Which bank is the “central” bank?

Liquidity flows through a financial network cannot be accurately described using external processing constraints alone. Behavioral aspects of participants also matter. A method similar to Google's PageRank procedure is used to produce a ranking of participants in the Canadian Large Value Transfer System in terms of their daily liquidity holdings. Accounting for differences in banks’ processing speeds is essential for explaining why observed distributions of liquidity differ from the initial distributions, which are determined by the credit limits selected by banks. Delay tendencies of banks are unobservable in the data and are estimated using a Markov model.     

International evidence on fiscal solvency: Is fiscal policy “responsible”?

We conduct a cross-country empirical analysis of fiscal solvency based on dynamic stochastic general equilibrium conditions. The results show evidence of fiscal solvency, in the form of a robust positive conditional response of the primary balance to changes in public debt, in panels for emerging and industrial economies and in a combined panel. Emerging economies show a stronger response and hence converge to lower mean debt-output ratios, as observed in the data. The results are weaker for countries with debt ratios exceeding panel means and medians. Hence, we can separate countries where fiscal solvency holds from those where it remains in doubt.     

Is “voting with your feet” an effective mutual fund governance mechanism?

Investors in open-end mutual funds can vote with their feet by withdrawing assets from or adding assets to these funds. This paper assesses the effectiveness of this market discipline mechanism by investigating whether voting with the feet prevents the abusive practices that led to the 2003-2004 trading scandals. The research results indicate that funds with higher flow sensitivity—that is, a higher density of vigilant clients—have lower arbitrage potential and fewer abnormal flows, which in turn implies less opportunistic trading. As a result, these funds have a lower probability of being implicated in scandals. These findings suggest that investor ability to withdraw assets from or add assets to the funds is an effective mutual fund governance mechanism. In funds with less sophisticated investors who cannot use this option, other means of governance are especially important.     

A happy “half way-house”? Medium term inflation targeting in New Zealand

The 2002 Policy Targets Agreement (PTA) between the government and central bank of New Zealand asks the central bank to target inflation “over the medium term” rather than over an annual target. Delegating such a medium term objective to the central bank shifts inflation targeting towards a “halfway-house” between inflation targeting and price level targeting. We show empirically that this helps time consistent policy approximate the first-best commitment policy even when the government asks the central bank to weight output stabilisation differently to society. We estimate the New Zealand economy with a small open economy DSGE model and show that the happiest halfway house is located around a two year averaging horizon at most, which leads to mild improvements in monetary policy efficiency.     

Sovereign ceilings “lite”? The impact of sovereign ratings on corporate ratings

Although credit rating agencies have gradually moved away from a policy of never rating a corporation above the sovereign (the ‘sovereign ceiling’), it appears that sovereign credit ratings remain a significant determinant of corporate credit ratings. We examine this link using data for advanced and emerging economies over the period of 1995–2009. Our main result is that a sovereign ceiling continues to affect the rating of corporations. The results also suggest that the influence of a sovereign ceiling on corporate ratings remains particularly significant in countries where capital account restrictions are still in place and with high political risk.     

Does the “Bund” dominate price discovery in Euro bond futures? Examining information shares

This paper examines the relative information shares of the Bund, i.e. the 10-year Euro bond future contract on German sovereign debt, versus two futures with shorter maturity. We find that the Bund is most important but does not dominate price discovery. The other contracts also have relevant - and at many days even higher - information shares. In examining determinants of information shares, we add order flow measures to market state variables and macroeconomic news. More order flow in a contract consistently increases this contract’s information share.     

Analyzing the German accounting triad — “Accounting Premium” for IAS/IFRS and U.S. GAAP vis-à-vis German GAAP?

This paper critically examines the impact of voluntary adoption of Internationally Accepted Accounting Principles (IAAP, i.e., IAS/IFRS and U.S. GAAP) on the cost of equity capital in Germany. We find that (1) overall cost of equity-capital estimates in the Capital Asset Pricing Model (CAPM) for companies applying IAAP are significantly lower compared to those applying German GAAP, (2) an enhanced multi-factor model which incorporates the accounting-regime differences (called “GM model”) absorbs the cost of equity-capital differences, and (3) changes of the institutional background in Germany and of the accounting standards lead to different cost of equity capital effects for subperiods of the 1998–2004 voluntary-adoption period, while particularly controlling for effects like self-selection, cross-listing, and New Market (Neuer Markt) listing.The central thesis advanced in this paper is that changes in the accounting standards and the institutional infrastructure can influence the impact of applying IAAP. Therefore, we suggest incorporating an accounting factor into the cost of equity-capital analysis.     

Statistical arbitrage in the Black–Scholes framework

In this study, we prove the existence of statistical arbitrage opportunities in the Black–Scholes framework by considering trading strategies that consist of borrowing at the risk-free rate and taking a long position in the stock until it hits a deterministic barrier level. We derive analytical formulas for the expected value, variance and probability of loss for the discounted cumulative trading profits. The statistical arbitrage condition is derived in the Black–Scholes framework, which imposes a constraint on the Sharpe ratio of the stock. Furthermore, we verify our theoretical results via extensive Monte Carlo simulations.     

Comparison of Black–Scholes Formula with Fractional Black–Scholes Formula in the Foreign Exchange Option Market with Changing Volatility

In this paper, the authors discuss the fractional option pricing with Black–Scholes formula, deduce the Fractional Black–Scholes formula, show the empirical results by using China merchants bank foreign exchange call option price, and find when the volatility is smaller, the asymptotic mean squared error of Fractional Black–Scholes is bigger than the Traditional Black–Scholes’, while the volatility is bigger—the market mechanism has a full play, the result is reverse. Namely when the market mechanism is given a full scope, the estimating effect of Fractional Black–Scholes is better than Traditional Black–Scholes’.     

A Black–Litterman approach to correlation stress testing

Correlation stress testing is motivated by a well-known phenomenon: correlations change under financial crises. The adjustment of correlation matrices may be required to evaluate the potential impact of these changes. Very often, some correlations are explicitly adjusted (core correlations), with the remainder left unspecified (peripheral correlations), although it would be more natural for both core correlations and peripheral correlations to vary. However, most existing methods ignore the potential change in peripheral correlations. In this paper, we propose a Black–Litterman approach to correlation stress testing in which the stress impact on the core correlations is transmitted to the peripheral correlations through the dependence structure of the empirical correlations.