointly analyzing the effects of financial depth and fragility in classic panel growth regressions.

Financial Repression in a Natural Experiment: Loan Allocation and the Change in the Usury Laws in 1714

If financial deepening aids economic growth, then financial repression should be harmful. We use a natural experiment – the change in the English usury laws in 1714 – to analyze the effects of interest rate restrictions. We use a sample of individual loan transactions to demonstrate how the reduction of the legal maximum rate of interest affected the supply and demand for credit. Average loan size and minimum loan size increased strongly, and access to credit worsened for those with little ‘social capital.’ While we have no direct evidence that loans were misallocated, the discontinuity in loan receipts makes this highly likely. We conclude that financial repression can undermine the positive effects of financial deepening.

Neglected risks, financial innovation, and financial fragility

We present a standard model of financial innovation, in which intermediaries engineer securities with cash flows that investors seek, but modify two assumptions. First, investors (and possibly intermediaries) neglect certain unlikely risks. Second, investors demand securities with safe cash flows. Financial intermediaries cater to these preferences and beliefs by engineering securities perceived to be safe but exposed to neglected risks. Because the risks are neglected, security issuance is excessive. As investors eventually recognize these risks, they fly back to safety of traditional securities and markets become fragile, even without leverage, precisely because the volume of new claims is excessive.

The Speed of the Financial Revolution: Evidence from Hoare’s Bank

Finance is important for development, yet the onset of modern economic growth in Britain lagged the British financial revolution by over a century. We present evidence from a new West-End London private bank to explain this delay. Hoare’s Bank loaned primarily to a highly select and well-born clientele, although it did not discriminate against “unknown” borrowers in the early 18th century. It could not extend credit more generally because of government restrictions (usury limits) and policies (frequent wars). Britain’s financial development could have aided growth substantially, had it not been for the rigidities and turmoil introduced by government interference.

Financial Crises and International Portfolio Dynamics

This paper analyzes the behavior of international capital flows by foreigners and domestic agents, especially during financial crises. We show that gross capital flows by foreigners and domestic agents are very large and volatile, especially relative to net capital flows. This is because when foreigners invest in a country domestic agents tend to invest abroad and vice versa. Gross capital flows are also pro-cyclical. During expansions, foreigners tend to bring in more capital and domestic agents tend to invest more abroad. During crises, there is retrenchment, i.e. a reduction in capital inflows by foreigners and an increase in capital inflows by domestic agents. This is especially true during severe crises and during systemic crises. The evidence can shed light on the nature of shocks driving international capital flows. It seems to favor shocks that affect foreigners and domestic agents asymmetrically -e.g. sovereign risk and asymmetric information- over productivity shocks.

The effects of poor financial information systems on the long term sustainability of local public services. Empirical evidence from the Catalan Municipalities

In this paper we describe the existence of financial illusion in public accountingand we comment on its effects for the future sustainability of local publicservices. We relate these features to the lack of incentives amongst publicmanagers for improving the financial reporting and thus management of publicassets. Financial illusion pays off for politicians and managers since it allowsfor larger public expenditure increases and managerial slack, these beingarguments in their utility functions. This preference is strengthen by the shorttime perspective of politically appointed public managers. Both factors runagainst public accountability. This hypothesis is tested for Spain by using anunique sample. We take data from around forty Catalan local authorities withpopulation above 20,000 for the financial years 1993-98. We build this databasis from the Catalan Auditing Office Reports in a way that it can be linkedto some other local social and economic variables in order to test ourassumptions. The results confirm that there is a statistical relationship between the financialillusion index (FI as constructed in the paper) and higher current expenditure.This reflects on important overruns and increases of the delay in payingsuppliers, as well as on a higher difficulties to face capital finance. Mechanismsfor FI creation have to do among other factors, with delays in paying suppliers(and thereafter higher future financial costs per unit of service), no adequateprovision for bad debts and lack of appropriate capital funding either forreposition or for new equipments. For this, it is crucial to monitor the way inwhich capital transfers are accounted in local public sheet balances. As a result,for most of the Municipalities we analyse, the funds for guaranteeing continuityand sustainability of public services provision are today at risk.Given managerial incentives at present in public institutions, we conclude thatpublic regulation recently enforced for assuring better information systems inlocal public management may not be enough to change the current state of affairs.

A subsampling approach to estimating the distribution of diversing statistics with application to assessing financial market risks

In this paper we propose a subsampling estimator for the distribution ofstatistics diverging at either known rates when the underlying timeseries in strictly stationary abd strong mixing. Based on our results weprovide a detailed discussion how to estimate extreme order statisticswith dependent data and present two applications to assessing financialmarket risk. Our method performs well in estimating Value at Risk andprovides a superior alternative to Hill's estimator in operationalizingSafety First portofolio selection.

The monetary pillar and the great financial crisis

Since its inception, a most distinctive (and controversial) feature of the ECB monetary policy strategy has been its emphasis on money and monetary analysis, which constitute the basis of the so-called monetary pillar. The present paper examines the performance of the monetary pillar around the recent financial crisis episode, and discusses its prospects in light of the renewed emphasis on financial stability and the need for enhanced macro-prudential policies.

International business cycles, financial markets and household production

This paper investigates the properties of an international real business cycle model with household production. We show that a model with disturbances to both market and household technologies reproduces the main regularities of the data and improves existing models in matching international consumption, investment and output correlations without irrealistic assumptions on the structure of international financial markets. Sensitivity analysis shows the robustness of the results to alternative specifications of the stochastic processes for the disturbances and to variations of unmeasured parameters within a reasonable range.

Contractual resolutions of financial distress

In a financial contracting model, we study the optimal debt structure to resolve financial distress. Weshow that a debt structure where two distinct debt classes co-exist - one class fully concentrated andwith control rights upon default, the other dispersed and without control rights - removes the controllingcreditor's liquidation bias when investor protection is strong. These results rationalize the use and theperformance of floating charge financing, debt financing where the controlling creditor takes the entirebusiness as collateral, in countries with strong investor protection. Our theory predicts that the efficiency ofcontractual resolutions of financial distress should increase with investor protection.

Austerity and anarchy: Budget cuts and social unrest in Europe, 1919-2008

Does fiscal consolidation lead to social unrest? Using cross-country evidencefor the period 1919 to 2008, we examine the extent to which societies becomeunstable after budget cuts. The results show a clear correlation between fiscalretrenchment and instability. Expenditure cuts are particularly potent infueling protests; tax rises have only small and insignificant effects. We test ifthe relationship simply reflects economic downturns, using a recently-developedIMF dataset on exogenous expenditure shocks, and conclude that this is not thecase. While autocracies and democracies show broadly similar responses to budgetcuts, countries with more constraints on the executive are less likely to seeunrest after austerity measures. Growing media penetration does not strengthenthe effect of cut-backs on the level of unrest. We also find that austerity episodesthat result in unrest lead to quick reversals of fiscal policy.