Asset Prices and the Financial Crisis of 2007–09: An Overview of Theories and Policies

The financial crisis of 2007–09 has led to a rethinking of the role of monetary and financial regulatory policy. It has also called into question the benefits of financial innovation and monetary policy that focuses solely on inflation and the output gap. This paper discusses financial instabilities in general, the recent financial crisis as well as the appropriate role of monetary and financial regulatory policy in dealing with asset bubbles. The paper concludes by evaluating appropriate policies to reduce the economic impact of future financial crises.     

The impact of information signals on market prices when agents have non-linear trading rules

Several methods have been developed for filtering seasonal influences and extreme returns in financial and economic time series. The theoretical support for these approaches is rather questionable since it focuses on the effects of shocks on prices and not on their sources. Removing such effects modifies the true generating system of market dynamics because of the non-proportional character of non-linearity. Thus, taking into account that the underlying process of economic time series is highly non-linear we cannot be certain a priori what the impact of new information will be on the dynamic structure of a system. The main contribution of this paper is to demonstrate using the methodology of simulations the eventual distortions in time series data arising from the arrival of news when agents follow non-linear trading strategies. We argue that if news can really modify the dynamical behaviour of a system, then the methodology of filtering exogenous distortions needs to be re-examined.     

Volume and Volatility in Foreign Currency Futures Markets

In this paper we propose and test several hypotheses concerning time series properties of trading volume, price, short and long-term relationships between price and volume and the determinants of trading volume in forcign currency futures. The nearby contracts for British Pound, Canadian Dollar, Japanese Yen, German Mark and Swiss Franc are analyzed in three frequencies i.e. daily, weekly and monthly.We find supportive evidence for all the five currencies that the price volatility is a determinant of the trading volume changes. Furthermore, the volatility of the price process is a determinant of the unexpected component of the changes in trading volume. Also, there is a significant relationship between the volatility of price and the volatility of trading volume changes for three of the five currencies in the daily frequency and for one currency in the monthly frequency.     

Investment principles for individual retirement accounts

The phenomenal growth of individual retirement accounts in the US, and globally, challenges both individuals and their advisors to rationally manage these investments. The two essential differences between an individual retirement account and an institutional portfolio are the length of the investment horizon and the regularity of monthly contributions. The purpose of this paper is to contrast principles of institutional investing with the management of individual retirement accounts. Using monthly historical data from 1926 to 2005 we evaluate the suitability for managing individual retirement portfolios of seven principles employed in institutional investing. We discover that some of these guidelines can be beneficially applied to the investment management of individual retirement accounts while others need to be reconsidered.     

Transparent US monetary policy: theory and tests

In 1994, the Federal Reserve System moved to a more transparent reporting of monetary policy. This article assesses the impact of monetary policy transparency on uncertainty about future monetary policy using T-bill rate forecast dispersions and ex post forecast errors from the Survey of Professional Forecasters as a proxy for monetary policy uncertainty. The empirical findings confirm that Federal Reserve transparency has reduced the uncertainty about future monetary policy.     

Episodic Nonlinearity in Leading Global Currencies

We perform non-linearity tests using daily data for leading currencies that include the Australian dollar, British pound, Brazilian real, Canadian dollar, euro, Japanese yen, Mexican peso, and the Swiss franc to resolve the issue of whether these currencies are driven by fundamentals or exogenous shocks to the global economy. In particular, we use a new method of testing for linear and nonlinear lead/lag relationships between time series, introduced by Brooks and Hinich (J Empir Finance 20:385–404, 1999), based on the concepts of cross-correlation and cross-bicorrelation. Our evidence points to a relatively rare episodic nonlinearity within and across foreign exchange rates. We also test the validity of specifying ARCH-type error structures for foreign exchange rates. In doing so, we estimate Bollerslev’s (J Econom 31:307–327, 1986) generalized ARCH (GARCH) model and Nelson’s (1988) exponential GARCH (EGARCH) model, using a variety of error densities [including the normal, the Student-t distribution, and the Generalized Error Distribution (GED)] and a comprehensive set of diagnostic checks. We apply the Brooks and Hinich (1999) nonlinearity test to the standardized residuals of the optimal GARCH/EGARCH model for each exchange rate series and show that the nonlinearity in the exchange rates is not due to ARCH-type effects. This result has important implications for the interpretation of the recent voluminous literature which attempts to model financial asset returns using this family of models.     

Toward Monetary Union of the European Community

A bstract . European Community monetary integration has received periodic attention often as a result of financial crises but has now evolved into its major aim. To achieve this goal the European Monetary System was established in 1979. It was designed to provide a tool, the Exchange Rate Mechanism , for exchange rate stabilization and convergence of economic and monetary policies. To give further impetus to monetary integration the Maastricht Treaty was approved in December 1991. Experiences with the operation of the European Monetary System show that there is no conclusive evidence that it has disciplined the monetary and fiscal policies of all its members. More recently, Germany's insistence on a tight monetary- policy, to fight the inflation that resulted from unification costs, has brought turmoil in European financial markets and has dealt a serious blow to the system. Furthermore, the ensuing recession and its impact on the European economies make improbable that the timetable of the Maastricht Treaty will be met.