Equity market contagion during the global financial crisis: Evidence from the world's eight largest economies

The global financial crisis (2007–2009) saw sharp declines in stock markets around the world, affecting both advanced and emerging markets. In this paper we test for the existence of equity market contagion originating from the US to advanced and emerging markets during the crisis period. Using a latent factor model, we provide strong evidence of contagion effects in both advanced and emerging equity markets. In the aggregate equity market indices, contagion from the US explains a large portion of the variance in stock returns in both advanced and emerging markets. However, in the financial sector indices we find less evidence of contagion than in the aggregate indices, and this is particularly the case for the advanced markets. The results suggest that contagion effects are not strongly related to high levels of global integration.     

A SURVEY OF RECENT DEVELOPMENTS IN THE LITERATURE OF FINANCE AND GROWTH

Abstract.  This paper provides a survey of the recent progress in the literature of financial development and economic growth. The survey highlights that most empirical studies focus on either testing the role of financial development in stimulating economic growth or examining the direction of causality between these two variables. Although the positive role of finance on growth has become a stylized fact, there are some methodological reservations about the results from these empirical studies. Several key issues unresolved in the literature are highlighted. The paper also points to several directions for future research.     

MONETARY POLICY AND BEHAVIOURAL FINANCE

Abstract.  There have been major advances in both theory and econometric techniques in mainstream macro-models and parallel advances in knowledge of the monetary transmission mechanism acting via asset prices. At the same time, behavioural finance has provided evidence that not all actors in the economy are 'fully rational' and this has influenced models of asset pricing on which part of the monetary policy transmission mechanism depends. Such uncertainty about the behaviour of asset prices has in part stimulated a move towards 'robustness', as an important criterion for guiding monetary policy. We argue that although we have discovered much, including 'what not to do', nevertheless our knowledge of the transmission mechanism is very incomplete. This is because, in spite of all the theoretical advances that have been made, there is still considerable uncertainty over the behaviour of agents, which has been reinforced by insights from behavioural finance.     

Recurrent crises in global games

Global games have unique equilibria in which aggregate behavior changes sharply when an underlying random fundamental crosses some threshold. This property relies on the existence of dominance regions: all players have a highest and lowest action that, for some fundamentals, is strictly dominant. But if the fundamental follows a random walk, it eventually spends nearly all of its time in these regions: crises gradually disappear. We obtain recurring crises by adding a single large player who lacks dominance regions. We also show that in order to obtain recurring crises, one must either relax dominance regions or restrict to fundamentals that continually return to or cross over a fixed region.     

FINANCIAL EDUCATION AND BEHAVIORAL FINANCE: NEW INSIGHTS INTO THE ROLE OF INFORMATION IN FINANCIAL DECISIONS

Recent empirical evidence based on surveys and experimental activities within the fields of behavioral finance and financial education has offered economists new empirically based insights into how individuals use information in making financial decisions. Specifically, the importance of information in financial decisions may be reduced or eliminated by psychological aspects of the individual, such as a state of overconfidence that is individual or shared with a group, or by the individual's limited ability to process complex and abundant information. This paper aims to complement this emerging body of literature by studying how individuals perceive and process information when making financial decisions. We review these contributions and suggest a number of broad guidelines that can provide a framework for future discussion of this topic within financial decision theory.     

A PRIMER ON MATHEMATICAL MODELLING IN ECONOMICS

Abstract The Commission on Graduate Education in Economics had raised several concerns regarding the role of mathematics in graduate training in economics ( Krueger, 1991 ; Colander, 1998, 2005 ). This paper undertakes a detailed scrutiny of the notion of a utility function to motivate and describe the common patterns across mathematical concepts and results that are used by economists. In the process one arrives at a classification of mathematical terms which is used to state mathematical results in economics. The usefulness of the classification scheme is illustrated with the help of a discussion of Arrow's impossibility theorem. Common knowledge of the patterns in mathematical concepts and results could be effective in enhancing communication between students, teachers and researchers specializing in different sub‐fields of economics.     

AUTOREGRESSIVE CONDITIONAL DURATION MODELS IN FINANCE: A SURVEY OF THE THEORETICAL AND EMPIRICAL LITERATURE

Abstract.  This paper provides an up-to-date survey of the main theoretical developments in autoregressive conditional duration (ACD) modeling and empirical studies using financial data. First, we discuss the properties of the standard ACD specification and its extensions, existing diagnostic tests, and joint models for the arrival times of events and some market characteristics. Then, we present the empirical applications of ACD models to different types of events, and identify possible directions for future research.     

A DISPLACED POISSON PROCESS APPLIED TO SCREENING FOR BREAST CANCER EN STRATIFIED SAMPLES WITH FALSE NEGATIVES*

A displaced Poisson process model allowing for stratified populations and “false negatives” is presented for describing the progress of certain chronic diseases. This model, which builds on earlier work by the authors, allows for the simple estimation of various parameters and distributions of interest in screening. A Monte Carlo simulation study illustrating and partially verifying the model predictions is given.     

ON BOOTSTRAPPING A CLASS OF DIFFERENTIABLE STATISTICAL FUNCNONALS WITH APPLICATIONS TO L– AND M– ESTIMATES

EFRON'S (1979) "bootstrap" method is justified for a class of differentiable statistical functionals which includes many L – and M –statistics. For illustration, a Monte Carlo study for the trimmed means is also included.     

MACROECONOMIC POLICY EVALUATION AND OPTIMAL CONTROL THEORY: A CRITICAL REVIEW OF SOME RECENT DEVELOPMENTS

Abstract. This survey addresses the recent literature on the application of optimal control theory and game theory to macroeconomic policy evaluation and design. This literature focuses on strategic interactions between governments and private agents engaged in dynamic non-cooperative games and emphasizes such issues as precommitment, credibility and reputation as important and endemic aspects of optimal policy design. A dominant theme is the problem of dynamic inconsistency and the inferiority of an equilibrium in single-stage full-information games without commitment. This may be alleviated in repeated games involving reputation effects and threat strategies designed to coerce rivals into pursuing particular strategies and to sustain a sequential equilibrium. The type and characteristics of a sequential equilibrium also depend importantly upon the information structure conditioning players'beliefs under uncertainty. Included here are separating and pooling equilibria, involving notions of learning, signalling and information revelation. Additional dimensions exist in stochastic systems which introduce other forms of uncertainty. Optimal control and game theory have also been applied to international macroeconomic policy design, with emphasis on the potential costs and benefits of non-cooperative and cooperative behaviour between countries and problems of international policy coordination.     

ENVY-FREENESS AND DISTRIBUTIVE JUSTICE: A REPLY TO KOLM'S COMMENT

Abstract. This reply takes up specific points raised by Professor Kolm over which there persists some disagreement between us. It offers a rather broad, philosophically oriented discussion of the issues. I explain why I think Kolm is right in preferring the term 'equity'to that of 'envy-freeness,'but I express moral doubts concerning the interpretation proposed by Kolm of equity as a criterion of equal liberty. On this basis, I then defend my own specific interpretation of equity as a welfarist-egalitarian criterion, and express some reluctance as to the alleged 'moral irrelevance'of individual preferences in the theory of equity. I also briefly discuss the conceptual role played by counterfactuals and try to mitigate somewhat Kolm's critique of the use of axioms involving 'imaginary' situations.     

BAYESIAN INFERENCE METHODS FOR UNIVARIATE AND MULTIVARIATE GARCH MODELS: A SURVEY

This survey reviews the existing literature on the most relevant Bayesian inference methods for univariate and multivariate GARCH models. The advantages and drawbacks of each procedure are outlined as well as the advantages of the Bayesian approach versus classical procedures. The paper makes emphasis on recent Bayesian non‐parametric approaches for GARCH models that avoid imposing arbitrary parametric distributional assumptions. These novel approaches implicitly assume infinite mixture of Gaussian distributions on the standardized returns which have been shown to be more flexible and describe better the uncertainty about future volatilities. Finally, the survey presents an illustration using real data to show the flexibility and usefulness of the non‐parametric approach.     

A THEORETICAL AND PRACTICAL PERSPECTIVE ON THE EQUITY RISK PREMIUM*

Abstract In historical perspective, equity returns have been higher than interest rates but have also varied a good deal more. However, the average excess return has been larger than what could be expected based on classical equilibrium theory: the equity risk premium (ERP) puzzle. This paper has two objectives. First, the paper presents a comprehensive overview of the vast literature developed aimed at adjusting theory and testing the robustness of the puzzle. Here we will show that the failure of theory to link asset prices to economics is mostly quantitative by nature and not qualitative (anymore). Second, beyond providing a survey of theory, we aim for a relevant practical angle as well. Our main contribution is that we spend time on why returns have been higher than investors reasonably could have expected. We present evidence that forecasts of equity returns can be enhanced by valuation models: low valuation levels (low price‐to‐earnings ratios) portend high subsequent returns. While conventional wisdom (several years ago) was to use historical returns to forecast future returns, a growing consensus now recognizes that the predictive power of valuation ratios is preferred. Finally we provide some practical implications based on this predictability. While the ERP is essentially a long‐term issue, the likelihood of a lower risk premium increases risk for many and means that short‐term volatility might not be neglected.     

DELIBERATIVE MONETARY VALUATION: IN SEARCH OF A DEMOCRATIC AND VALUE PLURAL APPROACH TO ENVIRONMENTAL POLICY

The use of deliberative methods to assess environmental values in monetary terms has been motivated by the potential for small group discussion to help with preference formation and the inclusion of non‐economic values. In this review, two broad approaches are identified: preference economisation and preference moralisation. The former is analytical, concentrates upon issues of poor respondent cognition and produces a narrow conception of value linked to utilitarianism. The latter emphasises political legitimacy, appeals to community values and tends to privilege arguments made in the public interest. Both approaches are shown to embrace forms of value convergence, which undermine the prospects for value pluralism. As a result exclusion and predefinition of values dominates current practice. In order to maintain democratic credentials, the importance attributed to monetary value needs to be left as an open question to be addressed as part of a process determining an “agreement to pay”. To this end we identify a discourse‐based approach as a third way consistent with the democratic and value plural potential of deliberative monetary valuation.     

PLAYING FAIR WITH FAIRNESS (A COMMENT ON ARNSPERGER'S 'ENVY-FREENESS AND DISTRIBUTIVE JUSTICE')

Abstract. The principle that 'no individual prefers another's allocation to his own'is central in the analysis of Economic Justice mainly because of its identity with the basic case of equality of liberty, rather than for its indirect relation with the sentiment of envy. The various reproaches which have been addressed to this principle, gathered by Arnsperger, either are misconceived, or have been answered by rational (justified) extensions or specifications of the principle.     

A COMPARISON OF THE POWERS OF A GENERALIZED FRIEDMAN'S RANK TEST AND AN ALIGNED RANK PROCEDURE BASED ON SIMULATION

This paper presents the results of an experimental determination by Monte Carlo techniques of the power functions of a generalized Friedman's rank test based on "standardized" ranks and a proposed test procedure based on aligned ranks for orthogonal designs. The simulation is carried out for five orthogonal designs and a number of Normal location alternatives and gives some information about the difference in power of the two test procedures for some orthogonal designs.     

WORDS, DEEDS AND OUTCOMES: A SURVEY ON THE GROWTH EFFECTS OF EXCHANGE RATE REGIMES

Abstract.  Recent studies on the growth effects of exchange rate regimes offer a wide range of different, sometimes contradictory results. In this paper, we systematically compare three prominent contributions in this field. Using a common data set, a common specification and common estimation methods, we argue that the contradictory findings can be explained by the fact that these studies use regime classifications which reflect fundamentally different aspects of exchange rate policy.