Covered interest parity with default risk

In this paper we derive a simple model of covered interest parity (CIP) with the assumption that interbank money market rates are risky. The model assumes that the default risk of uncollateralised loans can be hedged perfectly by credit default swap contracts. We show that the no-arbitrage condition is satisfied by a band. The location of this no-arbitrage band depends on the relative riskiness of the two counterparties in the CIP trade. We present evidence on the performance of the model for developed currency pairs in 2008–2011. We find that FX swap spreads (CIP deviations calculated from interbank interest rates of two countries) either fluctuated within the no-arbitrage bands or were close to the edges of the no-arbitrage bands.     

Monetary policy and covered interest parity in the post GFC period: Evidence from the Australian dollar and the NZ dollar

After the global financial crisis (GFC), most major currencies had higher interest rates than the US dollar on forward contract because of increased demand for the US dollar as international liquidity. However, unlike the other major currencies, the Australian dollar and the NZ dollar had lower interest rates than the US dollar on forward contract in the post GFC period. The purpose of this paper is to explore why this happened through estimating the covered interest parity (CIP) condition. In the analysis, we focus on a unique feature of Australia and New Zealand where short-term interest rates remained significantly positive even after the GFC. The paper first constructs a theoretical model where increased liquidity risk causes deviations from the CIP condition. It then tests this theoretical implication by using daily data of six major currencies. We find that both money market risk measures and policy rates had significant effects on the CIP deviations. The result implies that unique monetary policy feature in Australia and New Zealand made deviations from the CIP condition distinct on the forward contract.     

MARKET POWER IN THE PROPERTY/CASUALTY INSURANCE INDUSTRY

Abstract: Pro-consumer groups have charged that insurance firms are able to exercise market power to reduce coverage and/or increase rates. The ability of firms to earn economic rents (abnormal profits) is a factor in banks' interest in entering insurance markets. In classical economics such collusion is usually only possible with cartels. Recent work, examining the relationship between industry structure indicates that the power that can be exercised by cartels may be more limited than under the classical paradigms. We examine the ability of insurers to exercise market power in light of these modern theories.     

Do economic statistics contain information to predict stock indexes futures prices and returns? Evidence from Asian equity futures markets

This research examines the impact of local and international market factors on the pricing of stock indexes futures in East Asian countries. The purpose of this paper is to present a study of the significant factors that determine the major stock indexes futures’ prices of Hong Kong, Malaysia, Singapore, South Korea and Taiwan. This study first investigates the relationships between Hang Seng Index Futures, KLCI Futures, SiMSCI Futures, KOSPI Futures, Taiwan Exchange Index Futures and local interest rates, dividend yields, local exchange rates, overnight S&P500 index and a newly constructed index, Asian Tigers Malaysia Index (ATMI). 11 years historical data of stock indexes futures and the economic statistics are studied; 10 years in-sample data are used for testing and developing the pricing models, and 1 year out-of-sample data is used for the purpose of verifying the predicted values of the stock indexes futures. Using simple linear regressions, local interest rates, dividend yields, exchange rates, overnight S&P500 and ATMI are found to have significant impact on these futures contracts. In this research, the next period close is predicted using simple linear regression and non-linear artificial neural network (ANN). An examination of the prediction results using nonlinear autoregressive ANN with exogenous inputs (NARX) shows significant abnormal returns above the passive threshold buy and hold market returns and also above the profits of simple linear regression (SLR). The empirical evidence of this research suggests that economic statistics contain information which can be extracted using a hybrid SLR and NARX trading model to predict futures prices with some degree of confidence for a year forward. This justifies further research and development of pricing models using fundamentally significant economic determinants to predict futures prices.

     

Market efficiency and learning in an artificial stock market: A perspective from Neo-Austrian economics

An agent-based artificial financial market (AFM) is used to study market efficiency and learning in the context of the Neo-Austrian economic paradigm. Efficiency is defined in terms of the “excess” profits associated with different trading strategies, where excess is defined relative to a dynamic buy and hold benchmark in order to make a clean separation between trading gains and market gains. We define an Inefficiency matrix that takes into account the difference in excess profits of one trading strategy versus another (signal) relative to the standard error of those profits (noise) and use this statistical measure to gauge the degree of market efficiency. A one-parameter family of trading strategies is considered, the value of the parameter measuring the relative informational advantage of one strategy versus another. Efficiency is then investigated in terms of the composition of the market defined in terms of the relative proportions of traders using a particular strategy and the parameter values associated with the strategies. We show that markets are more efficient when informational advantages are small (small signal) and when there are many coexisting signals. Learning is introduced by considering “copycat” traders that learn the relative values of the different strategies in the market and copy the most successful one. We show how such learning leads to a more informationally efficient market but can also lead to a less efficient market as measured in terms of excess profits. It is also shown how the presence of exogeneous information shocks that change trader expectations increases efficiency and complicates the inference problem of copycats.     

Endogenous communication among lenders and entrepreneurial incentives

If banks have an informational monopoly about their clients,borrowers may curtail their effort level for fear of being exploitedvia high interest rates in the future. Banks can correct thisincentive problem by committing to share private informationwith other lenders. The fiercer competition triggered by informationsharing lowers future interest rates and future profits of banks.But, provided banks retain an initial informational advantage,their current profits are raised by the borrowers' higher effort.This trade-off determines the banks' willingness to share information.Their decision affects credit market competition, interest rates,volume of lending, and social welfare.     

公开市场操作与利率期限结构行为——基于混频数据信息的研究视角

在混频数据信息环境中,精准识别公开市场操作(央行政策利率)和国债收益率曲线(基准利率体系)之间的关联机制至关重要,其影响了货币政策期限结构传导的有效性。本文在混频Nelson-Siegel(N-S)利率期限结构模型框架下,引入央行政策利率,揭示公开市场操作与利率期限结构(水平、斜率、曲度)因子之间的作用机制。实证结果表明:混频数据信息条件下,引入的公开市场操作信息显著改进国债收益率曲线的拟合效果;斜率因子冲击对公开市场操作具有显著的正向影响,而利率期限结构因子对政策调控的反应不敏感。进一步研究表明,2015年以来,公开市场操作对斜率因子的影响逐渐扩大,政策利率向国债收益率曲线的传导效率得到显著提高,我国现代货币政策框架日益健全。     

Covered interest arbitrage profits: The role of liquidity and credit risk

We study the profitability of Covered Interest Parity (CIP) arbitrage violations and their relationship with market liquidity and credit risk using a novel and unique dataset of tick-by-tick firm quotes for all financial instruments involved in the arbitrage strategy. The empirical analysis shows that positive CIP arbitrage deviations include a compensation for liquidity and credit risk. Once these risk premia are taken into account, small arbitrage profits only accrue to traders who are able to negotiate low trading costs. The results are robust to stale pricing and the nonsynchronous trading occurring in the markets involved in the arbitrage strategy.     

International linkages and macroeconomic news effects on interest rate volatility — Australia and the US

We examine international linkages between daily time series of US and Australian 3-month treasury bills and 10-year government bonds from 1987–1995, paying particular attention to the effects of macroeconomic announcements in both countries. The two countries' interest rate data are modeled by a bivariate exponential generalized autoregressive conditional heteroscedasticity (EGARCH) formulation. The results suggest that market participants believed the Reserve Bank of Australia targeted the consumer price index (CPI), while the Federal Reserve targeted economic activity. Monetary policy announcements had significant effects on interest rates, as well as on their volatility in the short term. US macroeconomic activity announcements significantly moved Australian interest rates, particularly at the short end. Australian interest rates moved significantly in response to the previous day's US interest rate shocks. The conditional volatility of the Australian interest rate changes was also significantly influenced by lagged US interest rate shocks, as well as by surprises in US macroeconomic announcements. Some macroeconomic news announcements raised conditional volatilities, while others reduced them. Overall, there was a remarkable and complex array of linkages between the two countries.     

Interpreting deviations from covered interest parity during the financial market turmoil of 2007–08

This paper investigates the spillover effects of money market turbulence in 2007–08 on the short-term covered interest parity (CIP) condition between the US dollar and the euro through the foreign exchange (FX) swap market. Sharp and persistent deviations from the CIP condition observed during the turmoil are found to be significantly associated with differences in the counterparty risk between European and US financial institutions. Furthermore, evidence is found that US dollar term funding auctions by the ECB, supported by US dollar swap lines with the Federal Reserve, alleviated the level of dislocations, as well as the instability, of the FX swap market.     

The effects of reform on China’s bank structure and performance

This paper investigates the relationship between market structure and performance in China’s banking system from 1985 to 2002, a period when this sector was subject to gradual but notable reform. Using panel data estimation techniques, both the market-power and efficient-structure hypotheses are tested. In addition, the model is extended to consider issues such as the impact of bank size/ownership and whether the big four banks enjoy a “quiet life”. On average, X-efficiency declined significantly and most banks were operating below scale efficient levels. Estimation of the structure–performance models lends some support to the relative market-power hypothesis in the early period. The reforms had little impact on the structure of China’s banking sector, though the “joint stock” banks became relatively more X-efficient. There was no evidence to support the quiet-life hypothesis, probably because strict interest rate controls prevented the state banks from earning monopoly profits. Thus the ongoing liberalisation of interest rates should be accompanied by reduced concentration. Overall, to improve competitive structure, new policies should be directed at encouraging market entry and increasing the market share of the most efficient banks.     

放松利率管制、利润率均等化与实体企业“脱实向虚”

本文以我国贷款利率上下限放开为准自然实验,基于产权性质差异构造双重差分模型,实证考察放松利率管制如何影响实体企业金融化。研究发现:放松贷款利率下限管制能够显著抑制非国有企业金融化程度,而放松贷款利率上限管制则无显著作用,支持了“市场套利观”。机制检验发现贷款利率下限管制的放松显著抑制企业债务成本对企业利润的侵蚀作用;拓展性检验还发现对于盈利能力越强、规模越大以及市场竞争压力越小的公司,放松贷款利率下限管制对抑制非国有企业金融化的作用更显著。以上研究结论表明,实体经济与虚拟经济间的利润率差距是我国实体企业金融化的重要诱因,金融市场化改革有助于抑制实体企业金融化、改善“实体经济”与“虚拟经济”间的良性互动关系,从而助推实体经济的健康发展。     

An Anatomy of Trading Strategies: Evidence from China

Using a pooled cross-sectional time series approach, we evaluate profits of momentum strategies and identify the sources of profits in China's stock market. Momentum strategies generate significant and negative returns in the A-share market on investment horizons at one month and at and above nine months. In the B-share market, momentum strategies yield significant and negative returns at and above twelve months. Decomposition analysis finds that the negative returns are predominately attributed to the time series profitability of stock returns. Although momentum strategies generate significant and positive returns over the period after China opened its once foreign-restricted B-share market to domestic individual investors, the relative importance of the time series predictability and the cross-sectional variation does not change.     

The International Transmission of Arbitrage Information Across Futures Markets

Abstract:   This paper examines whether deviations from a domestic spot‐futures relation, as identified through mispricing series in stock index futures, spillover international boundaries. Such spillovers suggest that information from a mispricing series in one market conveys a signal of similar mispricing in another market. In the presence of arbitrage traders and in the absence of market frictions, mispricing series should be independent across international boundaries. The study employs a VAR analysis of stock index futures mispricing across three large futures markets – Australia, the UK and the USA. Using time zone differences, tests are conducted for the daily transmission of arbitrage information. The results reveal the relationship between mispricing series is bi‐directional. Based on this finding, a trading strategy is employed to examine the economic significance of apparent profits. The results show that some profits are possible after transaction costs but that a long horizon, probably beyond the scope of most traders, is required to exploit the spillover information.     

中国信贷市场利率与经济波动:2004-2010

本文基于VAR和VEC模型对我国信贷市场利率与经济波动的关系进行实证分析。研究结果表明:(1)投资、消费对于信贷市场利率的冲击处于负的脉冲响应,投资的响应更显著。投资、消费对信贷市场利率的影响非常有限。(2)投资波动对产出波动起主要作用;产出对投资波动和消费波动的影响程度有限;(3)信贷市场利率与投资、消费、产出之间存在长期均衡关系。基于这些分析结论,文章提出若干政策建议。     

Corporation taxes in the European Union: Slowly moving toward comprehensive business income taxation?

This paper surveys and evaluates the corporation tax systems of the Member States of the European Union on the basis of a comprehensive taxonomy of actual and potential regimes, which have as their base either profits; profits, interest and royalties; or economic rents. The current regimes give rise to various instate and interstate spillovers, which violate the basic tenets—neutrality and subsidiarity—of the single market. The trade-offs between the implications of these tenets—harmonization and diversity, respectively—can be reconciled by a bottom-up strategy of strengthening source-based taxation and narrowing differences in tax rates. The strategy starts with dual income taxation, proceeds with final source withholding taxes and rate coordination, and is made complete by comprehensive business income taxation. Common base and cash flow taxation are not favored.     

Dynamic Linkages among Budget Deficits,Interest Rates and the Stock Market*

This paper examines the dynamic linkages among the federal budget deficit, interest rates and the stock market for the United States from 1960 to 2006. The empirical strategy includes vector autoregression (VAR) and Granger causality analyses. The results suggest that budget deficits negatively impact upon stock returns, which implies a violation of the Ricardian Equivalence Proposition. Further analysis shows a higher sensitivity of stock returns to corporate taxes than to public spending. Finally, it is shown that although taxes are relevant for corporate profits in the short run, budget deficits are important for the stock market in the long run.     

Fiscal Consequences of Paying Interest on Reserves

We review the role of the central bank's balance sheet in a textbook monetary model and explore what changes if the central bank is allowed to pay interest on its liabilities. When the central bank (CB) cannot pay interest, away from the zero lower bound its (real) balance sheet is limited by the demand for money. Furthermore, if securities are not marked to market and the central bank holds its bonds to maturity, it is impossible for the CB to make losses, and it always obtains profits from being a monopoly provider of money. When the option of paying interest on liabilities is allowed, the limit on the CB's balance sheet is lifted. In this case, the CB is free to take on interest‐rate risk – for example, by buying long‐term securities and financing those purchases with short‐term debt that pays the market interest rate. This is a risky enterprise that can lead to additional profits but also to losses. To the extent that losses exceed the profits of the monopoly operations, the CB faces two options: either it is recapitalised by Treasury or it increases its monopoly profits by raising the inflation tax.     

经济利润、市场竞争与企业价值

从经济利润的涵义入手,从市场竞争的角度阐述了经济利润在企业经营过程中的变化趋势。由于市场竞争最终会趋于一个相对稳定的状态,即均衡竞争,因此,企业的投资资本回报率在充分竞争下会等于资本成本,经济利润最终将趋于零。经济利润与经济利润趋于零的思想对传统的估值理念与估值方法提出了新的挑战,为此,在经济增加值(EVA)和剩余收益(RI)估值模型原有的理论基础上,探讨了如何将新的估值理念运用到这两种估值模型中。     

Deviations from Covered Interest Rate Parity

We find that deviations from the covered interest rate parity (CIP) condition imply large, persistent, and systematic arbitrage opportunities in one of the largest asset markets in the world. Contrary to the common view, these deviations for major currencies are not explained away by credit risk or transaction costs. They are particularly strong for forward contracts that appear on banks' balance sheets at the end of the quarter, pointing to a causal effect of banking regulation on asset prices. The CIP deviations also appear significantly correlated with other fixed income spreads and with nominal interest rates.