How did the financial crisis alter the correlations of U.S. yield spreads?

We investigate the pairwise correlations of eleven U.S. fixed income yield spreads over a sample that includes the Great Financial Crisis of 2007–09. Using cross-sectional methods and nonparametric bootstrap breakpoint tests, we characterize the crisis as a period in which pairwise correlations between yield spreads were systematically and significantly altered in the sense that spreads comoved with one another much more than in normal times. We find evidence that, for almost half of the fifty-five pairs under investigation, the crisis has left spreads much more correlated than they were previously. This evidence is particularly strong for liquidity- and default-risk-related spreads, long-term spreads, and the spreads that were most likely directly affected by policy interventions.     

U.S. Monetary Policy Surprises: Identification with Shifts and Rotations in the Term Structure

We develop a model to extract measures of monetary policy surprises from the maturity structure of the yield curve. The model endogenously allows for the fact that the yield curve may either shift or rotate in response to monetary policy shocks. A latent factor model approach with identification through heteroskedasticity harnesses the term structure to extract monetary policy shocks. The approach offers informational advantages over event studies. Results from the U.S. term structure from 1994 strongly support the hypothesis that differing term structure responses are reactions to different types of monetary policy shock, rather than differing reactions to the same policy shock.     

The October 1979 Change in the U.S. Monetary Regime: Its Impact on the Forecastability of Canadian Interest Rates

Subsequent to the October 1979 shift in monetary policy in the United States, interest rates in North America not only reached unprecedented levels but also exhibited unprecedented volatility. Using Canadian data, the authors show that anticipated quarterly changes in long-term rates associated with the rational-expectations model have remained small during this post-shift period. The authors examine three sets of recorded forecasts of long-term interest rates in Canada and note their failure to improve upon the no-change prediction. The “perverse” relationship between the slope of the yield curve and the subsequent movement in long-term rates exists in the Canadian data but is of only modest value in a forecasting context. The excess returns on long-term bonds implicit in the recorded forecasts of the level of interest rates vary sharply, yet there is little evidence that forecasters have identified a predictable component of time-varying term premia.     

Mergers and the Value of Antitrust Deterrence

While the U.S. has pursued a vigorous antitrust policy towards horizontal mergers over the past four decades, mergers in Canada have until recently been permitted to take place in a virtually unrestricted antitrust environment. The absence of an antitrust overhang in Canada presents an interesting opportunity to test the conjecture that the rigid market share and concentration criteria of the U.S. policy effectively deters a significant number of potentially collusive mergers. The effective deterrence hypothesis implies that the probability of a horizontal merger being anticompetitive is higher in Canada than in the U.S. However, parameters in cross-sectional regressions reject the market power hypothesis on samples of both U.S. and Canadian mergers. Judging from the Canadian evidence, there simply isn't much to deter.     

International channels of the Fed's unconventional monetary policy

Previous research has established that the Federal Reserve's large scale asset purchases (LSAPs) significantly influenced international bond yields. We use dynamic term structure models to uncover to what extent signaling and portfolio balance channels caused these declines. For the U.S. and Canada, the evidence supports the view that LSAPs had substantial signaling effects. For Australian and German yields, signaling effects were present but likely more moderate, and portfolio balance effects appear to have played a relatively larger role than in the U.S. and Canada. Portfolio balance effects were small for Japanese yields and signaling effects basically nonexistent. These findings about LSAP channels are consistent with predictions based on interest rate dynamics during normal times: Signaling effects tend to be large for countries with strong yield responses to conventional U.S. monetary policy surprises, and portfolio balance effects are consistent with the degree of substitutability across international bonds, as measured by the covariance between foreign and U.S. bond returns.     

International Transmission Channels of U.S. Quantitative Easing: Evidence from Canada

The U.S. Federal Reserve responded to the great recession by implementing quantitative easing, or large‐scale asset purchases, when its conventional policy rate reached the zero lower bound. We assess the international spillover effects of this quantitative easing program on the Canadian economy in a factor‐augmented vector autoregression (FAVAR) framework, by considering a counterfactual scenario in which the Federal Reserve's long‐term asset holdings do not rise in response to the recession. We find that U.S. quantitative easing boosted Canadian output, mainly through the financial channel.     

Oil price shocks and their transmission mechanism in an oil-exporting economy: A VAR analysis informed by a DSGE model

This paper examines the macroeconomic effects of oil price shocks and the oil shock transmission mechanism in an oil-exporting country, Canada. We use a structural VAR with sign restrictions that comes from a two-country dynamic stochastic general equilibrium (DSGE) model to jointly identify oil price, domestic supply and U.S. and domestic monetary policy shocks. This identification strategy not only controls for reverse causality from the Canadian and U.S. macroeconomic conditions to the real oil prices, but more importantly, it also allows for contemporaneous interactions between the Canadian and U.S. variables. We find that oil shocks have a stimulative effect on Canadian aggregate demand, appreciate the Canadian dollar, improve the terms of trade and reduce real wages. Foreign disturbances, including innovations in oil prices and the U.S. interest rate, have a significant influence on Canadian economic activities. Our counterfactual analysis indicates that the reaction of the U.S. interest rate as an indirect transmission channel for oil price shocks plays a moderate role in explaining the real exchange rate and inflation, but has negligible impacts on the Canadian output and interest rate.     

Co-jumps in the U.S. interest rates and precious metals markets and their implications for investors

Using one-minute intraday data and wavelet decomposition of stochastic processes we obtain realised VCOV matrices with and without price discontinuities in the U.S. Treasuries and precious metals futures. Our work provides determinants of co-jumps in gold, silver and U.S. Treasuries across the yield curve and empirically demonstrates impact of price discontinues on hypothetical investor through realised correlations, hedging effectiveness ratios and several portfolio settings. We find that co-jumps in gold and silver have similar monetary characteristics to co-jumps in gold or silver with U.S. Treasuries futures. We further unpack investor choices between precious metals and U.S. bonds under the presence of high-frequency risks. We show that behaviour puzzle of simultaneous demand for safety and quality during market turmoils disappears if investors are seeking maximum diversification. We also find that runs to safety do not offer statistically significant improvements in diversification benefits unlike runs to short-term quality. Other results uncover higher investments to gold due to the shifts in the U.S. yield curve and potential gains in realised hedging effectiveness for the end of the yield curve investors through asymmetry in co-jumps of gold and U.S. Treasuries during periods of extreme market volatility such as beginning of the COVID-19 pandemic.     

What drives cross-market correlations during the United States Q.E.?

This paper investigates the dynamic cross-market correlations and its crucial drivers between the United States (U.S.) stock and currency market and foreign markets during the U.S. Quantitative Easing (QE) periods. We focus on countries with strong trade and financial linkages with the U.S., including Australia, Canada, and Mexico. Our empirical analyses deliver important findings. First, we consistently find positive (negative) correlations between the U.S. equity (currency) market and financial assets of the three foreign countries under the scenario of the U.S. QE. Second, the magnitude of the conditional correlations tends to be strengthened during the initiation of the U.S. QE1 but was weakened during the U.S. QE3. Lastly, we find that U.S. treasury yields and term premium were among the most significant economic drivers of the markets' linkages during both QE1 and QE3 but in an opposite role. Meanwhile, the expected uncertainty in the bond market additionally contributed to drive the markets' interrelationship during the QE2. Our findings deliver important information to investors and policymakers to anticipate the dynamics of market linkages under U.S. QE scenarios.     

A test of the firm characteristics hypothesis for LIFO choice of Canadian firms

This paper examines whether characteristics of Canadian firms can explain the observed difference in the use of LIFO for valuing inventory between the U.S. and Canada. Characteristics that help explain the choice between LIFO and FIFO use in the U.S. are used to compare Canadian firms to U.S. LIFO users and FIFO users separately. If Canadian firms are characteristically similar to U.S. FIFO users, then the firm characteristics hypothesis would be supported and LIFO would be infrequently used in Canada because few firms are LIFO-like in their underlying characteristics. Univariate nonparametric tests are used to compare U.S. and Canadian firms in the same industries on both an unmatched and matched basis. The results of this comparison indicate that Canadian average cost firms have more characteristics in common with U.S. LIFO users than FIFO users and Canadian FIFO firms have characteristics like both U.S. FIFO and U.S. LIFO firms. Logit models were estimated using the U.S. firms. These models predict that between three and 28% of Canadian firms would use LIFO. Thus, the firm characteristics explanation for infrequent use of LIFO in Canada is not supported by the data. These results imply that several Canadian firms may use LIFO if the institutional setting in Canada was more like that in the U.S.     

Information in the U.S. Treasury Term Structure of Interest Rates

We provide evidence of a significant change in the information content of the U.S. Treasury term structure of interest rates over the last 20 years. We apply a regression approach to measure the information in forward interest rates and introduce both a curve fitting method and an alternative data source. We find more information in the recent U.S. Treasury term structure about future interest rates than about expected holding period returns. These results document a significant departure from prior empirical findings.     

The capital structure of multinational corporations: Canadian versus U.S. evidence

Contrary to the U.S. evidence, we show that Canadian multinational corporations (MNCs) display higher leverage than domestic firms (DCs). This higher leverage is due to lower agency costs of debt associated with MNCs' U.S. operations. We also find that the Canadian firms with international bond market access have higher leverage than firms without such access. Comparison with a U.S. matched sample shows that the sensitivity of leverage to firm-specific factors differs between the two countries, especially for the MNCs samples. Our evidence indicates that capital structures of MNCs are a complex interaction of both home and host country factors and differences in leverage determinants across countries.     

The Turn-of-the-Year in Canada

A number of investigators have reported that January stock returns in the U.S. exceed returns for other months of the year. This paper documents a similar finding for Canadian stocks over the period 1951–1980. However, Canada did not introduce a capital gains tax until 1973 and the paper reports that January returns in Canada exceed returns for other months of the year before and after this date. Thus, these data do not support the tax-loss-selling-pressure hypothesis as the entire explanation for the turn-of-the-year effect in stock returns, nor, by implication, do they support the tax-loss-selling-pressure hypothesis as the complete explanation for the “small firm” effect in U.S. stocks returns.     

Estimating the Equity Risk Premium and Expected Equity Rates of Return: The Case of Canada

It is common to use the average excess return of equities over bonds estimated over long time periods as an expected equity risk premium on the grounds that going back far enough covers most possible economic scenarios. But although this data is useful in guiding the exercise of judgment, it cannot substitute for judgment. Adding more years of data to the near century of Canadian stock and bond returns that inform today's estimate of the equity risk premium will not produce a “random walk” for a simple reason: the historic bond series is the result of a specific historic monetary policy. This is particularly true of and important for the case of Canada, where today's very low current bond yields reflect the emergence of the Canadian dollar as a reserve currency as well as the impact of unconventional monetary policy elsewhere. After analyzing the historic record of the Canadian equity risk premium and noting the need for adjustments when this premium is applied to the current anomalously low Canadian long‐term bond yields, the author reaches the following conclusions:

• The historic Canadian equity risk premium is approximately 5.0% (based on arithmetic returns), which is slightly lower than the roughly 6.0% value for the U.S.
• The historic equity risk premium has not been constant because of obvious changes in the Canadian bond market. To some extent, the huge cycle in which bond yields began their increase from the 4.0% level starting in 1957, when markets were liberalized, and then fell back to the 4.0% level in 2007‐2008 completed an adjustment to changes in fiscal versus monetary policy. However, in 2016, average long Canada bond yields dropped to an anomalously low 1.8%, which is below the long‐term inflation target of the Bank of Canada, and have barely recovered since. It is difficult to view this as an equilibrium rate determined by private investors.
• Of the drop in bond yields, about 0.50% is unique to Government of Canada bonds as they became attractive to sovereign investors as a rare AAA‐rated issuer.
• Using an indicator variable for the post‐2010 years, a simple regression analysis indicates that current long Canada bond yields should be about 2.75% higher but for the recent changes. And for 2018, this means that the 2.35% average long Canada bond yield should have been about 5.0%. Apart from the impact of higher government deficits, this is consistent with average yields before the 2008 financial crisis.
• Adding an adjusted 5.0% long Canada bond yield to the historic equity risk premium in Canada of 4.50% gives 9.50% for the cost of the overall equity market or, given the Bank of Canada's target inflation rate of 2.0%, a real equity return of 7.5%, both slightly higher than the long‐run averages.

In sum, the conventional practice of adding a historic market risk premium to the current low Canada long bond yields would impart a sharp downward bias to current equity cost estimates; use of this method would not be appropriate until long Canada bond yields increase to at least the 4.0% level.     

Earnings Quality under Rules‐ versus Principles‐based Accounting Standards: A Test of the Skinner Hypothesis / LA QUALITÉ DES RÉSULTATS SELON QUE LES NORMES COMPTABLES SONT AXÉES SUR LES RÈGLES OU SUR LES PRINCIPES: VÉRIFICATION DE L'HYPOTHÈSE DE SKINNER*

We provide preliminary evidence, consistent with Skinner (1995), that Canada's relatively principles‐based GAAP yield higher accrual quality than the United States' relatively rules‐based GAAP. These results stem from a comparison of the Dechow‐Dichev (2002) measure of accrual quality for cross‐listed Canadian firms reporting under both Canadian and U.S. GAAP. However, we document lower accrual quality for Canadian firms reporting under U.S. GAAP than for U.S. firms, which are subject to stronger U.S. oversight, reporting under U.S. GAAP. The latter results suggest that stronger U.S. oversight compensates for inferior accrual quality associated with rules‐based GAAP. Consistent with the positive effect of Canada's principles‐based GAAP and the offsetting negative effect of Canada's weaker oversight, we find no overall difference in accrual quality between Canadian firms reporting under Canadian GAAP and U.S. firms reporting under U.S. GAAP. Our results imply that (1) policymakers who wish to compare the effectiveness of oversight across jurisdictions must control for the GAAP effect; and (2) accounting standard‐setters who wish to compare the effectiveness of principles‐ versus rules‐based GAAP must control for oversight strength.     

The impact of the Multi-jurisdiction Disclosure System on audit fees of cross-listed Canadian firms

The Multi-jurisdiction Disclosure System (MJDS), a treaty between Canada and the United States (U.S.), was intended to facilitate the cross-listing of a firm's securities in the neighboring country. Under this system, eligible Canadian companies are allowed to use home-country documents to meet U.S. disclosure requirements and these documents are generally not reviewed by the Securities and Exchange Commission (SEC). We posit that the single-reporting requirement and lower SEC scrutiny may result in lower audit fees for MJDS firms. Based on audit-fee disclosures mandated by the SEC rule-making authority granted by the Sarbanes-Oxley Act of 2002, we find a negative association between audit fees paid by U.S. cross-listed Canadian companies and their use of the MJDS. This result suggests that the lower audit fees provide an economic incentive to use the MJDS. Thus, our study provides evidence that the implementation of the MJDS may help facilitate cross-border listings by reducing audit costs. Additionally, this study confirms, for Canadian firms, some of the audit-fee determinants reported in earlier studies.     

Price Discovery in the U.S. Treasury Market: The Impact of Orderflow and Liquidity on the Yield Curve

We examine the role of price discovery in the U.S. Treasury market through the empirical relationship between orderflow, liquidity, and the yield curve. We find that orderflow imbalances (excess buying or selling pressure) account for up to 26% of the day‐to‐day variation in yields on days without major macroeconomic announcements. The effect of orderflow on yields is permanent and strongest when liquidity is low. All of the evidence points toward an important role of price discovery in understanding the behavior of the yield curve.     

Has Adoption of IFRS Increased Non–North American Institutional Investment in the Canadian Stock Markets?

We investigate whether non–North American (non‐NA) institutional investment in firms listed on the Canadian stock markets increased between the pre‐ and post‐IFRS adoption periods relative to such investment in firms listed on the U.S. stock markets. Prior to IFRS adoption, Canada had high‐quality financial reporting standards that were similar to the U.S. standards. As consequences of IFRS adoption, Canadian financial statements became more comparable with European and other IFRS country financial statements and less comparable with neighboring U.S. financial statements. Thus, a question of interest is whether the enhanced comparability with non‐NA companies was beneficial in terms of attracting non‐NA investment to Canadian companies versus U.S. companies. We find that there was no significant change in non‐NA institutional investment in Canadian firms relative to U.S. firms for the very largest (fifth quintile) and for smaller (first, second, and third quintiles) Canadian companies. However, intermediate‐sized Canadian companies in the fourth size quintile lost non‐NA institutional investment relative to their U.S. peer companies, suggesting that non‐NA investors cared more about comparability with U.S. peer companies than non‐NA peer companies for companies in this size quintile.     

Why have private savings rates in the United States and Canada diverged?

One of the central questions in macroeconomics for many years has been whether government policy can affect private saving rates, and if so, to what extent and through what channels. The question has remained controversial because, as with other macroeconomic questions, experiments to check divergent hypotheses cannot be deliberately performed, so economists must rely upon the often dubious evidence from the limited experiments with which nature and history have endowed us. This paper discusses the results of an exceptionally good natural experiment that has been provided by Canada and the U.S. over the past thirty-five years. After moving in tandem for almost twenty-five years, American and Canadian private saving rates have diverged dramatically over the last decade. The primary conclusion emerging from our analysis of this phenomenon is that tax policies can have a potent impact on private savings behavior. Differences in tax structures and in the interactions of taxation and inflation appear to be important factors explaining the divergent behavior of the American and Canadian private savings rates. Recognizing the importance of asset revaluations, caused partially but not entirely by tax effects, also helps to explain the different behavior of U.S. and Canadian savings. There may also be a relationship between government deficits and the private savings differential.     

The impact of prompt corrective action on the default risk of the U.S. commercial banking sector

As the Basel III reforms, which come into effect from 2012, place emphasis on default risk, assessing the impact of Prompt Corrective Action (PCA) on default risk is of practical relevance. We provide strong evidence that both the dynamic and the contemporaneous impact of the PCA-defined tier 1 risk-based capital ratio and the tier 1 leverage ratio on default risk is reduced following PCA’s introduction. We interpret this as evidence that PCA is effective in managing the default risk of the U.S. commercial banking sector.