Risk-premia,carry-trade dynamics,and economic value of currency speculation

In this paper, we derive the dynamics and assess the economic value of currency speculation by formalizing the concept of a trader inaction range. We show that exchange rate returns comprise a time-varying risk-premium and that uncovered interest parity (UIP) holds in a speculative sense. The often-cited ‘forward bias puzzle’ originates from the omission of the risk-premium in standard UIP tests. Consistent with its popularity among market professionals, the carry-trade strategy can be rationalized as it systematically collects risk-premia, however, the economic value generated by bilateral carry-trades is limited.     

Solving exchange rate puzzles with neither sticky prices nor trade costs

We present a simple framework in which both the exchange rates 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. Habit persistence 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.     

Habit formation,the cross section of stock returns and the cash-flow risk puzzle

Non-linear external habit persistence models, which feature prominently in the recent “equity premium” asset pricing and macroeconomics literature, generate counterfactual predictions in the cross-section of stock returns. In particular, we show that in the absence of cross-sectional heterogeneity in firms’ cash-flow risk, these models produce a “growth premium,” that is, stocks with high price-to-fundamental ratios command a higher premium than stocks with low price-to-fundamental ratios. This implication is at odds with the well-established empirical observation of a “value premium” in the cross-section of stock returns. Substantial heterogeneity in firms’ cash-flow risk yields both a value premium as well as most of the stylized facts about the cross-section of stock returns, but it generates a “cash-flow risk puzzle”: Quantitatively, value stocks have to have “too much” cash-flow risk compared to the data to generate empirically plausible value premiums.     

Flexible inflation targets,forex interventions and exchange rate volatility in emerging countries

Emerging economies with inflation targets (IT) face a dilemma between fulfilling the theoretical conditions of “strict IT”, which imply a fully flexible exchange rate, or applying a “flexible IT”, which entails a de facto managed-floating exchange rate with foreign exchange (forex) interventions to moderate exchange rate volatility. Using a panel data model for 37 countries we find that, although IT lead to higher exchange rate instability than alternative regimes, forex interventions in some IT countries have been more effective to lower volatility than in non-IT countries, which may justify the use of “flexible IT” by policymakers.     

Fuzzy logic,trading uncertainty and technical trading

From the market microstructure perspective, technical analysis can be profitable when informed traders make systematic mistakes or when uninformed traders have predictable impacts on price. However, chartists face a considerable degree of trading uncertainty because technical indicators such as moving averages are essentially imperfect filters with a nonzero phase shift. Consequently, technical trading may result in erroneous trading recommendations and substantial losses. This paper presents an uncertainty reduction approach based on fuzzy logic that addresses two problems related to the uncertainty embedded in technical trading strategies: market timing and order size. The results of our high-frequency exercises show that ‘fuzzy technical indicators’ dominate standard moving average technical indicators and filter rules for the Euro-US dollar (EUR-USD) exchange rates, especially on high-volatility days.     

The Feldstein-Horioka puzzle in the presence of structural shifts: The case of Japan versus the USA

This paper tests the Feldstein-Horioka “puzzle” for the two richest countries of the world: Japan and the USA. For this purpose it employs three different cointegration tests that are applied to the Feldstein-Horioka long-run investment-saving equation in conjunction with the Lumsdaine and Papell (1997) unit root test considering two structural shifts. A novel aspect of the paper is that it determines the number of breaks solely from a scrutiny of the data and that in constructing the dummy variables for the breaks it uses the endogenously determined break dates. It shows that allowing for structural shifts eliminates the “puzzle” both for Japan and the USA.     

Information acquisition,coordination, and fundamentals in a financial crisis

This paper reconciles the two explanations of a financial crisis, the self-fulfilling prophecy and the fundamental causes, in an empirically-relevant framework, by explicitly modeling the costly voluntary acquisition of information about fundamentals in a variant of Diamond and Dybvig [Diamond, D., Dybvig, P., 1983. Bank runs, deposit insurance, and liquidity. Journal of Political Economy 91, 401–419]. The model exhibits strategic complementarity in information acquisition. In the “partial run” equilibrium investors engage in costly evaluation of projects, so that banks with lower-return projects fail. There also exist the classic “full-run” and “no-run” equilibria in which there is no project evaluation. Investors’ coordination on a specific equilibrium is triggered by a self-fulfilling prophecy. So, financial crises are seen as both fundamentals-based and self-fulfilling prophecies-based phenomena.     

Evaluating foreign exchange market intervention: Self-selection,counterfactuals and average treatment effects

Estimating the effect of official foreign exchange market intervention is complicated by the fact that intervention at any point entails a “self-selection” choice made by the authorities and that no counterfactual is observed. To address these issues, we estimate the “counterfactual” exchange rate movement in the absence of intervention by introducing the method of propensity-score matching to estimate the “average treatment effect” (ATE) of intervention. To derive the propensity scores we estimate central bank intervention reaction functions. We estimate the ATE for daily official intervention in Japan over the January 1999–March 2004 period. This sample encompasses a remarkable variation in intervention frequencies as well as unprecedented frequent intervention towards the latter part of the period. We find that only sporadic and relatively infrequent intervention is effective.     

The ‘laissez faire’ bias of managed floating

The government of a small open economy trying to manage its exchange rate faces a ‘time consistency’ problem. If markets expect implementation of the optimal linear intervention rule, the government will be tempted to ‘defect’: knowing this, markets will expect less activism; and, in the discretionary equilibrium, this is what they get. How far this credibility problem can shift discretionary policy towards a free float is shown in two popular models of floating rates. One way of offsetting the ‘laissez faire’ bias of discretionary policy is to appoint a relatively ‘conservative’ central banker: but, as the time period of policy action and precommitment shrinks towards zero, the required conservative bias is found to go towards infinity. Other institutional features — such as central bank reputation, contracts and intermediate targets — may be crucial for successful exchange rate management.     

A multinomial logit approach to exchange rate policy classification with an application to growth

We model a country's de jure exchange rate policy as the choice from a multinomial logit response conditioned on the volatility of its bilateral exchange rate, the volatility of its international reserves, and the volatility of its effective exchange rate. The category with the highest predictive probability implied by the logit regressions serves as our de facto exchange rate policy. An empirical investigation into the relationship between the de facto classifications and GDP growth finds that growth is higher under stable currency-value policies. For non-industrialized countries, a more nuanced characterization of exchange rate policy finds that those who exhibit ‘fear of floating’ experience significantly higher growth.     

United States current account deficits: A stochastic optimal control analysis

The “Pessimists” and the “Optimists” disagree whether the US external deficits and the associated buildup of US net foreign liabilities are problems that require urgent attention. A warning signal should be that the debt ratio deviates significantly from the optimal ratio. The optimal debt ratio or debt burden should take into account the vulnerability of consumption to shocks from the productivity of capital, the interest rate and exchange rate. The optimal debt ratio is derived from inter-temporal optimization using Dynamic Programming, because the shocks are unpredictable, and it is essential to have a feedback control mechanism. The optimal ratio depends upon the risk adjusted net return and risk aversion both at home and abroad. On the basis of alternative estimates, we conclude that the Pessimists’ fears are justified on the basis of trends. The trend of the actual debt ratio is higher than that of the optimal ratio. The Optimists are correct that the current debt ratio is not a menace, because the current level of the debt ratio is not above the corresponding level of the optimum ratio.     

Home bias,exchange rate disconnect,and optimal exchange rate policy

This paper examines how much the central bank should adjust the interest rate in response to real exchange rate fluctuations. The paper first demonstrates, in a two-country Dynamic Stochastic General Equilibrium (DSGE) model, that home bias in consumption is important to replicate the exchange rate volatility and exchange rate disconnect documented in the data. When home bias is high, the shock to Uncovered Interest rate Parity (UIP) can substantially drive up exchange rate volatility while leaving the volatility of real macroeconomic variables, such as GDP, almost untouched. The model predicts that the volatility of the real exchange rate relative to that of GDP increases with the extent of home bias. This relation is supported by the data. A second-order accurate solution method is employed to find the optimal operational monetary policy rule. Our model suggests that the monetary authority should not seek to vigorously stabilize exchange rate fluctuations. In particular, when the central bank does not take a strong stance against the inflation rate, exchange rate stabilization may induce substantial welfare loss. The model does not detect welfare gain from international monetary cooperation, which extends Obstfeld and Rogoff's [Obstfeld, M., Rogoff, K.,2002. Global implications of self-oriented national monetary rules, Quarterly Journal of Economics May, 503–535] findings to a DSGE model.     

Cointegrated TFP processes and international business cycles

A puzzle in international macroeconomics is that real exchange rates are highly volatile. Standard international real business cycle (IRBC) models cannot reproduce this fact. This paper provides evidence that TFP processes for the U.S. and the “rest of the world” are characterized by a vector error correction model (VECM) and that adding cointegrated technology shocks to the standard IRBC model helps to explain the observed high real exchange rate volatility. Also, the model can explain the observed increase in real exchange rate volatility with respect to output in the last 20 years by changes in the parameters of the VECM.     

Speculative capital and currency carry trades

In this paper, we study a two-country general equilibrium model with partially segmented financial markets, where hedge funds emerge endogenously. Empirically, we show that the hedge fund investment strategy predicted by our model, which we call the “risk-adjusted carry trade” strategy, explains more than 16% of the overall hedge fund index returns and more than 33% of the fixed income arbitrage sub-index returns. The flow of new money to hedge funds affects market interest rates, exchange rates, and both the hedge funds’ contemporaneous and expected future returns as predicted by the model.     

Locals, foreigners, and multi-market trading of equities: Intraday evidence from Thailand

We study stock market orders and trades in a developing country, Thailand, where foreign ownership limits partially segment local and foreign investors into two distinct markets. Some foreigners forgo voting rights and distributions to trade on the “local board”, while some locals forgo such benefits and pay a price premium to trade on the “foreign board”. Regardless of nationality, these cross-market traders typically submit orders when liquidity is high, fill orders at relatively beneficial prices, exploit patterns in stock prices across markets, display profitable holding-period returns, and enhance price discovery. This suggests that skilled, informed trading that affects market quality does not depend on trader nationality.     

Cultures of sustainability and the aesthetics of the pattern that connects

Contemporary developments around the search for ‘sustainability’ offer an insightful approach to the question of an emerging global mindset change. In its cultural dimension, the search process for sustainability fosters a paradigmatic shift in world views and ways of life, breeding a sensibility to the “pattern that connects” (as coined by Gregory Bateson).     

Using survey data to resolve the exchange risk exposure puzzle: Evidence from U.S. multinational firms

This paper examines the effect of unexpected exchange rate movements on U.S. shareholder wealth. Empirical results based on a sample of 634 U.S. multinational firms (1) confirm previously reported evidence that the disaggregation of the worldwide trade-weighted U.S. dollar exchange rate index into seven region-specific trade-weighted indices increases the precision and significance of exposure estimates; (2) show that models assuming that changes in spot exchange rates are unanticipated are frequently misspecified and, thus, unable to correctly detect the impact of currency movements on firm value; (3) reveal that forward and survey expectations enable us to distinguish between the effect of ‘realized’ and ‘unexpected’ currency movements; and (4) reveal that investors making pricing and hedging decisions prefer to use the information contained in short-term forward and survey expectation rates to the information included in long-term forecasts.     

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.     

Give me a two-by-two matrix and I will create the market: Rankings,graphic visualisations and sociomateriality

Scholars have described how rankings can be consequential for the shaping of the economy. The prevailing argument is that they wield influence through encouraging ‘mechanisms of reactivity’ amongst market actors. We ask the question as to whether there are additional agential aspects found within rankings that extend ‘social’ accounts. We suggest that ‘sociomateriality’ is also a significant aspect of a ranking’s influence. Through developing the notion of a ‘ranking device’, we examine how the “format and furniture” of a ranking can mediate and constitute a domain. Drawing on a detailed study of a prominent graphical performance measure from within the information technology (IT) arena, we provide evidence to show that IT markets can be as much a product of the affordances and constraints of ranking devices as any other (non-material) aspects of the ranking. The article integrates literature from Accounting research and Science and Technology Studies to contribute to our understanding of how material things and the economy mutually constitute one another. It also offers one of the first empirical accounts of the sociomaterial construction of a graphical ranking.     

Do managers manage earnings to ‘just meet or beat’ analyst forecasts?: Evidence from Australia

This paper examines whether managers manage earnings to ‘just meet or beat’ analyst forecasts in Australia. Previous Australian studies on benchmark-beating have focused on loss avoidance and small earnings increases as benchmarks [Coulton, J., Taylor, S., & Taylor, S. (2005). Is ‘benchmark beating’ by Australian firms evidence of earnings management? Accounting and Finance, 45, 553-576; Holland, D., & Ramsay, A. (2003). Do Australian companies manage earnings to meet simple earnings benchmarks? Accounting and Finance, 43, 41-62]. This paper extends this earlier research on benchmark-beating in Australia by incorporating analyst forecast as an important benchmark. Using three different models of unexpected accruals as proxies for earnings management, this study did not find any significant difference between the mean and median unexpected accruals of the “‘just meet or beat” group as against the “just miss” group. Furthermore, for a long period of time (1997-2002), the proportion of Australian firms ‘just meeting or beating’ analyst forecasts benchmark increased, although such increase was not statistically significant.