Co-movement among oil,stock, bond,and housing markets: An analysis of U.S., Asian,and European economies

This study explores the co-movement among oil and the stock, bond, and housing markets of the U.S. and major developed countries across Europe and Asia. The results indicate that oil is long-run integrated with each asset class, and that the extent of convergence has increased after the onset of the 2007–2009 global financial crisis (GFC). Moreover, oil contributes most heavily toward the common trends, implying that oil is the “leader” sector that drives each asset class toward long-run equilibrium relationships. Short-run analyses indicate that oil shocks induce a negative response in stock and housing returns and a positive reaction in bond returns, showing a tendency to become more intense and persistent after the GFC. When oil shocks are disentangled, the results indicate that supply and demand have heterogeneous effects on the three global asset classes. Over the long-run, demand shocks make the most significant contribution to the common trends and “lead” the other asset classes, whereas supply shocks have either a negligible or a weaker impact. Over the short-run, demand shocks positively impact the stock and housing markets and negatively impact bonds, while supply shocks induce negative and weaker impacts on all three asset classes.     

Should the exchange rate be a shock absorber?

This paper examines the welfare case for the exchange rate as a “shock absorber”, cushioning an economy in face of shocks to world demand for its good. We provide an example in which, although the exchange rate acts perfectly as a shock absorber, stabilizing output around the natural rate, and eliminating the impact of nominal rigidities, it may in fact be better to prevent the exchange rate from adjusting at all. The explanation for this is that, with incomplete international financial markets, the natural rate is inefficient; it does not respond enough to demand shocks. While fixing the exchange rate increases the volatility of consumption, the pro-cyclical nature of monetary policy under a fixed exchange rate allows for a more efficient composition of consumption between home and foreign goods. Furthermore, for the shocks examined, a welfare maximizing monetary rule always dampens exchange rate volatility relative to that of a free float, and in some cases may imply a fixed exchange rate.     

The welfare effect of international asset market integration under nominal rigidities

This paper assesses the impact of integrating international asset markets when segmented markets are not the only distortion. Using a two-country general equilibrium model with nominal rigidities and monetary shocks, we show that integration is not universally beneficial. Instead, the welfare impact depends on the degree to which exchange rate fluctuations are passed through to consumer prices. While the integration is welfare neutral in the polar cases of complete or zero pass-through, this is not the case when pass-through is partial. When shocks are equally volatile in both countries, integration can be detrimental or beneficial depending on the degree of pass-through. When shocks are more volatile in one country, it benefits from integration compared with the more stable country.     

A quantitative analysis of employment guarantee programmes with an application to rural India

This paper examines the welfare effects of a workfare programme in an economy where agents face exogenous income shocks and are unable to insure themselves through private markets. A dynamic general equilibrium model is calibrated using data from two ICRISAT villages in the Indian state of Maharashtra, which had a functioning Employment Guarantee Scheme (EGS), in the period 1979–84. The optimal wage and the welfare gains of the program depend on how productive the EGS is, relative to the private sector. When agents are paid the optimal wage rate, they do not hold the non-interest-bearing asset for precautionary savings and all insurance is provided by the EGS. There are significant welfare gains from paying the optimal wage rate as opposed to simply paying the marginal product of labour in the EGS.     

Liquidity shocks,commodity financialization,and market comovements

We explore whether and how liquidity factors influence risk transfers between commodity and stock markets using a composite liquidity index and five different types of liquidity measures. We find that liquidity shocks, including both funding liquidity and market liquidity, are positively associated with comovements between commodity and stock markets after 2000, although the relationship is insignificant before 2000. The structural change indicates that financialization creates a role for adverse liquidity shocks to increase cross-market correlations. Further evidence shows that the effect of liquidity on cross-market correlations is state-dependent and intensifies when liquidity conditions deteriorate and asset returns sustain substantial declines. Our findings are not explained by business cycles.     

Optimality of Stationary Asset Equilibria Under A Stochastic Inflation Tax

In this paper we characterize the set of Pareto optimal asset equilibria in an incomplete market OLG framework when inflation-tax-financed monetary shocks impinge on the economy. We show that it is the strength rather than the mere presence of monetary disturbances that accounts for, if the market mechanism fails to achieve allocating efficiency.     

Macroeconomic interdependence under incomplete markets

This paper uses a two-country, flexible-price model with overlapping generations of infinitely lived households to study the role of net foreign asset dynamics in the propagation of productivity shocks. Absence of Ricardian equivalence ensures existence of a unique steady-state level of net foreign assets, to which the economy returns following temporary shocks. Model dynamics are significantly different from those of a setup in which terms of trade movements perform all the international adjustment and net foreign assets do not move. The difference relative to a complete markets economy in which net foreign asset movements play no role in shock transmission is smaller. It is amplified if the substitutability across goods rises and if shocks are permanent.     

Segmented asset markets and optimal exchange rate regimes

This paper revisits the issue of the optimal exchange rate regime in a flexible price environment. The key innovation is that we analyze this question in the context of environments where only a fraction of agents participate in asset market transactions (i.e., asset markets are segmented). Under this friction alternative exchange rate regimes have different implications for real allocations in the economy. In the context of this environment we show that flexible exchange rates are optimal under monetary shocks and fixed exchange rates are optimal under real shocks.     

Third-Degree Price Discrimination, Consumption Externalities, and Market Opening

This study investigates the effects of monopolistic third-degree price discrimination on market opening in the presence of consumption externalities between separate markets. Assuming symmetric interdependent linear demands and constant marginal cost, we indicate the possibility that with negative externalities a monopolist can do better by closing the relatively small market from the social welfare viewpoint, while it prefers opening that market if price discrimination is feasible. This result contradicts the previous literature on third-degree price discrimination and market opening which asserts that, in the case of non-increasing marginal cost, price discrimination improves social welfare if it opens new markets that are closed under uniform pricing.     

Entry and Component Pricing in Regulated Markets

This paper discusses work on computable models of entry into regulated markets. Cournot, Stackelberg and Fringe entry are considered for the case where the incumbent operator‘s profitability is regulated and component pricing influences the desirability of entry. The simulation results illustrate that welfare optimal component pricing can be highly sensitive to model specification (behavioural assumptions about agents, the nature of competition, the extent of product differentiation etc.) and that no welfare ranking of simple component pricing rules (such as marginal cost, average cost, opportunity cost or efficient component price) exists. In addition, the welfare desirability of entry is seen to be sensitive to the choice of welfare benchmark for comparison     

Market power in banking,countercyclical margins and the international transmission of business cycles

By introducing an imperfectly competitive banking sector into a standard two-country, two-good RBC model with complete asset markets, we study the international transmission of aggregate TFP shocks in an environment with noncompetitive financial intermediation. In this model, price-cost margins in a global loan market are endogenous and countercyclical. As a result, a positive TFP shock in one country spills over to another through a reduction in the global cost of both credit and externally financed investment. The quantitative analysis shows that countercyclical margins on loans play a key role in bringing the predictions of the theory closer to the observed cross-country cyclical co-movements of consumption, employment, investment and output. Recessions are deeper when the cost of credit rises during these economic downturns. Thus, a financial accelerator arises in our framework, unveiling the increased importance of stabilization policies in economies where margins in credit markets are countercyclical.     

Equilibrium with Default and Endogenous Collateral

We study a two‐period general equilibrium model with incomplete asset markets and default. We make collateral endogenous by allowing each seller of assets to fix the level of collateral. Sellers are required to provide collateral whose first‐period value, per unit of asset, exceeds the asset price by an arbitrarily small amount. Moreover, borrowers are also required to be fully covered by the purchase, in the first period, of state‐by‐state default insurance. These insurance contracts are offered by lenders. The insurance cost or revenue is a linear charge and plays the role of a spread penalizing borrowers who will incur in default and benefiting lenders who will suffer default. Under these assumptions, equilibrium always exists.     

Financial connectedness of BRICS and global sovereign bond markets

The paper examines the financial connectedness via return and volatility spillovers between Brazil, Russia, India, China and South Africa (BRICS) and three global bond market indices represented by the United States of America (USA), European Monetary Union (EMU) and Japan for the period 01 January 1997 to 27 July 2016 (weekly data). We find that Russia followed by South Africa is the net transmitter of shocks within BRICS, implying that the risk arising from these markets may have an adverse impact on others in BRICS. However, China and India exhibit weak connectedness, suggesting that these markets may be useful for hedging and diversification opportunities in BRICS. The networks of pairwise spillover results further confirm this. Among global indices, China appears as highly interconnected with the USA. USA is the strongest transmitter of shocks to BRICS bond indices. The panel data results further confirm the significant determinants of net directional spillover. Thus, we can conclude that BRICS is a heterogeneous asset class even in the case of the bond market. India and China are the markets to look for better risk management strategies.     

Time consistent export quotas in an oligopolistic world market

We investigate the strategic behavior between exporting countries that face endogenous terms of trade on the world market. In a non-cooperative setting, if production decisions occur before consumption decisions, the ex-ante optimal export quota is not time consistent as the ex-post elasticity of the residual foreign import demand curve is lower than the ex-ante elasticity. However, we show that the exporters’ inability to irrevocably commit to their quota may be welfare superior to the precommitment solution. If exporters can sell forward a proportion of their exports before production decisions are made, they will do so even though, in equilibrium, it may decrease welfare compared to a situation in which forward markets do not exist. Moreover, the equilibrium with forward markets is welfare inferior to the commitment equilibrium for exporters.     

On commodity price limits

This paper examines the behavior of futures prices and trader positions around the occurrence of price limits in commodity futures markets. We ask whether limit events are the result of shocks to fundamental volatility or the result of temporary volatility induced by the trading of noncommercial market participants (speculators). We find little evidence that limits events are the result of speculative activity, but instead associated with shocks to fundamentals that lead to persistent price changes. When futures trading halts price discovery migrates to options markets, but option prices provide a biased estimate of subsequent future prices when trading resumes.     

Looking for contagion in currency futures markets

This article tests whether there are pure contagion effects in both conditional means and volatilities among British pound, Canadian dollar, Deutsche mark, and Swiss franc futures markets during the 1992 ERM crisis. A conditional version of international capital asset pricing model (ICAPM) in the absence of purchasing power parity (PPP) is used to control for economic fundamentals. The empirical results indicate that overall there are no mean spillovers among those futures markets, but they are detected during the crisis period. That is, past return shocks originating in any one of the four markets have no impact on the other three markets during the entire sample period, suggesting that these markets are weak‐form efficient. However, this weak‐form market efficiency fails to hold during the market turmoil, especially for British pound and Swiss franc, and the sources of contagion‐in‐mean effects are mainly due to the return shocks originating in three European currency futures markets. As for the contagion‐in‐volatility, it is detected for British pound only because its conditional volatility is influenced by the negative volatility shocks from Canadian dollar, Deutsche mark, and Swiss franc, with Deutsche mark playing the dominant role in generating these shocks. JEL Classifications: C32; F31; G12. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:957–988, 2003     

Market integration and contagion: Evidence from Asian emerging stock and foreign exchange markets

This paper examines whether Asian emerging stock markets (India, Korea, Malaysia, Philippines, Taiwan, and Thailand) have become integrated into world capital markets since their official liberalization dates by estimating and testing a dynamic integrated international capital asset pricing model (ICAPM) in the absence of purchasing power parity (PPP) using an asymmetric multivariate GARCH(1,1)-in-Mean approach. Also examined in this paper is whether there are pure contagion effects between stock and foreign exchange markets for each Asian country during the 1997 Asian crisis. The empirical results show that first, both currency and world market risks are priced and time-varying, suggesting that an international asset pricing model under PPP and constant price of risk might give rise to model misspecification. Second, the stock markets for India, Korea, Malaysia, Philippines, and Thailand were segmented from the world capital markets before their liberalization dates, but all six markets have become fully integrated since then. Third, the market liberalization has reduced the cost of capital and price volatility for most of the countries. Finally, as for the contagion effects, strong positive impact of return shocks originating from the domestic stock market to its foreign exchange market during the crisis is found. This dynamic relationship between stock market and foreign exchange market is consistent with stock-oriented exchange rate models.     

To be or not to be in monetary union: A synthesis

Monetary union can benefit countries suffering from policy credibility problems if it eliminates the inflation bias and also allows for more efficient management of certain shocks. But it also carries costs as some stabilization may be feasible even in the absence of credibility, and this may be more than what an individual country can hope for in a monetary union. In this paper, we combine the stabilization and credibility branches of the currency union literature and construct a simple welfare criterion that can be used to evaluate alternative monetary arrangements. We produce examples where monetary union may be welfare improving even for low-modest levels of inflation bias (2-3%) as long as business cycles are not too a-synchronized across countries.     

A Vicious Cycle of Manias,Crises and Asymmetric Policy Responses – An Overinvestment View

Over the past three decades, we find that asymmetric policy responses heavily contributed to manias and bursting bubbles that eventually trapped the major industrial economies into near zero short‐term interest rates with rapidly rising public indebtedness. The article uses the endogenous business cycle theories of Wicksell, Mises, Schumpeter, Hayek and Minsky to show how ostensible counter‐cyclical monetary policies are asymmetric, as central banks are less willing to raise interest rates in booms than cut them when bubbles collapse. After interest rates have fallen towards zero, fiscal policy is called on which sooner or later becomes bounded by extraordinary debt to GDP ratios. Central banks hesitate to raise interest rates even in the face of a partial economic recovery because the cost of public debt service would become prohibitive. The economies then languish at very low interest rates that encourage low productivity real investments and a continual threat of bubbles in asset and raw material markets. This makes them unable to deal with further macroeconomic shocks.     

Intraday Volatility in Interest‐Rate and Foreign‐Exchange Markets: ARCH,Announcement, and Seasonality Effects

We explore the determinants of intraday volatility in interest‐rate and foreign‐exchange markets, focusing on the importance and interaction of three types of information in predicting intraday volatility: (a) knowledge of recent past volatilities (i.e., ARCH or Autoregressive Conditional Heteroskedasticity effects); (b) prior knowledge of when major scheduled macroeconomic announcements, such as the employment report or Producer Price Index, will be released; and (c) knowledge of seasonality patterns. We find that all three information sets have significant incremental predictive power, but macroeconomic announcements are the most important determinants of periods of very high intraday volatility (particularly in the interest‐rate markets). We show that because the three information sets are not independent, it is necessary to simultaneously consider all three to accurately measure intraday volatility patterns. For instance, we find that most of the previously documented time‐of‐day and day‐of‐the‐week volatility patterns in these markets are due to the tendency for macroeconomic announcements to occur on particular days and at particular times. Indeed, the familiar U‐shape completely disappears in the foreign‐exchange market. We also find that estimates of ARCH effects are considerably altered when we account for announcement effects and return periodicity; specifically, estimates of volatility persistence are sharply reduced. Separately, our results show that high volatility persists longer after shocks due to unscheduled announcements than after equivalent shocks due to scheduled announcements, indicating that market participants digest information much more quickly if they are prepared to receive it. However, contrary to results from equity markets, we find no evidence of a meaningful difference in volatility persistence after positive or negative price shocks. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21: 517–552, 2001