Behaviour and rationality in corporate governance

Marnet, Oliver, 'Behaviour and rationality in corporate governance', Journal of Economic Issues (2005) 39(3) pp.613-632 RAE2008

The Euro as an International Currency: explaining puzzling first evidence from the foreign exchange markets

This paper presents evidence that the bid-ask spreads in euro rates increased relative to the corresponding bid-ask spreads in the German mark (DM) prior to the creation of the currency union. This comes with a decrease in transaction volume in the euro rates relative to the previous DM rates. The starkest example is the DM(euro)/yen rate in which the spread has risen by almost two-thirds while the volume decreased by more than one third. This outcome is surprising because the common currency concentrated market liquidity in fewer external euro rates and higher volume tends to be associated with lower spreads. We propose a microstructure explanation based on a change in the information environment of the FX market. The elimination of many cross currency pairs increased the market transparency for order flow imbalances in the dealership market. It is argued that higher market transparency adversely affects the inventory risk sharing efficiency of the dealership market and induces the observed euro spread increase and transaction volume shortfall.

Fixed versus Flexible: lessons from EMS order Flow

We extend the literature on regime-dependent volatility in two ways. First, our microstructural model provides a qualitatively new explanation. Second, we test implications of our model using Europe's recent shift to rigidly fixed rates (EMS to EMU). In the model, shocks to order flow induce more volatility under flexible rates because the elasticity of speculative demand is (endogenously) low, leading to pronounced portfolio-balance effects. New data on FF/DM transactions show that order flow had persistent effects on the exchange rate before EMU parities were announced. After announcement, the FF/DM rate was decoupled from order flow, as the model predicts.

Solving exchange rate puzzles with neither sticky prices nor trade costs

We present a simple framework in which both the exchange rate disconnect and forward bias puzzles are simultaneously resolved. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habitpersistence is modeled using Campbell Cochrane preferences with ‘deep’ habits along the lines of the work of Ravn, Schmitt-Grohe and Uribe. By deep habits, we mean habits defined over goods rather than countries. The model is simulated using the artificial economy methodology. It offers a neo-classical explanation of the Meese–Rogoff puzzle and mimics the failure of fundamentals to explain nominal exchange rates in a linear setting. Finally, the model naturally generates the negative slope in the standard forward market regression.