Forecasting Emerging Market Exchange Rates from Foreign Equity Options

The use of derivatives to infer future exchange rates has long been a subject of interest in the international finance literature. With the recent currency crises in Mexico, Southeast Asia, and Brazil, work on exchange rate expectations in emerging markets is of particular interest. For some emerging markets, foreign equity options are the only liquid exchange‐traded derivatives with currency information embedded in their prices. Given that emerging markets sometimes undergo currency realignment with discrete jumps in their exchange rate, estimation of risk‐neutral probability density functions from foreign equity option data provides valuable evidence concerning market expectations. To illustrate the use of foreign equity options in estimating market beliefs, we consider Telmex options around the 1994 peso devaluation and find evidence that markets anticipated the change in the Mexican government's foreign exchange policy.     

Are the Best Small Companies the Best Investments?

Previous research finds that large companies previously judged to be excellent growth companies have subsequently been poor investments. We examine small companies selected by Business Week on the basis of multiple criteria used in annual articles featuring highly rated growth companies. We study the investment performance over the three years before eleven annual Business Week publications and the three years after publication. We find positive excess returns in the pre‐publication period, but negative excess returns in the post‐publication period. This reversal in investment performance appears to be due to a mean‐reversion tendency in operating performance, in which the earnings and the past rates of return on capital of such companies subsequently decrease significantly.     

Forms of Foreign Investment Liberalization and Risk in Emerging Stock Markets

I examine the effect of different forms of foreign investment liberalization on risk in emerging equity markets, including international cross-listings and closed-end country funds, and in the domestic equity market as foreign investment restrictions are eliminated. I find that in Latin American markets volatility declines significantly with different forms of foreign investment liberalization, and in Asian markets volatility does not increase significantly. Volatility is driven by domestic factors in South America, but the transmission of volatility from the United States to Mexico increases after liberalization. The market risk exposure increases in Argentina after liberalization, in Chile with an index of American Depositary Receipts, and in Thailand with greater foreign ownership, reducing the diversification benefits of these markets.     

ALL THINGS CONSIDERED,TAXES DRIVE THE JANUARY EFFECT

The multitude of explanations for the January effect leaves the reader confused about its primary cause(s): is it tax‐loss selling, window dressing, information, bid‐ask bounce, or a combination of these causes? The confusion arises, in part, because evidence has generally been presented in support of a particular hypothesis though the same evidence may be consistent with another hypothesis. Furthermore, prior work does not adequately control for the bid‐ask bounce. In this article we try to disentangle different explanations of the January effect and identify its primary cause. We find that tax‐related selling is the most important cause, overshadowing other explanations.     

On the Statistical Significance of Event Effects on Unsystematic Volatility

We develop a method for determining the significance of the effect of a certain event (stock split, corporate restructuring, change in regulation, etc.) on unsystematic volatility of asset returns. Simulations show that the suggested tests reject the true null hypothesis of no effect on volatility at appropriate levels, whereas the rejection rates of a false null hypothesis increase with the magnitude of the effect. An application of the method to corporate spin‐offs reveals statistically significant and long‐lasting estimated increases in unsystematic volatility of parent companies' returns.     

Competitive and Information Effects of Cross-Border Stock Listings

We examine the effect of 269 cross‐border listings on rivals in the listing and domestic markets and find that U.S. rivals experience significant gains whereas domestic rivals do not. Both competitive and information effects are important in explaining the reaction of U.S. rivals. Regarding the competitive effects, the reaction of rivals is less favorable when listings originate in developed countries and more favorable when listing firms do not have prior operating presence in the United States. Regarding the information effects, the reaction is less favorable when listings are combined with equity offerings and more favorable when the listing is the first to occur within an industry.     

German Exchange Rate Exposure at DAX and Aggregate Levels, International Trade and the Role of Exchange Rate Adjustment Costs

Abstract. This article analyses value changes of German stock market companies in response to movements of the US dollar. The approach followed in this work extends the standard means of measuring exchange rate exposure in several ways, e.g. by using multifactor modelling instead of augmented Capital Asset Pricing Model, application of moving window panel regressions and orthogonalization of overall market risk vis-à-vis currency risk. A further innovation lies in testing the theoretical implications of exchange rate adjustment costs (hedging costs) for firm values and economic exposure. Based on time series and panel data of German Deutsche Aktien Xchange companies, Deutsche Mark/dollar rates and macroeconomic factors, we find a rather unstable, time-variant exposure of German stock market companies. Dollar sensitivity is positively affected by the ratio of exports/gross domestic product (GDP) and negatively affected by imports/GDP. Moreover, as expected from theoretical findings, firm values and exchange rate exposure are significantly reduced by adjustment costs depending on the distance of the exchange rate from the expected long-run mean.     

Does the Choice between Wage Inequality and Unemployment Affect Productivity Growth?

Abstract. We present a non-scale continuous-time overlapping-generations growth model that provides an explanation for why economies with relative wage rigidity feature higher unemployment, but not slower productivity growth, than economies with flexible wages. The compression of the wage distribution associated with relative wage rigidity slows down human capital accumulation and growth ceteris paribus . But unemployment among the low-skilled workers strengthens the incentives to invest in human capital and, hence, growth. The two effects are offsetting, and growth is independent of the prevailing degree of relative wage rigidity. This knife-edge result is robust with respect to some modifications of the model.