Bayesian estimation and selection of nonlinear vector error correction models: The case of the sugar-ethanol-oil nexus in Brazil

Nonlinear adjustment toward long-run price equilibrium relationships in the sugar-ethanol-oil nexus in Brazil is examined. We develop generalized bivariate error correction models that allow for cointegration between sugar, ethanol, and oil prices, where dynamic adjustments are potentially nonlinear functions of the disequilibrium errors. A range of models are estimated using Bayesian Monte Carlo Markov Chain algorithms and compared using Bayesian model selection methods. The results suggest that the long-run drivers of Brazilian sugar prices are oil prices and that there are nonlinearities in the adjustment processes of sugar and ethanol prices to oil price but linear adjustment between ethanol and sugar prices.

A multiple error-correction model of housing supply

This paper considers supply dynamics in the context of the Irish residential market. The analysis, in a multiple error-correction framework, reveals that although developers did respond to disequilibrium in supply, the rate of adjustment was relatively slow. In contrast, however, disequilibrium in demand did not impact upon supply, suggesting that inelastic supply conditions could explain the prolonged nature of the boom in the Irish market. Increased elasticity in the later stages of the boom may have been a contributory factor in the extent of the house price falls observed in recent years.

Can we explain the dynamics of the UK FTSE 100 stock and stock index futures markets?

If stock and stock index futures markets are functioning properly price movements in these markets should best be described by a first order vector error correction model with the error correction term being the price differential between the two markets (the basis). Recent evidence suggests that there are more dynamics present than should be in effectively functioning markets. Using self-exciting threshold autoregressive (SETAR) models, this study analyses whether such dynamics can be related to different regimes within which the basis can fluctuate in a predictable manner without triggering arbitrage. These findings reveal that the basis shows strong evidence of autoregressive behaviour when its value is between the two thresholds but that the extra dynamics disappear once the basis moves above the upper threshold and their persistence is reduced, although not eradicated, once the basis moves below the lower threshold. This suggests that once nonlinearity associated with transactions costs is accounted for, stock and stock index futures markets function more effectively than is suggested by linear models of the pricing relationship.

Price discovery of credit spreads in tranquil and crisis periods

In this paper we investigate the price discovery process in single-name credit spreads obtained from bond, credit default swap (CDS), equity and equity option prices. We analyse short term price discovery by modelling daily changes in credit spreads in the four markets with a vector autoregressive model (VAR). We also look at price discovery in the long run with a vector error correction model (VECM). We find that in the short term the option market clearly leads the other markets in the sub-prime crisis (2007-2009). During the less severe sovereign debt crisis (2009-2012) and the pre-crisis period, options are still important but CDSs become more prominent. In the long run, deviations from the equilibrium relationship with the option market still lead to adjustments in the credit spreads observed or implied from other markets. However, options no longer dominate price discovery in any of the periods considered. Our findings have implications for traders, credit risk managers and financial regulators.

A structural time series approach to modelling multiple and resurgent meat scares in Italy

This paper exploits a structural time series approach to model the time pattern of multiple and resurgent food scares and their direct and cross-product impacts on consumer response. A structural time series Almost Ideal Demand System (STS-AIDS) is embedded in a vector error correction framework to allow for dynamic effects (VEC-STS-AIDS). Italian aggregate household data on meat demand is used to assess the time-varying impact of a resurgent BSE crisis (1996 and 2000) and the 1999 Dioxin crisis. The VEC-STS-AIDS model monitors the short-run impacts and performs satisfactorily in terms of residuals diagnostics, overcoming the major problems encountered by the customary vector error correction approach.

The inflation hedging characteristics of US and UK investments: a multi-factor error correction approach

Historic analysis of the inflation hedging properties of stocks produced anomalous results, with equities often appearing to offer a perverse hedge against inflation. This has been attributed to the impact of real and monetary shocks to the economy, which influence both inflation and asset returns. It has been argued that real estate should provide a better hedge: however, empirical results have been mixed. This paper explores the relationship between commercial real estate returns (from both private and public markets) and economic, fiscal and monetary factors and inflation for US and UK markets. Comparative analysis of general equity and small capitalisation stock returns in both markets is carried out. Inflation is subdivided into expected and unexpected components using different estimation techniques. The analyses are undertaken using long-run error correction techniques. In the long-run, once real and monetary variables are included, asset returns are positively linked to anticipated inflation but not to inflation shocks. Adjustment processes are, however, gradual and not within period. Real estate returns, particularly direct market returns, exhibit characteristics that differ from equities.

Asymmetric response of demand-supply mismatch to investor's sentiment

We look through both the demand and supply side information to understand dynamics of price determination in the real estate market and examine how accurately investors’ attitudes predict the market returns and thereby flagging off extent of any demand-supply mismatch. Our hypothesis is based on the possibility that investors’ call for action in terms of their buy/sell decision and adjustment in reservation/offer prices may indicate impending demand-supply imbalances in the market. In the process, we study several real estate sectors to inform our analysis. The timeframe of our analysis (1995-2010) allows us to observe market dynamics over several economic cycles and in various stages of those cycles. Additionally, we also seek to understand how investors’ attitude or the sentiment affects the market activity over the cycles through asymmetric responses. We test our hypothesis variously using a number of measures of market activity and attitude indicators within several model specifications. The empirical models are estimated using Vector Error Correction framework. Our analysis suggests that investors’ attitude exert strong and statistically significant feedback effects in price determination. Moreover, these effects do reveal heterogeneous responses across the real estate sectors. Interestingly, our results indicate the asymmetric responses during boom, normal and recessionary periods. These results are consistent with the theoretical underpinnings.

Intermittently-visual tracking experiments reveal the roles of error-correction and predictive mechanisms in the human visual-motor control system

Prediction mechanism is necessary for human visual motion to compensate a delay of sensory-motor system. In a previous study, “proactive control” was discussed as one example of predictive function of human beings, in which motion of hands preceded the virtual moving target in visual tracking experiments. To study the roles of the positional-error correction mechanism and the prediction mechanism, we carried out an intermittently-visual tracking experiment where a circular orbit is segmented into the target-visible regions and the target-invisible regions. Main results found in this research were following. A rhythmic component appeared in the tracer velocity when the target velocity was relatively high. The period of the rhythm in the brain obtained from environmental stimuli is shortened more than 10%. The shortening of the period of rhythm in the brain accelerates the hand motion as soon as the visual information is cut-off, and causes the precedence of hand motion to the target motion. Although the precedence of the hand in the blind region is reset by the environmental information when the target enters the visible region, the hand motion precedes the target in average when the predictive mechanism dominates the error-corrective mechanism.

Transition from an anti-phase error-correction-mode to a synchronization mode in the mutual hand tracking

Proactive motion in hand tracking and in finger bending, in which the body motion occurs prior to the reference signal, was reported by the preceding researchers when the target signals were shown to the subjects at relatively high speed or high frequencies. These phenomena indicate that the human sensory-motor system tends to choose an anticipatory mode rather than a reactive mode, when the target motion is relatively fast. The present research was undertaken to study what kind of mode appears in the sensory-motor system when two persons were asked to track the hand position of the partner with each other at various mean tracking frequency. The experimental results showed a transition from a mutual error-correction mode to a synchronization mode occurred in the same region of the tracking frequency with that of the transition from a reactive error-correction mode to a proactive anticipatory mode in the mechanical target tracking experiments. Present research indicated that synchronization of body motion occurred only when both of the pair subjects operated in a proactive anticipatory mode. We also presented mathematical models to explain the behavior of the error-correction mode and the synchronization mode.

Threshold effects in price transmission: The case of Brazilian wheat, maize, and soya prices

Recent studies into price transmission have recognized the important role played by transport and transaction costs. Threshold models are one approach to accommodate such costs. We develop a generalized Threshold Error Correction Model to test for the presence and form of threshold behavior in price transmission that is symmetric around equilibrium. We use monthly wheat, maize, and soya prices from the United States, Argentina, and Brazil to demonstrate this model. Classical estimation of these generalized models can present challenges but Bayesian techniques avoid many of these problems. Evidence for thresholds is found in three of the five commodity price pairs investigated.

Asymmetric adjustment in the City of London office market

Earlier estimates of the City of London office market are extended by considering a longer time series of data, covering two cycles, and by explicitly modeling of asymmetric space market responses to employment and supply shocks. A long run structural model linking real rental levels, office-based employment and the supply of office space is estimated and then rental adjustment processes are modeled using an error correction model framework. Rental adjustment is seen to be asymmetric, depending both on the direction of the supply and demand shocks and on the state of the space market at the time of the shock. Vacancy adjustment does not display asymmetries. There is also a supply adjustment equation. Two three-equation systems, one with symmetric rental adjustment and the other with asymmetric adjustment, are subjected to positive and negative shocks to employment. These illustrate differences in the two systems.

Capital market expectations and the London office market

The analysis of office market dynamics has generally concentrated on the impact of underlying fundamental demand and supply variables. This paper takes a slightly different approach to many previous examinations of rental dynamics. Within a Vector-Error-Correction framework the empirical analysis concentrates upon the impact of economic and financial variables on rents in the City of London and West End of London office markets. The impulse response and variance decomposition reveal that while lagged rental values and key demand drivers play a highly important role in the dynamics of rents, financial variables are also influential. Stock market performance not only influences the City of London market but also the West End, whilst the default spread plays an important role in recent years. It is argued that both series incorporate expectations about future economic performance and that this is the basis of their influence upon rental values.