Determinants of Japanese Yen interest rate swap spreads: Evidence from a smooth transition vector autoregressive model

This study investigates the determinants of variations in the yield spreads between Japanese yen interest rate swaps and Japan government bonds for a period from 1997 to 2005. A smooth transition vector autoregressive (STVAR) model and generalized impulse response functions are used to analyze the impact of various economic shocks on swap spreads. The volatility based on a GARCH (generalized autoregressive conditional heteroskedasticity) model of the government bond rate is identified as the transition variable that controls the smooth transition from a high volatility regime to a low volatility regime. The break point of the regime shift occurs around the end of the Japanese banking crisis. The impact of economic shocks on swap spreads varies across the maturity of swap spreads as well as regimes. Overall, swap spreads are more responsive to the economic shocks in the high volatility regime. Moreover, a volatility shock has profound effects on shorter maturity spreads, whereas the term structure shock plays an important role in impacting longer maturity spreads. Results of this study also show noticeable differences between the nonlinear and linear impulse response functions. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:82–107, 2008     

The components of interest rate swap spreads: Theory and international evidence

This article contains both a theoretical and an empirical analysis of the components of interest rate swap spreads defined as the difference between the fixed swap rate and the risk‐free rate of equal maturity. The components are determined by expected LIBOR spreads, default risk, and market structure. A model of the swap market incorporating debt market imperfections and corporate financing choices is used to explain participation by both swap buyers and sellers. The model also motivates an empirical relationship between swap spreads and the slope of the risk‐free term structure. The article then provides empirical evidence on the cross‐sectional and time‐series variation of swap spreads in seven international markets. The evidence is consistent with the suggested components across both markets and swap maturities as well as over time. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:347–387, 2003     

Exchange rate policies in Asia in an era of financial globalisation: An empirical assessment

Ebbs and flows of capital have complicated macroeconomic policy management for all emerging market and developing economies (EMDEs) regardless of whether they have adopted flexible or managed exchange rate regimes. In the light of the renewed interest in the trilemma versus dilemma debate, we contribute to the related literature by presenting an empirical analysis of exchange rate flexibility and intervention for selected Asian EMDEs over the time period 2001–2016. In addition to estimating augmented Frankel–Wei regressions, we employ a generalised auto‐regressive conditional heteroscedasticity (GARCH) model to assess the extent of foreign exchange (FX) intervention and whether there exist any asymmetries in the way countries intervene. Our results show that although there is greater flexibility in exchange rates, there is evidence of some countries potentially using FX intervention to manage currency movements. We also find evidence of asymmetry in intervention where exchange rate volatility responds more emphatically to FX sales than purchases.     

Is the Yen/Dollar Exchange Rate Really Responsible for East Asia's Export and Business Cycles? A Commentary on McKinnon and Schnabl (2003)

In a paper published in The World Economy, Ronald McKinnon and Gunther Schnabl claim that fluctuations in the nominal yen/dollar exchange rate are the principal causal factor behind the export and business cycles in East Asian countries ( McKinnon and Schnabl, 2003 ). Their econometric work, however, suffers from at least two important difficulties. First, while McKinnon and Schnabl preclude industry shocks as an explanation for the East Asian countries’ macroeconomic fluctuations, cyclical fluctuations in the global electronics industry have a significant impact on their short‐run export and output dynamics. Second, although McKinnon and Schnabl assume that the relative industrial competitiveness of Japan and other East Asian countries moves in tandem with fluctuations in the nominal yen/dollar exchange rate, the empirical validity of this assumption is not indisputable. Once these two issues are taken into account properly, it becomes very difficult to make a convincing case for the yen/dollar exchange rate being the main driver of East Asia's macroeconomic instability. A brief critique will also be made of another paper that has appeared recently in The World Economy ( Doraisami, 2004 ), which models Malaysia's pre‐crisis export dynamics using the nominal yen/dollar exchange rate as a proxy for the country's export competitiveness.     

A Filtering Process to Remove the Stochastic Component from Intraday Seasonal Volatility

The intraday seasonal variance pattern contains stochastic as well as deterministic components. Therefore, the estimation of information arrivals in the associated volatility process requires the proper filtering of both of these seasonal components. However, popular current models remove only the deterministic part of the typical U‐shape volatility. Here, we provide the first empirical results of the importance of the stochastic component, as developed by Cho and Daigler (2012). We show that a highly significant additional 8.5% to 12.9% of the total seasonal variance is explained by the stochastic seasonal variance component for S&P500 futures, live cattle futures, and the Japanese yen‐U.S. dollar spot exchange rate. Moreover, we show that the stochastic seasonal filtering model implemented here does not create any statistical distortions of the filtered series, as occurs with deterministic‐based seasonal adjustment processes, as well as comparing the model examined here with the most popular current deterministic model. As part of our analysis we examine the application of the model to macroeconomic news and out‐of‐sample results for the model. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 34:479–495, 2014     

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     

Timing the Market with a Combination of Moving Averages

A combination of simple moving average trading strategies with several window lengths delivers a greater average return and skewness as well as a lower variance and kurtosis compared with buying and holding the underlying asset using daily returns of value‐weighted US decile portfolios sorted by market size, book‐to‐market, momentum, and standard deviation as well as more than 1000 individual US stocks. The combination moving average (CMA) strategy generates risk‐adjusted returns of 2% to 16% per year before transaction costs. The performance of the CMA strategy is driven largely by the volatility of stock returns and resembles the payoffs of an at‐the‐money protective put on the underlying buy‐and‐hold return. Conditional factor models with macroeconomic variables, especially the market dividend yield, short‐term interest rates, and market conditions, can explain some of the abnormal returns. Standard market timing tests reveal ample evidence regarding the timing ability of the CMA strategy.     

Immigration,uncertainty and macroeconomic dynamics

This paper examines the macroeconomic effects of rising migration uncertainty in four advanced economies (i.e. US, UK, Germany and France). Migration uncertainty is first captured by the Migration Policy Uncertainty (MPUI) and the Migration Fear (MFI) news-based indexes developed by Baker et al. (Immigration fears and policy uncertainty, 2015), and then by a novel Google Trend Migration Uncertainty Index (GTMU) based on the frequency of Internet searches for the term ‘immigration’. VAR investigations suggest that the macroeconomic implications of rising migration uncertainty differ across countries. Moreover, news-based and Google search-based migration fear shocks generate different macroeconomic effects. For instance, in the US (France), MPUI, MFI and GTMU shocks all improve (undermine) production and labour market conditions in the medium run. For Germany and the UK, mixed evidence is found, suggesting that increasing media attention on migration phenomena and rising population's interest in migration-related issues influence people's mood differently. The observed heterogeneity in the macroeconomic effects of rising migration uncertainty can be explained by cross-country gaps in (a) the level of labour market rigidity, (b) the degree of people's happiness and life satisfaction and (c) the percentage of graduates.     

Scheduled announcements and volatility patterns: The effects of monetary policy committee announcements on LIBOR and short sterling futures and options

Both the UK spot and futures markets in short‐term interest rates are found to react strongly to surprises in the scheduled announcements of the repo rate and RPI. Therefore, these announcements should also affect the market for options on short‐term interest rate futures. Because the repo rate and RPI announcements are scheduled, the options market can predict the days on which announcement shocks may hit, and build this information into its volatility expectations. It is argued that the volatility used in pricing options should alter over time in a predictable nonlinear manner that varies with contract maturity and the number of forthcoming announcements; but is independent of announcement content. The empirical results support this hypothesis. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:773–797, 2003     

An empirical comparison of continuous time models of the short term interest rate

This article tests the performance of a wide variety of well-known continuous time models—with particular emphasis on the Black, Derman, and Toy (1990; henceforth BDT) term structure model—in capturing the stochastic behavior of the short term interest rate volatility. Many popular interest rate models are nested within a more flexible time-varying BDT framework that allows us to compare the models and find the proper specification of the dynamics of short rates. The empirical results indicate that the equilibrium models that do not allow the drift and diffusion parameters to vary over time and parameterize the volatility only as a function of interest rate levels overemphasize the sensitivity of volatility to the level of interest rate and fail to model adequately the serial correlation in conditional variances. On the other hand, the GARCH-based arbitrage-free models with time-dependent parameters in the drift and diffusion functions define the volatility only as a function of unexpected information shocks and fail to capture adequately the relationship between interest rate levels and volatility. This study shows that the most successful models in capturing the dynamics of short term interest rates are those that introduce time-dependent parameters to the short rate process and define the conditional volatility as a function of both the interest rate levels and the last period's unexpected news. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 777–797, 1999     

Foreign exchange futures volatility: Day-of-the-week,intraday, and maturity patterns in the presence of macroeconomic announcements

Using standard deviations and numbers of price changes calculated from tick data for currency futures, this study finds strong day-of-the-week effects for both the Deutsche mark and Japanese yen, mild effects for the British pound, and no effects for the Canadian dollar after controlling for scheduled macroeconomic announcements and days to contract expiration. The day-of-the-week effects are found to be caused either by Mondays’ low volatility, or by Thursdays’ or Fridays’ high volatility. This result suggests that the day-of-the-week effects in the currency futures are not driven by the announcements of macroeconomic indicators as proposed in previous studies, but rather by other factors, such as private information-based trading or by market microstructure. This study also finds that the announcements are processed equally across the days of the week for all four currency futures. © 1999 John Wiley & Sons, Inc. Jrl Fut Mark 19: 665–693, 1999     

Short Rate Dynamics and Regime Shifts*

We characterize the dynamics of the US short‐term interest rate using a Markov regime‐switching model. Using a test developed by Garcia, we show that there are two regimes in the data: In one regime, the short rate behaves like a random walk with low volatility; in another regime, it exhibits strong mean reversion and high volatility. In our model, the sensitivity of interest rate volatility to the level of interest rate is much lower than what is commonly found in the literature. We also show that the findings of nonlinear drift in Aït‐Sahalia and Stanton, using nonparametric methods, are consistent with our regime‐switching model.     

The CBOE S&P 500 three‐month variance futures

In this article, we study the market of the Chicago Board Options Exchange S&P 500 three‐month variance futures that were listed on May 18, 2004. By using a simple mean‐reverting stochastic volatility model for the S&P 500 index, we present a linear relation between the price of fixed time‐to‐maturity variance futures and the VIX². The model prediction is supported by empirical tests. We find that a model with a fixed mean‐reverting speed of 1.2929 and a daily‐calibrated floating long‐term mean level has a good fit to the market data between May 18, 2004, and August 17, 2007. The market price of volatility risk estimated from the 30‐day realized variance and VIX² has a mean value of −19.1184. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:48–70, 2010     

What moves the gold market?

In this article, we provide a detailed characterization of the intraday return volatility in gold futures contracts traded on the COMEX division of the New York Mercantile Exchange. The approach allows the study of intraday patterns, interday ARCH effects, and announcement effects in a coherent framework. We show that the intraday patterns exert a profound impact on the dynamics of return volatility. Among the 23 U.S. macroeconomic announcements, we identify employment reports, gross domestic product, consumer price index, and personal income as having the greatest impact. Finally, by appropriately filtering out the intraday patterns, we find that the high‐frequency returns reveal long‐memory volatility dependencies in the gold market, which have important implications on the pricing of long‐term gold options and the determination of optimal hedge ratios. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:257–278, 2001     

The compatibility of one‐factor market models in caps and swaptions markets: Evidence from their dynamic hedging performance

This study examines the dynamic hedging performance of the one‐factor LIBOR and swap market models in both caps and swaptions markets, using a procedure similar to the way that these models are used in practice. The effects of different calibration methods on model performance are investigated as well. The LIBOR market models and the swap market models are calibrated to the cross‐sectional Black implied volatilities for caps and swaptions respectively; the test is based on their effectiveness in hedging floors and swaptions that are not used in the calibration. We find that the LIBOR market models outperform the swap market models in hedging floors and perform as well as the swap market models in hedging swaptions. Our results also show that incorporating a humped volatility structure into these models does not significantly improve their hedging performance. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:109–130, 2008     

Equity volatility,bond yields,and yield spreads

This study examines the impact of implied and contemporaneous equity market volatility on Treasury yields, corporate bond yields, and yield spreads over Treasuries. The CBOE VIX is the measure of implied volatility, and the measure of contemporaneous volatility is constructed using intraday squared S&P 500 returns. We find that bond yields and spreads respond to changes in equity market volatility in a manner consistent with a flight‐to‐quality effect. Both short‐ and long‐term Treasury yields fall in response to increases in implied volatility, and the yield curve flattens modestly. Yields on short‐term investment grade bonds fall in response to contemporaneous volatility shocks, while long‐term spreads on low‐quality issues widen. This indicates that investors “look ahead” in anticipation of changes in equity market volatility but respond more strongly to changes in contemporaneous market activity. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark     

The Chinese interbank repo market: An analysis of term premiums

Because of the lack of short‐term government bonds, the interbank repo market in China has been providing the best information about market‐driven short‐term interest rates since its inception. This article examines the behavior of the repo rates of various terms and their term premiums. The work in this article supplements the study by F. Longstaff (2000), which reports supportive evidence for the pure expectations hypothesis over the short range of the term structure with the use of repo data from the United States. It is found that the pure expectations hypothesis is statistically rejected, although the term premiums are economically small. It is shown that the short‐term repo rate, repo rate volatility, repo market liquidity, and repo rate spreads are all important in determining the term premiums. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:153–167, 2006     

Useful Properties of Exchange Rate Forecasts for Risk Management and Derivative Pricing

We examine three useful properties of the yen/dollar exchange‐rate forecasts that are published in January and July in the Wall Street Journal. Those properties are the level of explanatory power, whether some forecasters are consistently better than others, and whether the dispersion of forecasts can predict the volatility of the exchange rates. The results show that the relative accuracy of the individual forecasts has not been random each period, and the evidence suggests that some forecasters are consistently better than others. The forecasts from the best forecasters explain about half of the variability in the semiannual exchange‐rate series. Finally, the dispersion of all the forecasts each period, as measured by the standard deviation, has predictive power with respect to the daily volatility of the forecasts for the three months following the survey. This final property has implications for the pricing and use of currency options. © 2001 John Wiley & Sons, Inc.     

Monetary policy and long‐term interest rates: Evidence from the U.S. economy

This paper addresses the ability of central banks to affect the structure of interest rates. We assess the causal relationship between the short‐term Effective Federal Funds Rate (FF) and long‐term interest rates associated with both public and private bonds and specifically, the 10‐Year Treasury Bond (GB10Y) and the Moody's Aaa Corporate Bond (AAA). To do this, we apply Structural Vector Autoregressive models to U.S. monthly data for the 1954–2018 period. Based on results derived from impulse response functions and forecast error variance decomposition, we find: a bidirectional relationship when GB10Y is considered as the long‐term rate and a unidirectional relationship that moves from short‐ to long‐term interest rates when AAA is considered. These conclusions show that monetary policy is able to permanently affect long‐term interest rates and the central bank has a certain degree of freedom in setting the levels of the short‐term policy rate.     

Benchmark tipping and the role of the swap market in price discovery

The author uses a high‐frequency data set to investigate the roles of the sterling swap and futures markets in price discovery at the short‐end of the sterling yield curve. Information flows between the futures and swap markets are found to be largely contemporaneous. Causal information flows are bidirectional, although the futures market dominates the information flow over the very short term. Thus, the futures market remains the primary locus of price discovery despite the increased use of swaps as a pricing benchmark and hedging instrument in recent years. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:981–1001, 2007