Exchange rate predictability and dynamic Bayesian learning

We consider how an investor in the foreign exchange market can exploit predictive information by means of flexible Bayesian inference. Using a variety of vector autoregressive models, the investor is able, each period, to learn about important data features. The developed methodology synthesizes a wide array of established approaches for modeling exchange rate dynamics. In a thorough investigation of monthly exchange rate predictability for 10 countries, we find that using the proposed methodology for dynamic asset allocation achieves substantial economic gains out of sample. In particular, we find evidence for sparsity, fast model switching, and exploitation of the exchange rate cross-section.     

Forecasting with High‐Dimensional Panel VARs

This paper develops methods for estimating and forecasting in Bayesian panel vector autoregressions of large dimensions with time‐varying parameters and stochastic volatility. We exploit a hierarchical prior that takes into account possible pooling restrictions involving both VAR coefficients and the error covariance matrix, and propose a Bayesian dynamic learning procedure that controls for various sources of model uncertainty. We tackle computational concerns by means of a simulation‐free algorithm that relies on analytical approximations to the posterior. We use our methods to forecast inflation rates in the eurozone and show that these forecasts are superior to alternative methods for large vector autoregressions.     

Large time-varying parameter VARs

In this paper, we develop methods for estimation and forecasting in large time-varying parameter vector autoregressive models (TVP-VARs). To overcome computational constraints, we draw on ideas from the dynamic model averaging literature which achieve reductions in the computational burden through the use forgetting factors. We then extend the TVP-VAR so that its dimension can change over time. For instance, we can have a large TVP-VAR as the forecasting model at some points in time, but a smaller TVP-VAR at others. A final extension lies in the development of a new method for estimating, in a time-varying manner, the parameter(s) of the shrinkage priors commonly-used with large VARs. These extensions are operationalized through the use of forgetting factor methods and are, thus, computationally simple. An empirical application involving forecasting inflation, real output and interest rates demonstrates the feasibility and usefulness of our approach.     

Risk appetite,carry trade and exchange rates

Using exchange rate data from four different countries (time zones), we examine the relationship between the Yen exchange rate against major currencies (i.e. USD/JPY, EUR/JPY, GBP/JPY, AUD/JPY and NZD/JPY) and measures of risk appetite (i.e. the S&P500 index, Dow Jones Industrial Average index and the VIX index). Our results show that the equity indexes, especially the Dow Jones Industrial Average, play a more important role in the determination of the Yen cross rates than VIX. The popular carry-trade currencies, i.e. NZD/JPY, AUD/JPY and GBP/JPY, are more affected by the US equity market than USD/JPY and EUR/JPY. While the long-term relationships are consistent across the four different time zones, the short-term dynamics are different. We find that the response of NZD/JPY, AUD/JPY and GBP/JPY to changes in the US stock market is much greater in the New Zealand and Australian zones than in the UK or US. Although the short-term relationship between exchange rates and the equity index is quite strong, the error correction speed is very sluggish. We also find evidence of asymmetric adjustment in the response of exchange rates to changes in global risk aversion. Carry trade currencies tend to appreciate gradually when conditions are favorable but fall sharply when market risk increases.     

A jump diffusion model for VIX volatility options and futures

Volatility indices are becoming increasingly popular as a measure of market uncertainty and as a new asset class for developing derivative instruments. Although jumps are widely considered as a salient feature of volatility, their implications for pricing volatility options and futures are not yet fully understood. This paper provides evidence indicating that the time series behaviour of the VIX index is well approximated by a mean reverting logarithmic diffusion with jumps. This process is capable of capturing stylized facts of VIX dynamics such as fast mean-reversion at higher levels, level effects of volatility and large upward movements during times of market stress. Based on the empirical results, we provide closed-form valuation models for European options written on the spot and forward VIX, respectively.     

Efficiency and productivity growth in the banking industry of Central and Eastern Europe

We employ the directional technology distance function and provide estimates of bank efficiency and productivity change across Central and Eastern European (CEE) countries and across banks with different ownership status for the period 1998–2003. Our results demonstrate the strong links of competition and concentration with bank efficiency. They also show that productivity for the whole region initially declined but has improved more recently with further progress on institutional and structural reforms. Input-biased technical change has been consistently positive throughout the entire period suggesting that the reforms have induced favorable changes in relative input prices and input mix. However we find evidence of diverging trends in productivity growth patterns across banking industries and that foreign banks outperform domestic private and state-owned banks both in terms of efficiency and productivity gains. Overall, we find that productivity change in CEE is driven by technological change rather than efficiency change.     

Minority shareholders’ wealth effects and stock market development: Evidence from increase-in-ownership M&As

This paper examines, using a global M&A data set, the relationship between the target firm’s minority shareholders’ returns and a country’s stock market development in deals in which large shareholders increase their ownership stakes. For the purpose of this study, we use two measures of stock market development: (1) turnover over GDP, and (2) turnover over market capitalization. We provide evidence supporting the view that minority shareholders in target firms gain significantly more in countries with high stock market development than their counterparts in less-developed markets. Our results are robust to several firm and deal characteristics and provide evidence to policy makers that the degree of stock market development is a key determinant in improving minority shareholders’ welfare.