Budget deficits,money growth and causality: Further OECD evidence

This paper investigates the causal linkage between budget deficits and money growth in seven major OECD countries using multivariate Granger-causality tests combined with Akaike's AIC criterion and Zellner's iterative seemingly unrelated regressions. The accommodation hypothesis that deficits Granger-cause positive long-run changes in money growth is systematically rejected across all countries. The reverse hypothesis that money growth Granger-causes long-run changes in deficits is also rejected across countries. These results suggest that monetary and fiscal policies are set independently in each of the OECD countries.     

Inflation and productive activity in a multiple-matching model of money

This paper investigates the relationship between money growth, inflation, and productive activity in a dynamic general-equilibrium, multiple-matching framework where trade frictions are manifested by limited consumption variety. Productive activity and matching in the goods market are endogenized by a time allocation decision of work and search effort. We find that a high degree of complementarity between participation in the labor and goods markets creates a channel by which inflation can positively influence production and output. This feature arises when household preferences for consumption variety is sufficiently large and it can also lead to the multiplicity of monetary equilibria.     

Tight money and inflation: Further Results

The Sargent-Wallace results on inflationary effects of monetary restraint are considered in a Sidrauski money growth model when the utility function is unrestricted except for separability. Temporary monetary tightening will eventually lead to higher inflation when the deficit is fixed only if the elasticity of money demand with respect to the money growth rate is less than unity. It is also shown that for inflation to rise immediately further requires the elasticity with respect to the nominal interest rate to be no less than unity.     

Household response to a money rain: Real and portfolio balance effects reconsidered

In order for changes in the stock of money to lead to changes in economic activity, production and spending units such as households and firms must respond to changes in the money supply. With respect to wealth effects on households, the real balance effect on consumption is thought to be empirically small. This puts the burden on portfolio balance and labor supply effects. Labor supply is shown to decrease in response to an increase in the money supply, and depending on the extent of markets, portfolio balance effects may be nonexistent.     

Stock prices and demand for money in China: New evidence

This paper investigates the relationship between stock prices and the real money demands for China within a cointegrated framework. This study reports two important results. First, test results reveal that a stable long-term relationship exists between broad money (M2) and its determinants including real income, foreign interest rate, and stock prices. Second, stock prices have a significant substitute (positive) effect on long-run broad-money (M2) demand and its omission can lead to serious misspecification in the money demand function in both the short- and long-run. Finally, we demonstrate that long-run income elasticity is not significantly different from unity with the inclusion of stock prices in the money demand equation.     

Forecasting stock market volatility: Further international evidence

Abstract

This paper evaluates the out-of-sample forecasting accuracy of eleven models for monthly volatility in fifteen stock markets. Volatility is defined as within-month standard deviation of continuously compounded daily returns on the stock market index of each country for the ten-year period 1988 to 1997. The first half of the sample is retained for the estimation of parameters while the second half is for the forecast period. The following models are employed: a random walk model, a historical mean model, moving average models, weighted moving average models, exponentially weighted moving average models, an exponential smoothing model, a regression model, an ARCH model, a GARCH model, a GJR-GARCH model, and an EGARCH model. First, standard (symmetric) loss functions are used to evaluate the performance of the competing models: mean absolute error, root mean squared error, and mean absolute percentage error. According to all of these standard loss functions, the exponential smoothing model provides superior forecasts of volatility. On the other hand, ARCH-based models generally prove to be the worst forecasting models. Asymmetric loss functions are employed to penalize under-/over-prediction. When under-predictions are penalized more heavily, ARCH-type models provide the best forecasts while the random walk is worst. However, when over-predictions of volatility are penalized more heavily, the exponential smoothing model performs best while the ARCH-type models are now universally found to be inferior forecasters.     

Foreign reserve and money dynamics with asset portfolio adjustment: international evidence

In this paper we argue that more complete modeling of foreign exchange intervention and sterilization dynamics is necessary when there are adjustment costs to changing private portfolios and/or the central bank attempts to balance longer-run monetary control against short-term exchange rate objectives. We show that measured correlations between domestic credit and foreign asset changes, often interpreted as ‘sterilization coefficients’, may be misleading because they vary with the pattern of disturbances as well as private agent and central bank behavior. We assess the empirical significance of this issue by estimating vector error correction models of the domestic and foreign asset components of the monetary base for Japan and Germany. In both countries, we find that that the impact of foreign exchange intervention on domestic credit falls markedly after several months, implying that the degree of sterilization decreases over time. However, the monetary base remained largely insulated as foreign asset positions were subsequently ‘unwound.’     

Demand and supply functions for money in Canada: Some further evidence

The demand and supply functions for money in Canada are estimated in a simultaneous-equation model format in which the supply of money is considered endogenous. The results indicate that the important determinants of the demand for money are income, short-term interest rate and lagged real cash balance variables. Wealth is an unimportant explanatory variable in money demand thus rejecting the hypothesis that an increase in outside wealth increases the demand for money. The monetary base and cash reserve ratio are important explanatory variables in the money supply function and play a direct role in monetary control.     

Real effects of bank capital regulations: Global evidence

We examine the effect of the full set of bank capital regulations (capital stringency) on loan growth, using bank-level data for a maximum of 125 countries over the period 1998–2011. Contrary to standard theoretical considerations, we find that overall capital stringency only has a weak negative effect on loan growth. In fact, this effect is completely offset if banks hold moderately high levels of capital. Interestingly, the components of capital stringency that have the strongest negative effect on loan growth are those related to the prevention of banks to use as capital borrowed funds and assets other than cash or government securities. In contrast, compliance with Basel guidelines in using Basel- and credit-risk weights has a much less potent effect on loan growth.     

Real effects of anticipated and unanticipated money: Some problems of estimation and hypothesis testing

The paper addresses two issues that arise in estimation and testing of the real effects of anticipated and unanticipated money. First it is shown that identification of the effects of unanticipated (or unperceived) monetary growth on real output is possible only if the a priori restriction is imposed that monetary growth does not depend on unanticipated (or unperceived) output. Second, the existing empirical work of Barro and others does not allow for three known channels through which money can affect real variables. These are (1) past and present anticipations of future monetary growth (the inflation tax channel), (2) expectations of monetary growth in a given period conditioned at various preceding dates (the Fischer-Phelps-Taylor effect) and (3) past and present revisions in forecasts of future monetary growth. The presence of the first of these would mean that alternative open-loop monetary growth rules have real effects. The presence of the other two implies that monetary feedback rules can have real effects. Omission of the first channel can lead to biased estimates of the effects of past anticipated monetary growth. Potentially serious observational equivalence problems are associated with the other two.     

Revisiting the demand for money function: evidence from the random coefficients approach

This article employs second-generation random coefficient (RC) modeling to investigate the time-varying behavior and the predictability of the money demand function in Taiwan over the period from 1982Q1 to 2006Q4. The RC procedure deals with some of the limitations of previous studies, such as unknown functional forms, omitted variables, measurement errors, additive error terms, and the correlations between explanatory variables and their coefficients. Our main findings are as follows. First, the empirical results indicate that the values of the elasticities in the RC estimation are significantly different from those in other studies, because of the use of coefficient drivers. Second, by observing the time-varying behavior of the coefficients, we find some specific points in our time profile of coefficients; that is, we can make an association with real events occurring in Taiwan, such as the financial liberalization after 1989 and the Asian financial crisis of 1997–1998. Finally, we compare the predicted values via the time intervals and different specifications and find that we should adapt different specifications of the RC model to estimate each interval.     

Locked Up by a Lockup: Valuing Liquidity as a Real Option

Hedge funds often impose lockups and notice periods to limit the ability of investors to withdraw capital. We model the investor's decision to withdraw capital as a real option and treat lockups and notice periods as exercise restrictions. Our methodology incorporates time-varying probabilities of hedge fund failure and optimal early exercise. We estimate a two-year lockup with a three-month notice period costs approximately 1% of the initial investment for an investor with constant relative risk aversion utility and risk aversion of three. The cost of illiquidity can easily exceed 10% if the hedge fund manager can arbitrarily suspend withdrawals.     

Size-related anomalies and stock return seasonality: Further empirical evidence

This study examines, month-by-month, the empirical relation between abnormal returns and market value of NYSE and AMEX common stocks. Evidence is provided that daily abnormal return distributions in January have large means relative to the remaining eleven months, and that the relation between abnormal returns and size is always negative and more pronounced in January than in any other month — even in years when, on average, large firms earn larger risk-adjusted returns than small firms. In particular, nearly fifty percent of the average magnitude of the ‘size effect’ over the period 1963–1979 is due to January abnormal returns. Further, more than fifty percent of the January premium is attributable to large abnormal returns during the first week of trading in the year, particularly on the first trading day.     

Real estate returns,money and fiscal deficits: Is the real estate market efficient?

This research examines the causal relationship between several financial variables and a portfolio of real estate returns using monthly data from January 1965 to December 1986. The empirical analysis is based on multivariate Granger-causality tests in conjunction with Akaike's final prediction error criterion. The results indicate that measures approximating monetary policy and market returns play an important role in causing changes in real estate returns. In particular, our findings suggest that base money and market returns have had significant lagged effects on current real estate returns.     

Valuation of a Developmental Drug as a Real Option

Valuing a capital investment as a real option (or series of options) has advantages over standard DCF valuation when the investment creates the future flexibility to delay, abandon, or expand an element of the project based on the resolution of a major source of uncertainty. The uncertainty is generally dealt with using a “volatility” term that aims to reflect the variability in the future value of the underlying asset. But there are certain situations in which the uncertainty has a second dimension. For example, drugs in development can be abandoned either because of bad technical outcomes (the drug doesn't work) or unfavorable resolutions of market risk (though the drug works, its market potential turns out to be too limited). In an article published earlier in this journal, the authors illustrated the valuation of an early‐stage pharma R&D investment using a real options approach in which the market and technical risks were folded together into the volatility parameter. In this article, the authors explain why they have concluded that this is an incorrect approach and then show how to handle market and technical risk as two separate dimensions of risk in valuing an R&D program. The potential use of this technique extends beyond pharma and biotech R&D to any situation in which the outcome of an important uncertainty is independent of the resolution of market risk associated with the underlying asset.     

The Lucas hypothesis on the Phillips Curve: Further international evidence

This paper is a further attempt to test the ‘Lucas Hypothesis on the Phillips Curve’ by making cross country comparisons. That hypothesis posits that nominal shocks affect real aggregates only if individuals mistake them for what they are not — movements in real variables. The existence of a trade-off between output and inflation is conditional on economic agents misinterpreting the price movements they observe. Countries with widely fluctuating exogenous shocks will have a more vertical Phillips Curve as their inhabitants sharpen their instrumental to differentiate between real and nominal shocks. Hence cross country comparisons provide fertile grounds to test this hypothesis; if it holds true, we should find a positive correlation between Phillips Curve slopes and the standard deviations of the exogenous shocks. The evidence presented here confirms Lucas's findings.     

Momentum and contrarian strategies in international stock markets: Further evidence

Previous studies have shown that market participants underestimate earnings growth for past winner stocks, and that growth stocks are more sensitive to earnings surprises. These findings suggest implementing momentum strategies with growth stocks. This study investigates linkages between value versus growth investment styles and momentum strategies in international markets. In addition, we extend Jegadeesh and Titman (2001)-type tests, which attempt to distinguish between competing explanations of the momentum phenomenon, to international market indices. Our full sample results show that momentum profits are concentrated in the growth indices, and that there is evidence of short-term overreaction in these and other indices that is subsequently corrected. Our subsample results are mixed; there is some evidence that the profitability of momentum (but not contrarian) strategies persists in the post-December 1987 period. However, unlike the earlier period, there is no evidence that markets overreact and that these overreactions are subsequently corrected.     

Commodity money inflation: theory and evidence from France in 1350–1436

This paper presents a theory of inflation in commodity money and supports it by evidence from inflationary episodes in France during the 14th and 15th centuries. The paper shows that commodity money can be inflated similarly to fiat money through repeated debasements, which act like devaluations. Furthermore, as with fiat money, demand for commodity money falls with inflation. However, at high rates of inflation demand for commodity money becomes insensitive to inflation, since commodity money has intrinsic value in addition to its transactions value. Finally, we show that anticipated stabilization reduces demand for commodity money.     

Common stock returns,real activity,money, and inflation: Some international evidence

This paper tests whether the negative relationship between real stock returns and inflation in the United States is in fact proxying for a positive relationship between stock returns and real activity variables in six major industrial countries over 1966–1979. Consistent with Fama's ‘proxy-effect’ hypothesis, we document a negative relationship between inflation and real activity and a positive one between real stock returns and real activity variables. Real activity variables dominate money growth rates and expected and unexpected inflation in explaining real stock returns. A puzzling result that still remains is the positive role of money and the negative role of expected inflation in explaining these real stock returns in all major industrial countries.