Financial integration and currency risk premium in CEECs: Evidence from the ICAPM

This paper aims to study the Central and Eastern European Countries' (CEECs) dynamics of financial integration in the euro area with the prospect of their integration into the European Monetary Union. Our empirical analysis is based, successively, on a MGARCH model with time-varying correlations, a state-space model and a Markov-switching model. The results show that financial integration (i) is not perfect but is increasing and (ii) is linked to currency stability. The growing financial integration in 2007–2009 seems to be rather the result of the shock propagated by the global crisis.     

International capital flows

The surge in international asset trade since the early 1990s has lead to renewed interest in models with international portfolio choice. We develop the implications of portfolio choice for both gross and net international capital flows in the context of a simple two-country dynamic stochastic general equilibrium (DSGE) model. We focus on the time-variation in portfolio allocation following shocks, and resulting capital flows. Endogenous time-variation in expected returns and risk, which are the key determinants of portfolio choice, affect capital flows in often subtle ways. The model is consistent with a broad range of empirical evidence. An additional contribution of the paper is to overcome the technical difficulty of solving DSGE models with portfolio choice by developing a broadly applicable solution method.     

Domestic productivity and variety gains from trade

We show theoretically and confirm empirically that domestic productivity has a significant impact on the demand for foreign varieties under the assumption that domestic and foreign varieties are imperfect substitutes. In particular, the demand for imported varieties is more elastic for countries with comparative advantage. For an average good facing a median trade barrier, doubling the importer–exporter relative export performance decreases the number of imported varieties by 17%. Our findings suggest that the variety gains estimates could be significantly biased if we ignore the substitutability between imported and domestic varieties.     

International real business cycles with endogenous markup variability

The aggregate impact of decisions made at the level of the individual firm has recently attracted a lot of attention in both the macro and trade literatures. We adapt the benchmark international real business cycle model to a game-theoretic environment to add a channel for the strategic interaction among domestic and foreign firms. We show how the sum of strategic pricing decisions made at the level of the individual firm can have significant effects on the volatility and cross country co-movement of GDP and its components. Specifically we show that the addition of this one channel for strategic interaction leads to a significant increase in the cross-country co-movement of production and investment, as well as a significant decrease in the volatility of investment and the trade balance over the benchmark IRBC model.     

Stock market correlations between China and its emerging market neighbors

We examine interlinkages of stock return behavior for China and three emerging market neighbors from the Asia Pacific region from November 1993 to July 2008. Results are based on a VAR model. Impulse responses and vector decomposition of VAR are also utilized. Evidence suggests that the aggregate markets are mostly not interrelated. However, we observe relations between China and the other markets when foreign investor returns are specifically accounted for. In addition, a shock originating in China is significantly felt in the other equity markets. Stock market characteristics and macroeconomic conditions of these countries may help explain the observed relations.     

Tariff wars in the Ricardian Model with a continuum of goods

This paper describes strategic tariff choices within the Ricardian framework of Dornbusch, Fischer, and Samuelson (1977) using CES preferences. The optimum tariff schedule is uniform across goods and inversely related to the import demand elasticity of the other country. In the Nash equilibrium of tariffs, larger economies apply higher tariff rates. Productivity adjusted relative size (≈ GDP ratio) is a sufficient statistic for absolute productivity advantage and the size of the labor force. Both countries apply higher tariff rates if specialization gains from comparative advantage are high and transportation cost is low. A sufficiently large economy prefers the inefficient Nash equilibrium in tariffs over free trade due to its quasi-monopolistic power on world markets. The required threshold size is increasing in comparative advantage and decreasing in transportation cost. I discuss the implications of the static Nash-equilibrium analysis for the sustainability and structure of trade agreements.     

Habit formation and fiscal transmission in open economies

In this paper we analyze the ability of an open economy version of the neoclassical model to account for the time-series evidence on fiscal policy transmission. Revisiting the evidence, we find that i) government spending raises output, while inducing a simultaneous decline of investment and the current account and ii) the responses of output and investment are more muted in more open economies while current account deficits tend to be larger. Turning to the model, we explore the role of habit formation for fiscal policy transmission. Specifically, we show that the model can account for the evidence if consumption behavior is characterized by habit formation and the terms of trade adjust endogenously.     

Does corporate governance risk at home affect investment choices abroad?

Disparity between control and ownership rights gives rise to the risk of tunneling by the controlling shareholder, and is prevalent in many emerging market economies and present in some developed countries. At the same time, international investors come from different countries whose home markets are characterized by varying degrees of control–ownership disparity. This paper studies whether this difference in investors' home countries affects their portfolio choice in an emerging market. It combines two unique data sets on ownership and control in business groups, and investor-stock level foreign investment in Korea. A key finding is that investors from low-disparity countries disfavor high-disparity stocks in Korea, but investors from high-disparity countries are indifferent. Moreover, investors from low-disparity countries became averse to disparity only after the Asian financial crisis. These results suggest that the nature of corporate governance in international investors' home countries affects their portfolio choice abroad, and therefore these investors should not be lumped together in the analyses of their portfolio choice.     

Regional financial integration in the GCC

We investigate the extent of regional financial integration in the member countries of the Gulf Cooperation Council. Interest rate data show that convergence exists and that interest rate differentials are relatively short-lived—especially relative to other unified currency area and comparable to those of the Euro Area post 1999. Equity data using cross-listed stocks confirm that stock markets are fairly integrated compared to other emerging market regions, although price equalization is hampered by market illiquidity. The limited volume data available suggests that intra-GCC capital flows are sizeable.     

International transmission of transitory and persistent monetary shocks under imperfect information

We analyze the transmission of monetary shocks in a new open-economy macroeconomics model with one-period nominal contracts and imperfect information. Shocks may have transitory and persistent components that can be disentangled only through the accumulation of information over time. As a consequence, the responses to shocks are significantly altered compared with the case of full information. There are persistent effects on international relative prices, and delayed exchange-rate overshooting is possible following a persistent shock. In some cases, there are (ex post) excess returns as a positive interest rate spread is accompanied by an appreciating currency (or vice versa). Lastly, it is demonstrated that staggering reinforces persistence.     

Geographical focus in emerging markets and hedge fund performance

Emerging market hedge funds are an asset class which does not seem to outperform the market benchmarks. We hypothesize that the poor aggregate performance may be due to lack of focus of these funds. Our results suggest that a portfolio of emerging market hedge funds, which have geographical focuses, outperform their underlying stock markets. Hedge funds which focus on Eastern Europe appear to have the best outperformance. However, we also find that the performance of all emerging market hedge funds has reduced after the start of the 2008 Crisis.     

Foreign equity flows and the “Size Bias”: Evidence from an emerging stock market

This paper examines foreign investors' equity-level transactions in an emerging stock market, the Istanbul Stock Exchange, for the period 1997–2008 to derive insights into the debate on information asymmetries between domestic and foreign investors and the home bias puzzle. The analysis suggests two important findings. First, foreign investors do not consider the market portfolio of domestic securities as predicted by standard theories of international portfolio diversification. Second, the firm's size and the expected return are central to explain foreign investors' equity trades. The results are consistent with models based upon the hypothesis of differential information between foreign and domestic investors.     

Exporting out of poverty: Provincial poverty in Vietnam and U.S. market access

Can a developing country reduce poverty by gaining increased market access to a large, rich country? The 2001 U.S.–Vietnam Bilateral Trade Agreement (BTA) provides an excellent opportunity to examine this question as, unlike other bilateral trade agreements, the U.S. tariff cuts were not influenced by Vietnamese industries. Using variation in the structure of the labor force across provinces prior to the trade agreement, I construct provincial measures of U.S. tariffs. To address concerns over confounding trends between changes in provincial poverty and changes in provincial tariffs I follow two approaches: controlling for trends based on observable initial conditions and differencing away time invariant trends using pre-BTA data. I find that provinces that were more exposed to the U.S. tariff cuts experienced faster decreases in poverty between 2002 and 2004. Additionally, I document that the movement of workers across provinces is limited in scale, particularly for those with low levels of education. Finally, I show that the most exposed provinces experienced faster wage growth for workers with low levels of education, but not for highly educated workers.     

Foreign subsidization and excess capacity

The U.S. steel industry has long held that foreign subsidization and excess capacity has led to its long-run demise, yet no one has formally examined this hypothesis. In this paper, we incorporate foreign subsidization considerations into a model based on Staiger and Wolak's (1992) cyclical dumping framework and illustrate testable implications of both cyclical excess capacity and structural excess capacity stemming from foreign subsidization. We then use detailed product- and foreign country-level data on steel exports to the U.S. market to estimate these excess capacity effects. While the full sample results provide evidence of both cyclical and structural excess capacity effects for exports to the U.S. market, these effects are confined to such a narrow range of country–product combinations that it is unlikely that such effects were a significant factor in the fortunes of U.S. steel firms over the past decades.     

The impact of trade liberalization on productivity: Evidence from India's formal and informal manufacturing sectors

Despite a large literature investigating the impacts of trade on firm productivity, there is almost no evidence on how small firms react to trade liberalization. Using a unique dataset of firm-level surveys that are representative of the entire Indian manufacturing industry, I show that India's unilateral reduction in final goods tariffs increased the average productivity of small, informal firms, which account for 80% of Indian manufacturing employment but have been excluded from previous studies. In contrast, the increase in productivity among larger, formal firms was driven primarily by the concurrent reduction in input tariffs. By examining the effect of the tariff liberalization on the distributions of productivity and firm size, I find evidence consistent with the exit of the smallest, least productive firms from the informal sector. In addition, I find that although the decline in final goods tariffs did not significantly impact average formal sector productivity, it did increase productivity among the top quantiles of the distribution.     

The specific factors continuum model, with implications for globalization and income risk

This paper embeds the specific factors model in the goods continuum approach of Dornbusch et al. (1977, 1980) and applies it to analyze the effect of globalization on income risk. Globalization amplifies sector specific income risk induced by idiosyncratic sectoral technology shocks, but tends to reduce income risk to both mobile and immobile factors induced by aggregate technology shocks that differ by country. Aggregate risk bears most heavily on the poorest specific factors.     

Who's afraid of a globalized world? Foreign Direct Investments, local knowledge and allocation of talents

We study the distributional effects of globalization within a model of heterogeneous agents where both managerial talent and knowledge of the local economic environment are required in order to become a successful entrepreneur. Agents willing to set up a firm abroad incur a learning cost that depends on how different the foreign and domestic entrepreneurial environments are. In this context, we show that globalization fosters FDI and raises wages, output and productivity. However, not everybody wins. The steady state relationship between globalization and income is U-shaped: high- and low-income agents are better off in a globalized world, while middle-income agents (domestic entrepreneurs) are worse off. Thus, consistently with recent empirical evidence, the model predicts globalization to increase inequality at the top of the income distribution while decreasing it at the bottom.     

Exchange rate exposure: A nonparametric approach

The typical conclusion reached when researchers examine exchange rate exposure is that only a few firms are exposed. This finding is puzzling since institutional knowledge and theory suggests a larger effect. In this paper, we compare results obtained using a linear approach with those from nonlinear and nonparametric models. Among firms that don't have a linear exposure, we find that a considerable proportion of these are exposed when nonlinear or nonparametric models are used. This exposure is most striking when a nonparametric model is used. We also find that firms' hedging activities decrease linear exposure but don't affect nonparametric exposure.