Jumps in the Volatility of Financial Markets.

Recent work suggests that the conditional variance of financial returns may exhibit sudden jumps. This paper extends a non-parametric procedure to detect discontinuities in otherwise continuous functions of a random variable developed by Delgado and Hidalgo (1996) to higher conditional moments, in particular the conditional variance. Simulation results show that the procedure provides reasonable estimates of the number and location of jumps. This procedure detects several jumps in the conditional variance of daily returns on the S&P 500 index.

Uncovering Financial Markets Beliefs About Inflation Targets

This paper exploits the term structure of interest rates to develop testable economic restrictions on the joint process of long-term interest rates and inflation when the latter is subject to a targeting policy by the Central Bank. Two competing models that econometrically describe agents’ inferences about inflation targets are developed and shown to generate distinct predictions on the behavior of interest rates. In an empirical application to the Canadian inflation target zone, results indicate that agents perceive the band to be substantially narrower than officially announced and asymmetric around the stated mid-point. The latter result (i) suggests that the monetary authority attaches different weights to positive and negative deviations from the central target, and (ii) challenges on empirical grounds the assumption, frequently made in the literature, that the policy maker’s loss function is symmetric (usually a quadratic function) around a desired inflation value.

General equilibrium model with restricted participation in financial markets

The paper analyses a general equilibrium model with financiaI markets in which households may face restrictions in trading financiaI assets such as borrowing constraints and collateral (restricted participation model). However, markets are not assumed to be incomplete. We consider a standard general equilibrium model with H > 1 households, 2 periods and S states of nature in the second period. We show that generically the set of equilibrium allocations ia indeterminate, provided the existence of at least one nominal asset and one household for who some restriction is binding. Suppose there are C > 1 commodities in each state of nature and assets pays in units of some commodity. In this case for each household with binding restrictions it is possible to reduce the set of feasible assets trading and obtain a new equilibrium that utility improve alI those households. There is however an upper bound on the number of households to be improved related to the number of states of nature and the number of commodities. In particular, if the number of households ia smaller than the number of states of nature it is possible to Pareto improve any equilibrium by reducing the feasible choice set for each household.

Making political capital:the behaviour of UK financial markets during Election 97

This article examines the behaviour of the UK capital markets during the overnight trading period that coincided with the announcement of the results of the UK general election in May 1997. Evidence that the financial markets responded to the evolving pattern of results is found. In addition, the consensus move experienced as the markets opened the next trading day was influenced by the extent of the moves that had already occurred overnight.

Patterns in financial markets: Dynamic time warping

A Work Project, presented as part of the requirements for the Award of a Masters Degree in Finance from the NOVA – School of Business and Economics

Hope, change, and the financial markets: Can Obama's public speeches drive the U.S. Stock Market

A Work Project, presented as part of the requirements for the Award of a Masters Degree in Economics from the NOVA – School of Business and Economics

Three essays in financial markets

A PhD Dissertation, presented as part of the requirements for the Degree of Doctor of Philosophy from the NOVA - School of Business and Economics

Noise traders, rational traders, and the rest: A new approach to efficient financial markets

A PhD Dissertation, presented as part of the requirements for the Degree of Doctor of Philosophy from the NOVA - School of Business and Economics

Monetary policy strategies, financial institutions and financial markets in the Middle East and North Africa: an overview

Three polar types of monetary architecture are identified together with the institutional and market infrastructure required for each type and the kinds of monetary policy feasible in each case: a ‘basic’ architecture where there is little or no financial system as such but an elementary central bank which is able to fix the exchange rate, as a substitute for a proper monetary policy; a ‘modern’ monetary architecture with developed banks, financial markets and central bank where policy choices include types of inflation targeting; and an ‘intermediate’ monetary architecture where less market-based monetary policies involving less discretion are feasible. A range of data is used to locate the various MENA countries with respect to these polar types. Five countries (Iran, Libya, Sudan, Syria and Yemen) are identified as those with the least developed monetary architecture, while Bahrain and Jordan are identified as the group at the other end of the spectrum, reaching beyond the intermediate polar type in some dimensions but not others. The countries in between vary on different dimensions but all lie between basic and intermediate architectures. The key general findings are that the MENA countries are both less differentiated and less ‘developed’ than might have been expected. The paper ends by calling for research on the costs and benefits of different types of monetary architecture.

Private Governance of Financial Markets: the US Regulatory Regime on Hedge Funds

The article investigates the private governance of financial markets by looking at the evolution of the regulatory debate on hedge funds in the US market. It starts from the premise that the privatization of regulation is always the result of a political decision and analyzes how this decision came about and was implemented in the case of hedge funds. The starting point is the failure of two initiatives on hedge funds that US regulators launched between 1999 an 2004, which the analysis explains by elaborating the concept of self-capture. Facing a trade off between the need to tackle publicly demonized issues and the difficulty of monitoring increasingly sophisticated and powerful private markets, regulators purposefully designed initiatives that were not meant to succeed, that is, they “self-captured” their own activity. By formulating initiatives that were inherently flawed, regulators saved their public role and at the same time paved the way for the privatization of hedge fund regulation. This explanation identifies a link between the failure of public initiatives and the success of private ones. It illustrates a specific case of formation of private authority in financial markets that points to a more general practice emerging in the regulation of finance.

Financial Markets and Real Ecinomy: Four Essays in International Trade

Financial markets play an important role in an economy performing various functions like mobilizing and pooling savings, producing information about investment opportunities, screening and monitoring investments, implementation of corporate governance, diversification and management of risk. These functions influence saving rates, investment decisions, technological innovation and, therefore, have important implications for welfare. In my PhD dissertation I examine the interplay of financial and product markets by looking at different channels through which financial markets may influence an economy.My dissertation consists of four chapters. The first chapter is a co-authored work with Martin Strieborny, a PhD student from the University of Lausanne. The second chapter is a co-authored work with Melise Jaud, a PhD student from the Paris School of Economics. The third chapter is co-authored with both Melise Jaud and Martin Strieborny. The last chapter of my PhD dissertation is a single author paper.Chapter 1 of my PhD thesis analyzes the effect of financial development on growth of contract intensive industries. These industries intensively use intermediate inputs that neither can be sold on organized exchange, nor are reference-priced (Levchenko, 2007; Nunn, 2007). A typical example of a contract intensive industry would be an industry where an upstream supplier has to make investments in order to customize a product for needs of a downstream buyer. After the investment is made and the product is adjusted, the buyer may refuse to meet a commitment and trigger ex post renegotiation. Since the product is customized to the buyer's needs, the supplier cannot sell the product to a different buyer at the original price. This is referred in the literature as the holdup problem. As a consequence, the individually rational suppliers will underinvest into relationship-specific assets, hurting the downstream firms with negative consequences for aggregate growth. The standard way to mitigate the hold up problem is to write a binding contract and to rely on the legal enforcement by the state. However, even the most effective contract enforcement might fail to protect the supplier in tough times when the buyer lacks a reliable source of external financing. This suggests the potential role of financial intermediaries, banks in particular, in mitigating the incomplete contract problem. First, financial products like letters of credit and letters of guarantee can substantially decrease a risk and transaction costs of parties. Second, a bank loan can serve as a signal about a buyer's true financial situation, an upstream firm will be more willing undertake relationship-specific investment knowing that the business partner is creditworthy and will abstain from myopic behavior (Fama, 1985; von Thadden, 1995). Therefore, a well-developed financial (especially banking) system should disproportionately benefit contract intensive industries.The empirical test confirms this hypothesis. Indeed, contract intensive industries seem to grow faster in countries with a well developed financial system. Furthermore, this effect comes from a more developed banking sector rather than from a deeper stock market. These results are reaffirmed examining the effect of US bank deregulation on the growth of contract intensive industries in different states. Beyond an overall pro-growth effect, the bank deregulation seems to disproportionately benefit the industries requiring relationship-specific investments from their suppliers.Chapter 2 of my PhD focuses on the role of the financial sector in promoting exports of developing countries. In particular, it investigates how credit constraints affect the ability of firms operating in agri-food sectors of developing countries to keep exporting to foreign markets.Trade in high-value agri-food products from developing countries has expanded enormously over the last two decades offering opportunities for development. However, trade in agri-food is governed by a growing array of standards. Sanitary and Phytosanitary standards (SPS) and technical regulations impose additional sunk, fixed and operating costs along the firms' export life. Such costs may be detrimental to firms' survival, "pricing out" producers that cannot comply. The existence of these costs suggests a potential role of credit constraints in shaping the duration of trade relationships on foreign markets. A well-developed financial system provides the funds to exporters necessary to adjust production processes in order to meet quality and quantity requirements in foreign markets and to maintain long-standing trade relationships. The products with higher needs for financing should benefit the most from a well functioning financial system. This differential effect calls for a difference-in-difference approach initially proposed by Rajan and Zingales (1998). As a proxy for demand for financing of agri-food products, the sanitary risk index developed by Jaud et al. (2009) is used. The empirical literature on standards and norms show high costs of compliance, both variable and fixed, for high-value food products (Garcia-Martinez and Poole, 2004; Maskus et al., 2005). The sanitary risk index reflects the propensity of products to fail health and safety controls on the European Union (EU) market. Given the high costs of compliance, the sanitary risk index captures the demand for external financing to comply with such regulations.The prediction is empirically tested examining the export survival of different agri-food products from firms operating in Ghana, Mali, Malawi, Senegal and Tanzania. The results suggest that agri-food products that require more financing to keep up with food safety regulation of the destination market, indeed sustain longer in foreign market, when they are exported from countries with better developed financial markets.Chapter 3 analyzes the link between financial markets and efficiency of resource allocation in an economy. Producing and exporting products inconsistent with a country's factor endowments constitutes a serious misallocation of funds, which undermines competitiveness of the economy and inhibits its long term growth. In this chapter, inefficient exporting patterns are analyzed through the lens of the agency theories from the corporate finance literature. Managers may pursue projects with negative net present values because their perquisites or even their job might depend on them. Exporting activities are particularly prone to this problem. Business related to foreign markets involves both high levels of additional spending and strong incentives for managers to overinvest. Rational managers might have incentives to push for exports that use country's scarce factors which is suboptimal from a social point of view. Export subsidies might further skew the incentives towards inefficient exporting. Management can divert the export subsidies into investments promoting inefficient exporting.Corporate finance literature stresses the disciplining role of outside debt in counteracting the internal pressures to divert such "free cash flow" into unprofitable investments. Managers can lose both their reputation and the control of "their" firm if the unpaid external debt triggers a bankruptcy procedure. The threat of possible failure to satisfy debt service payments pushes the managers toward an efficient use of available resources (Jensen, 1986; Stulz, 1990; Hart and Moore, 1995). The main sources of debt financing in the most countries are banks. The disciplining role of banks might be especially important in the countries suffering from insufficient judicial quality. Banks, in pursuing their rights, rely on comparatively simple legal interventions that can be implemented even by mediocre courts. In addition to their disciplining role, banks can promote efficient exporting patterns in a more direct way by relaxing credit constraints of producers, through screening, identifying and investing in the most profitable investment projects. Therefore, a well-developed domestic financial system, and particular banking system, would help to push a country's exports towards products congruent with its comparative advantage.This prediction is tested looking at the survival of different product categories exported to US market. Products are identified according to the Euclidian distance between their revealed factor intensity and the country's factor endowments. The results suggest that products suffering from a comparative disadvantage (labour-intensive products from capital-abundant countries) survive less on the competitive US market. This pattern is stronger if the exporting country has a well-developed banking system. Thus, a strong banking sector promotes exports consistent with a country comparative advantage.Chapter 4 of my PhD thesis further examines the role of financial markets in fostering efficient resource allocation in an economy. In particular, the allocative efficiency hypothesis is investigated in the context of equity market liberalization.Many empirical studies document a positive and significant effect of financial liberalization on growth (Levchenko et al. 2009; Quinn and Toyoda 2009; Bekaert et al., 2005). However, the decrease in the cost of capital and the associated growth in investment appears rather modest in comparison to the large GDP growth effect (Bekaert and Harvey, 2005; Henry, 2000, 2003). Therefore, financial liberalization may have a positive impact on growth through its effect on the allocation of funds across firms and sectors.Free access to international capital markets allows the largest and most profitable domestic firms to borrow funds in foreign markets (Rajan and Zingales, 2003). As domestic banks loose some of their best clients, they reoptimize their lending practices seeking new clients among small and younger industrial firms. These firms are likely to be more risky than large and established companies. Screening of customers becomes prevalent as the return to screening rises. Banks, ceteris paribus, tend to focus on firms operating in comparative-advantage sectors because they are better risks. Firms in comparative-disadvantage sectors finding it harder to finance their entry into or survival in export markets either exit or refrain from entering export markets. On aggregate, one should therefore expect to see less entry, more exit, and shorter survival on export markets in those sectors after financial liberalization.The paper investigates the effect of financial liberalization on a country's export pattern by comparing the dynamics of entry and exit of different products in a country export portfolio before and after financial liberalization.The results suggest that products that lie far from the country's comparative advantage set tend to disappear relatively faster from the country's export portfolio following the liberalization of financial markets. In other words, financial liberalization tends to rebalance the composition of a country's export portfolio towards the products that intensively use the economy's abundant factors.

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.

Extreme times in financial markets.

We apply the theory of continuous time random walks (CTRWs) to study some aspects involving extreme events in financial time series. We focus our attention on the mean exit time (MET). We derive a general equation for this average and compare it with empirical results coming from high-frequency data of the U.S. dollar and Deutsche mark futures market. The empirical MET follows a quadratic law in the return length interval which is consistent with the CTRW formalism.

Testing Mean-Variance Efficiency in CAPM with Possibly Non-Gaussian Errors : An Exact Simulation-Based Approach

In this paper we propose exact likelihood-based mean-variance efficiency tests of the market portfolio in the context of Capital Asset Pricing Model (CAPM), allowing for a wide class of error distributions which include normality as a special case. These tests are developed in the frame-work of multivariate linear regressions (MLR). It is well known however that despite their simple statistical structure, standard asymptotically justified MLR-based tests are unreliable. In financial econometrics, exact tests have been proposed for a few specific hypotheses [Jobson and Korkie (Journal of Financial Economics, 1982), MacKinlay (Journal of Financial Economics, 1987), Gib-bons, Ross and Shanken (Econometrica, 1989), Zhou (Journal of Finance 1993)], most of which depend on normality. For the gaussian model, our tests correspond to Gibbons, Ross and Shanken’s mean-variance efficiency tests. In non-gaussian contexts, we reconsider mean-variance efficiency tests allowing for multivariate Student-t and gaussian mixture errors. Our framework allows to cast more evidence on whether the normality assumption is too restrictive when testing the CAPM. We also propose exact multivariate diagnostic checks (including tests for multivariate GARCH and mul-tivariate generalization of the well known variance ratio tests) and goodness of fit tests as well as a set estimate for the intervening nuisance parameters. Our results [over five-year subperiods] show the following: (i) multivariate normality is rejected in most subperiods, (ii) residual checks reveal no significant departures from the multivariate i.i.d. assumption, and (iii) mean-variance efficiency tests of the market portfolio is not rejected as frequently once it is allowed for the possibility of non-normal errors.