Analyzing determinants of bond yield spreads with Bayesian Model Averaging

This paper analyzes determinants of country default risk in emerging markets, reflected by sovereign yield spreads. The results reported so far in the literature are heterogeneous with respect to significant explanatory variables. This could indicate a high degree of uncertainty about the “true” regression model. We use Bayesian Model Averaging as the model selection method in order to find the variables which are most likely to determine credit risk. We document that total debt, history of recent default, currency depreciation, and growth rate of foreign currency reserves as well as market sentiments are the key drivers of yield spreads.     

Fatal attraction: Using distance to measure contagion in good times as well as bad

This paper proposes a new measure of contagion that is good at anticipating future vulnerabilities. Building on previous work, it uses correlations of equity markets across countries to measure contagion, but in a departure from previous practice measures contagion using the relationship of these correlations with distance. Also in contrast to previous work, our test is good at identifying periods of “positive contagion,” in which capital flows to emerging markets in a herd-like manner largely unrelated to fundamentals. Identifying such periods of “fatal attraction” is important as they provide the essential ingredients for subsequent crises and rapid outflows of capital.     

On measuring synchronization of bulls and bears: The case of East Asia

This paper implements estimation and testing procedures for comovements of stock market “cycles” or “phases” in Asia. We extend the Harding and Pagan [Harding, D., Pagan, A.P., 2006. Synchronization of cycles. Journal of Econometrics 132 (1), 59–79] test for strong multivariate nonsynchronization (SMNS) between business cycles to a test that allows for an imperfect degree of multivariate synchronization between stock market cycles. Moreover, we propose a test for endogenously determining structural change in the bivariate and multivariate synchronization indices. Upon applying the technique to five Asian stock markets we find a significant increase in the cross country comovements of Asian bullish and bearish periods in 1997. A power study of the stability test suggests that the detected increase in comovement is more of a sudden nature (i.e. contagion or “Asian Flu”) instead of gradual (i.e. financial integration). It is furthermore argued that stock market cycles and their propensity toward (increased) synchronization contain useful information for both investors, policy makers and financial regulators.     

Sovereign debt disputes: A database on government coerciveness during debt crises

This paper measures “debt disputes” between governments and foreign private creditors in periods of sovereign debt crises. We construct an index of government coerciveness, consisting of 9 objective sub-indicators. Each of these sub-indicators captures unilateral government actions imposed on foreign banks and bondholders. The results provide the first systematic account of debt crises that goes beyond a binary categorization of default versus non-default. Overall, government behavior and rhetoric show a strong variability, ranging from highly confrontational to very smooth crisis resolution processes. In a preliminary analysis on the determinants of coercive behavior, we find political institutions to be significant, while economic and financial factors play a lesser role. These results open up an agenda for future research.     

The optimal currency basket under vertical trade

This paper explores the theory of optimal currency basket in a small open economy general equilibrium model with sticky prices. In contrast to existing literature, we focus on an economy with vertical trade, where the currencies in the basket may play different roles in invoicing trade flow. In a simple two-currency basket, one currency is used to invoice imported intermediate goods and is called “import currency”, while the other currency is used to invoice exported finished goods and is called “export currency”. We find that the optimal weights of the import currency and the export currency depends critically on the structure of vertical trade. Moreover, if a country decides to choose a single-currency peg, the choice of pegging currency also depends on how other competing economies respond to external exchange rate fluctuations.     

Foreign currency debt,financial crises and economic growth: A long-run view

Foreign currency debt is widely believed to increase risks of financial crisis, especially after being implicated as a cause of the East Asian crisis in the late 1990s. In this paper, we study the effects of foreign currency debt on currency and debt crises and its indirect effects on short-term growth and long-run output effects in both 1880–1913 and 1973–2003 for 45 countries. Greater ratios of foreign currency debt to total debt are associated with increased risks of currency and debt crises, although the strength of the association depends crucially on the size of a country's reserve base and its policy credibility. We found that financial crises, driven by exposure to foreign currency, resulted in significant permanent output losses. We estimate some implications of our findings for the risks posed by currently high levels of foreign currency liabilities in eastern Europe.     

Realizing the volatility impacts of sovereign credit ratings information on equity and currency markets: Evidence from the Asian Financial Crisis

We examine the effects of different types of sovereign rating announcements on realized stock and currency market volatilities and cross-asset correlations around periods of financial crises. Using intraday market data and sovereign ratings data for nine sample countries in the Asia-Pacific region over 1997–2001, we find that currency and stock markets react somewhat heterogeneously to various rating announcements and that stock markets are more responsive to rating news than currency markets. We find new evidence that ratings events have significant and asymmetric impacts on intraday market data and that national market attributes influence rating impacts during financial crises.     

Capital account liberalization, financial development and industry growth: A synthetic view

This paper synthesizes studies analyzing the effects of capital account liberalization on industry growth while controlling for financial crises, domestic financial development and the strength of institutions. We find evidence that financial openness has positive effects on the growth of financially dependent industries, although these growth-enhancing effects evaporate during financial crises. Further analysis indicates that the positive effects of capital account liberalization are limited to countries with relatively well-developed financial systems, good accounting standards, strong creditor rights and rule of law. It suggests that countries must reach a certain threshold in terms of institutional and economic development before they can expect to benefit from capital account liberalization.     

Unobservable shocks as carriers of contagion

We propose an identified structural GARCH model to disentangle the dynamics of financial market crises. We distinguish between the hypersensitivity of a domestic market in crisis to news from foreign non-crisis markets, and the contagion imported to a tranquil domestic market from foreign crises. The model also enables us to connect unobserved structural shocks with their source markets using variance decompositions and to compare the size and dynamics of impulses during crises periods with tranquil period impulses. To illustrate, we apply the method to data from the 1997–1998 Asian financial crisis which consists of a complicated set of interacting crises. We find significant hypersensitivity and contagion between these markets but also show that links may strengthen or weaken. Impulse response functions for an equally-weighted equity portfolio show the increasing dominance of Korean and Hong Kong shocks during the crises and covariance responses demonstrate multiple layers of contagion effects.     

Determinants of business cycle comovement: a robust analysis

This paper investigates the determinants of business cycle comovement between countries. Our dataset includes over 100 countries, both developed and developing. We search for variables that are “robust” in explaining comovement, using the approach of Leamer (Amer. Econom. Rev. 73 (1983) 31). Variables considered are (i) bilateral trade between countries; (ii) total trade in each country; (iii) sectoral structure; (iv) similarity in export and import baskets; (v) factor endowments; and (vi) gravity variables. We find that bilateral trade is robust. However, two variables that the literature has argued are important for business cycles—industrial structure and currency unions—are found not to be robust.     

Liquidity Pools, Risk Sharing, and Financial Contagion

This paper reevaluates the Allen–Gale (2000) analysis of interbank deposits to explain financial contagion. This paper modifies the pecking order of asset liquidation developed in Allen–Gale, which is essential in fragility analysis. Furthermore, we also provide a claim structure called liquidity pool that can both achieve risk sharing and prevent financial contagion across regions when asymmetric information about bank assets is absent. This model can partly explain why bank panics reduced substantially after the founding of the Fed and the role of IMF in regional financial crises.     

De facto exchange rate regimes and currency crises: Are pegged regimes with capital account liberalization really more prone to speculative attacks?

This paper empirically examines whether de facto exchange rate regimes affect the occurrence of currency crises in 84 countries over the 1980–2001 period by using the probit model. We employ the de facto classification of Reinhart and Rogoff (2004) that allows us to estimate the impact of relatively long-lived exchange rate regimes on currency crises with much greater precision. We find that pegged regimes significantly decrease the likelihood of currency crises compared with floating regimes. By using the combined data of exchange rate regimes and the existence of capital controls, we also find interesting evidence that pegged regimes with capital account liberalization significantly lower the likelihood of currency crises compared with other regimes. These results are robust to a wide variety of samples and models. From the standpoint of the macroeconomic policy trilemma, we can conjecture that pegged regimes with capital account liberalization are substantially less prone to speculative attacks because they can enhance greater credibility in their currencies by abandoning monetary policy autonomy.     

Valuation impact of currency crises: Evidence from the ADR market

This study analyzes American depository receipts (ADR) performance surrounding the outbreak of major currency crises during the past decade. By employing event-study methodologies and multifactor pricing models, we find that the outbreak of a currency crisis is accompanied by a negatively significant abnormal return for the corresponding ADRs, even after controlling for variations in exchange rates. We also find significant upward shifts in the exchange rate exposure of ADRs when the home currency is switched from a “pegging” to a “floating” exchange rate regime. In addition, ADR-originating firms with larger sizes, greater proportions of U.S. market activities, and greater market liquidity have relatively less negative abnormal returns (ARs) and less significant upward shifts in currency exposure, implying that such firms are relatively better hedged against currency crises.     

Financial contagion in the laboratory: The cross-market rebalancing channel

We present the results of the first experimental study of financial markets contagion. We develop a model of financial contagion amenable to be tested in the laboratory. In the model, contagion happens because of cross-market rebalancing, a channel for transmission of shocks across markets first studied by Kodres and Pritsker (2002). Theory predicts that, because of portfolio rebalancing, a negative shock in one market transmits itself to the others, as investors adjust their portfolio allocations. The theory is supported by the experimental results. The price observed in the laboratory is close to that predicted by theory, and strong contagion effects are observed. The results are robust across different market structures. Moreover, as theory predicts, lower asymmetric information in a (“developed”) financial market increases the contagion effects in (“emerging”) markets.     

Financial liberalization,insurance market,and the likelihood of financial crises

This paper provides empirical evidence to investigate the direct impact of financial liberalization on the likelihood of currency/systemic banking crises, and examines the roles of insurance market, country risk, and economic conditional variables on the relationship between financial liberalization and financial crises in 39 countries. Our empirical results support that financial liberalization does have a significantly negative impact on the likelihood of currency/systemic banking crises, and that the indirect effects of insurance development and lower country risk decrease the probability of crises, but the indirect effect of economic conditional proxies is enhanced with the likelihood of a financial crisis. The policy implication is that the government or authority should strengthen the positive role of the insurance sector in order to combat financial crises.     

从货币地位角度看美国次贷危机与亚洲金融危机的差异

相比亚洲金融危机等历次金融危机,美国次贷危机有着类似的宏观经济和制度背景,但次贷危机在形式、影响和危机国应对政策方面均体现出与传统金融危机不同的特征。该文比较了美国次贷危机与亚洲金融危机的差异,认为危机发源国货币地位的不同是这些差异产生的重要因素。     

The relationship between investment and large exchange rate depreciations in dollarized economies

We use a simple financial friction in an economy with high degree of liability dollarization - and currency mismatch - to show that the negative balance-sheet effect of an exchange rate depreciation may be observable only if the magnitude of the depreciation is large enough. This result justifies the difficulty to find strong empirical evidence for balance-sheet effects and suggests the convenience of including a “large depreciation” term in empirical analyses. We review some of the related empirical literature and provide some new evidence of this large depreciation effect.     

Unraveling the complex interrelationships between exchange rates and fundamentals

This research investigates the intrinsic characteristics of currency values by fundamentally decomposing investor expectations on 16 currencies. The results on 195 exchange rates over several decades indicate investors perceive countries to be more likely to choose devaluation solutions to BOP problems when inflation is lower and when an alternative drop in real income growth is more “painful”. In addition, empirical support is provided for the hypothesis that forward rates often appear biased because the distributional expectations incorporated into them include, for a country with a current account deficit, a small probability of a large spot decline that does not actually occur in most finite samples.     

On the importance of indirect banking vulnerabilities in the Eurozone

This paper investigates banking and sovereign distress in the Eurozone and the importance of direct and indirect financial exposures. We use BIS cross-border banking claims to link member states in a GVAR framework and jointly model sectoral CDS premia. Based on balance sheet positions of an intermediate debtor country, we calculate indirect exposures and asses how the level of interconnectedness is impacted when indirect links are accounted for. We notice a general slowdown in financial integration and a reduction in cross-border assets in the hope of limiting international contagion. By differentiating between direct and indirect links, we show that the impact of reduced weights on core member states is mostly insignificant and that deleveraging strategies are not generally able to successfully reduce risk.     

Are twin currency and debt crises special?

In the literature on currency and banking crises it has become the standard procedure to distinguish pure currency crises, pure banking crises and combined (“twin”) currency and banking crises. We show theoretically and empirically that a similar differentiation should be chosen with regard to currency and debt crises. Twin currency and debt crises differ from both pure currency and pure debt crises in their determinants, course of events, and economic consequences. We find that each type of crises has a unique set of macroeconomic causes. We also identify internal contagion and selection bias effects, which may lead to biased empirical estimates if twin crises are not treated as a specific type of crises. Such a separation allows in significantly improving the efficiency of early warning systems especially for debt and twin crises.