Central bank intervention and exchange rate volatility — Australian evidence

This paper examines the key characteristics of foreign exchange intervention by the Reserve Bank of Australia in the period 1983–1997, which can be broken into five distinct phases. We investigate the changing effectiveness of daily intervention on the $US/$A exchange rate by decomposing the exchange rate response to the intervention into various separate components. We find contemporaneous positive correlation between the direction of intervention and the conditional mean and variance of exchange rate returns. We show that sustained and large interventions have a stabilising influence in the foreign exchange market in terms of direction and volatility. Without these interventions, the market would have moved further and exhibited more volatility.     

Australia’s equity home bias and real exchange rate volatility

The main purpose of this paper is to consider the effect of real exchange rate volatility on equity investment by Australian investors. Equity investment is of major importance to savers and investors in Australia. Also real exchange rate volatility is an important influence on Australia’s financial integration in the global economy. Analysis of the effect of real exchange rate volatility on Australia’s equity home bias is important since Australian dollar is a commodity currency. There is a close relationship between Australia’s terms of trade and real exchange rate volatility. Home bias is measured on the basis of free float-adjusted market capitalization in recognition of the fact that closely held shares are not available to ordinary investors. Real exchange rate volatility is measured by deviations from purchasing power parity on a bilateral basis between Australia and 35 countries. The cross-border equity investment data over the period 2001–2007 are from International Monetary Fund’s Coordinated Portfolio Investment Survey. Australian investors are found to invest significantly less in a country if the real exchange rate volatility of that country is relatively high (results that are robust to standard control measures and generalized method of moments).     

What matters and for which firms for corporate governance in emerging markets? Evidence from Brazil (and other BRIK countries)

A central issue in corporate governance research is the extent to which “good” governance practices are universal (one size mostly fits all) or instead depend on country and firm characteristics. We report evidence that supports the second view. We first conduct a case study of Brazil, in which we survey Brazilian firms' governance practices at year-end 2004, construct a corporate governance index, and show that the index, as well as subindices for ownership structure, board procedure, and minority shareholder rights, predicts higher lagged Tobin's q. In contrast to other studies, greater board independence predicts lower Tobin's q. Firm characteristics also matter: governance predicts market value for nonmanufacturing (but not manufacturing) firms, small (but not large) firms, and high-growth (but not low-growth) firms. We then extend prior studies of India, Korea, and Russia, and compare those countries to Brazil, to assess which aspects of governance matter in which countries, and for which types of firms. Our “multi-country” results suggest that country characteristics strongly influence both which aspects of governance predict firm market value, and at which firms that association is found. They support a flexible approach to governance, with ample room for firm choice.     

Can exchange rate volatility explain persistence in the forward premium?

The persistence of the forward premium has been cited both as evidence of the failure of the unbiasedness hypothesis and as rationale for the forward premium anomaly. This paper examines the recent proposition that forward premium persistence can be explained solely by the conditional variance of the spot rate. We provide theoretical and empirical evidence to challenge this proposition. Our empirical results are shown to be robust to the presence of structural breaks. A corollary of the results is that the ‘true’ risk premium contains a long memory component. This is non-standard and has implications for the construction of rational expectations models of the foreign exchange market.     

What drives volatility persistence in the foreign exchange market?

We propose a new empirical specification of volatility that links volatility to the information flow, measured as the order flow in the market, and to the price sensitivity to that information. The time-varying market sensitivity to information is estimated from high-frequency data, and movements in volatility can therefore be directly related to movements in order flow and market sensitivity. Empirically, the model explains a large share of the long-run variation in volatility. Importantly, the time variation in the market's sensitivity to information is at least as relevant in explaining the persistence of volatility as the rate of information arrival itself. This may be evidence of a link between changes over time in the aggregate behavior of market participants and the time-series properties of realized volatility.     

Can the evolution of implied volatility be forecasted? Evidence from European and US implied volatility indices

We address the question whether the evolution of implied volatility can be forecasted by studying a number of European and US implied volatility indices. Both point and interval forecasts are formed by alternative model specifications. The statistical and economic significance of these forecasts is examined. The latter is assessed by trading strategies in the recently inaugurated CBOE volatility futures markets. Predictable patterns are detected from a statistical point of view. However, these are not economically significant since no abnormal profits can be attained. Hence, the hypothesis that the volatility futures markets are efficient cannot be rejected.     

Does prestigious board membership matter? Evidence from New Zealand

This study investigates whether ‘prestigious’ multiple board membership is positively associated with firm performance. We employ Resource Dependency theory to explain why performance outcomes may be improved by the presence of ‘prestigious’ multiple directorships. Our analysis relies on extensive hand‐collected data on New Zealand company directorships. The results support the contention that ‘prestigious’ multiple directorships are related to better accounting and market performance. Conclusions reflect upon how Resource Dependency theory informs this phenomenon and how ‘prestigious’ board members may be a valuable resource for firms. We also reveal how these findings expose a new avenue for board governance research.     

How important is the term structure in implied volatility surface modeling? Evidence from foreign exchange options

We claim that previously proposed parametric specifications that linearly approximate the term structure of the implied volatility surface (IVS) in option prices fail to capture important information regarding the expectations of market participants. This paper proposes a parametric specification for describing the IVS that allows flexible modeling of the term structure through a Nelson and Siegel (1987) factorization, recently proposed by Diebold and Li (2006) in the context of yield curve modeling. The specification is tested on implied volatilities from the over-the-counter foreign exchange options market, where contracts with long expiries are actively traded and thus the term structure dimension of the surface should be very important. We first show that the proposed volatility specification can consistently and remarkably improve our ability to describe the surface on any given day. We then establish the economic relevance of the incremental information captured by our proposed specification by showing that it can produce more accurate forecasts of implied volatility that can support long-term profitable trading strategies in the absence of transaction costs.     

Is information risk priced? Evidence from abnormal idiosyncratic volatility

We propose a new, price-based measure of information risk called abnormal idiosyncratic volatility (AIV) that captures information asymmetry faced by uninformed investors. AIV is the idiosyncratic volatility prior to information events in excess of normal levels. Using earnings announcements as information events, we show that AIV is positively associated with informed return run-ups, abnormal insider trading, short selling, and institutional trading during pre-earnings-announcement periods. We find that stocks with high AIV earn economically and statistically larger future returns than stocks with low AIV. Taken together, our findings support the notion that information risk is priced.     

What determines the composition of banks’ loan portfolios? Evidence from transition countries

This paper explores how bank characteristics and the institutional environment influence the composition of banks’ loan portfolios. We use a new and unique data set based on the EBRD Banking Environment and Performance Survey (BEPS), which was conducted for 220 banks in 20 transition countries. We show that bank ownership, bank size, and legal creditor protection are important determinants of the composition of banks’ loan portfolios. In particular, we find that foreign banks play an active role in mortgage lending. Moreover, banks that perceive pledge and mortgage laws to be of high quality choose to focus more on mortgage lending.     

Is exchange rate – Customer order flow relationship linear? Evidence from the Hungarian FX market

Over the last decade, the microstructure approach to exchange rates has become very popular. The underlying idea of this approach is that the order flows at different levels of aggregation contain valuable information to explain exchange rate movements. The bulk of empirical literature has focused on evaluating this hypothesis in a linear framework. This paper analyzes non-linearities in the relation between exchange rates returns and customer order flows. We show that the relationship evolves over time and that it is different under different exchange rate volatility conditions. Further, we found that the non-linearity can be captured successfully by the Transition Regression and Markov Switching models, which provide substantial explanatory power beyond the constant coefficients approach.     

Does country risks predict stock returns and volatility? Evidence from a nonparametric approach

We use the k-th order nonparametric causality test at monthly frequency over the period of 1984:1–2015:12 to analyze whether aggregate country risk, and its components (economic, financial and political) can predict movements in stock returns and volatility of eighty-three developed and developing economies. The nonparametric approach controls for the existing misspecification of a linear framework of causality, and hence, the weak evidence of causality obtained under the standard Granger tests cannot be relied upon. When we apply the nonparametric test, we find that, while there is no evidence of predictability of squared stock returns barring one case, at times, there are nearly 50 percent of the countries where the aggregate risks and its components tend to predict stock returns and realized volatility.     

What determines the share of non-resident public debt ownership? Evidence from Euro Area countries

This paper provides, for the first time, a detailed picture of the composition of public debt by type of holder (foreign vs. domestic) and type of holding institution for a set of 7 Euro Area countries between 1991Q1 and 2015Q4. In addition, it empirically inspects the determinants of nonresident public debt ownership, accounting for both domestic and external factors and paying special attention to the global financial crisis period. Using a previously unexplored dataset and by means of panel and country-specific time series regressions, we find that improved fiscal positions, systemic stress and financial volatility, a strong business cycle position, all increase share of public debt held by non-residents. Also, a higher share of monetary and financial institutions cross-border holdings of sovereign debt issued by the other Euro Area countries was correlated with higher share of public debt held by non-residents. Finally, results are robust to outliers inspection and other sensitivity checks.     

Does foreign institutional ownership increase return volatility? Evidence from China

This paper investigates the impact of foreign institutional ownership on firm-level stock return volatility in China, based on our study of a sample of 1458 firms between 1998 and 2008. The empirical results show that share ownership by foreign institutions (both financial and non-financial) increases firm-level stock return volatility, even after controlling for a complete ownership structure, firm size, turnover, and leverage, and correcting for potential endogeneity problems. However, the results also show that foreign individual shareholdings reduce volatility. Furthermore, we document a positive relationship between domestic shareholdings (individual, institutional, and governmental) and firm-level stock return volatility. Empirical results with interaction terms show that foreign institutional ownership increases firm-level return volatility by strengthening the positive impact of liquidity on volatility. The volatility reduction effect of foreign individual ownership is attenuated by government ownership suggests a poor governance environment as a result of the involvement of the Chinese government.     

Does institutional ownership increase stock return volatility? Evidence from Vietnam

The literature on institutional ownership and stock return volatility often ignores small emerging countries. However, this issue is more profound, due to the large size of institutional investors and small stock market size, in emerging equity markets. This paper examines the effects of the institutional ownership on the firm-level volatility of stock returns in Vietnam. Our data cover most of non-financial firms listed on the Ho Chi Minh City stock exchange for the period 2006–2012. Employing different analysis techniques for panel data and controlling for possible endogeneity problems, our empirical results suggest that institutional investors stabilize the stock return volatility. Moreover, we document that: i) the stabilizing effect of institutional investor ownership is higher in dividend paying firms, and ii) if firms are paying out more dividends, this stabilizing effect is greater. Our results outline the important role of institutional investors in maintaining the stability in emerging stock markets.     

Monetary Policy Stress in EMU: What Role for Fundamentals and Missed Forecasts?

This article reexamines the problem of monetary policy stress in the EMU. In addition to estimating the amount of stress in particular countries, we investigate its sources by breaking it down into its “fundamental” parts, covering how it is a result of country-specific macroeconomic divergences and the EMU-wide “non-fundamental” component, with special attention given to the role of missed forecasts. Our results confirm that peripheral countries were exposed to risks emerging from low interest rates while the “core” countries did not suffer from much monetary policy stress. Interestingly, the bulk of it was non-fundamental, i.e., not caused by inflation and output gap differentials between countries. We show that missed forecasts did make an important contribution to this part of the stress and were mainly responsible for pushing the interest rate below its rule-consistent level.     

Can trade costs explain why exchange rate volatility does not feed into consumer prices?

If countries specialize in imperfectly substitutable goods, trade costs increase the share of expenditure devoted to domestic output, reducing the exposure of consumer price inflation to exchange rate changes. I present a multi-country flexible-price model where expenditure shares are inversely related to trade costs through a gravity equation. In this setting, consumer price inflation can be approximated as an expenditure-share-weighted average of the contributions to inflation from all countries. I use data from 24 OECD countries, 1970-2003, to estimate a structural gravity model. I combine the fitted expenditure shares from the estimation with actual data on exchange rates to construct predictions of inflation. The behavior of these predictions indicates that trade costs can explain both qualitatively and quantitatively the failure of exchange rate volatility to feed into inflation.     

Evidence, What Evidence? The Foundations for Housing Policy

Developments in housing policy and practice have been marked by strong ideological stances and a persistent unwillingness to clarify ends and means, so that key policy questions remain unresolved. Evidence can, and does, impact on policy, but only under certain conditions; for example, if it relates to a specific policy question, is restricted to the interests of a single government department and, especially, if it implies reductions in public spending. Moreover, housing's complexity and relationship with a range of policy areas requires a linked perspective, at a local scale. A predominance of sector-specific, cross-sectional and qualitative research, allied to inadequate data impede the production of evidence to meet this challenge.     

Does interest rate and its volatility affect banking sector development? Empirical evidence from emerging market economies

This study investigates the relationship between interest rate, interest rate volatility, and banking sector development in 12 emerging market economies located around the world. For this purpose, panel data analysis was conducted using annual data from 1980 to 2014. In parallel to the financial development literature, which asserts that banking sector development, as a broad and complex concept, cannot be measured by a single indicator, this study adopts a set of measures of banking sector development. The empirical results reveal that while interest rate has a positive impact on all banking sector indicators, this relationship weakens at higher interest levels, showing a concave relationship between interest rate and banking sector development. In addition, the empirical results provide evidence that interest rate fluctuations have a negative impact on most banking sector development (BSD) indicators, suggesting that the banking sectors of emerging countries are vulnerable to interest rate risks. Furthermore, all measures of the banking sector indicators are positively affected by economic growth rates, while this association weakens at higher levels of income, confirming a nonlinear relationship. Thus, the results have important implications for policymakers in improving the banking system and promoting the economic growth of these emerging economies.     

Does internationalisation increase exchange rate exposure? -Evidence from Chinese financial firms

This study investigates both the symmetric and asymmetric exchange rate exposures of Chinese financial firms in the context of an accelerated pace of RMB internationalisation. We find that an increasing number of Chinese financial firms are exposed to negative symmetric effects from the change in the trade weighted effective exchange rate. The evidence concerning asymmetries shows that after 2009 negative exchange rate shocks (a weaker RMB) have a stronger effect on exposures than positive shocks (a stronger RMB). Changes in the bilateral exchange rate also have a significant impact on firm returns, given the importance of the USD in the effective exchange rate. Further, the empirical analysis reveals that exchange rate exposures are associated with firm level characteristics including total assets, earnings per share, net cash flows, investment incomes, total liabilities and firm size. Finally, we suggest that domestic and foreign stakeholders need to pay close attention to the movement of the Yuan's exchange rate before it becomes completely convertible.