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1. International Financial Spillovers to Emerging Market Economies: How Important Are Economic Fundamentals?

Author:
Shaghil Ahmed, Brahima Coulibaly, and Andrei Zlate
Publication Date:
05-2015
Content Type:
Commentary and Analysis
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We assess the importance of economic fundamentals in the transmission of international shocks to financial markets in various emerging market economies (EMEs). Our analysis covers the so-called taper-tantrum episode of 2013 and six earlier episodes of severe EME-wide financial stress since the mid-1990s. Cross-country regressions lead us to the following results: (1) EMEs with relatively better economic fundamentals suffered less deterioration in financial markets during the 2013 taper-tantrum episode. (2) Differentiation among EMEs set in quite early and persisted throughout this episode. (3) Controlling for economic fundamentals, we also find that, during the taper tantrum, financial conditions deteriorated more in those EMEs that had earlier experienced larger private capital inflows and greater exchange rate appreciation. (4) For earlier episodes, we find little evidence of investor differentiation across EMEs being explained by differences in their relative vulnerabilities during EME crises of the 1990s and early 2000s. (5) That said, differentiation across EMEs based on fundamentals does not appear to be unique to the 2013 episode. Differences in economic fundamentals played a role in explaining the heterogeneous EME financial market responses during the global financial crisis of 2008, and the role of fundamentals appeared to progressively increase through the European crisis in 2011 and subsequently the 2013 taper tantrum.
Topic:
Economics, Emerging Markets, Markets, Exchange Rate Policy, Fiscal Policy, and Economic Crisis
Political Geography:
Global Focus

2. The Liquidity Effects of Official Bond Market Intervention

Author:
Michiel De Pooter, Robert F Martin, and Seth Pruitt
Publication Date:
07-2015
Content Type:
Commentary and Analysis
Institution:
Board of Governors of the Federal Reserve System
Abstract:
To "ensure depth and liquidity," the European Central Bank in 2010 and 2011 repeatedly intervened in sovereign debt markets through its Securities Markets Programme. These purchases provide a unique natural experiment for testing the effects of large-scale asset purchases on risk premia arising from liquidity concerns. To explore how official intervention influences liquidity premia, we develop a search-based asset-pricing model. Consistent with our model's predictions, we find statistically and economically significant stock and flow effects on sovereign bonds' liquidity premia in response to official purchases.
Topic:
Markets, Bonds, Banking, and Liquidity
Political Geography:
Europe

3. Uncovered Equity Parity and Rebalancing in International Portfolios

Author:
Stephanie E. Curcuru, Charles P. Thomas, Francis E. Warnock, and Jon Wongswan
Publication Date:
05-2014
Content Type:
Commentary and Analysis
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Portfolio rebalancing is a key driver of the Uncovered Equity Parity (UEP) condition. According to UEP, when foreign equity holdings outperform domestic holdings, domestic investors are exposed to higher exchange rate exposure and hence repatriate some of the foreign equity to decrease their exchange rate risk. By doing so, foreign currency is sold, leading to foreign currency depreciation. We examine the relationship between U.S. investors' portfolio reallocations and returns and find some evidence consistent with UEP: Portfolio shifts are related to past returns in the underlying equity markets. But we argue that a motive other than reducing currency risk exposure is likely behind this rebalancing. In particular, U.S. investors may be exploiting mean reversion in underlying equity markets, rebalancing away from equity markets that recently performed well and moving into equity markets market just prior to relatively strong performance. Such behavior suggests tactical reallocations to increase returns rather than reduce risk.
Topic:
Economics, Markets, Risk, International Portfolios, and Equity
Political Geography:
North America and United States of America

4. U.S. Unconventional Monetary Policy and Transmission to Emerging Market Economies

Author:
David Bowman, Juan M. Londono, and Horacio Sapriza
Publication Date:
06-2014
Content Type:
Commentary and Analysis
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We investigate the effects of U.S. unconventional monetary policies on sovereign yields, foreign exchange rates, and stock prices in emerging market economies (EMEs), and we analyze how these effects depend on country-specifc characteristics. We find that, although EME asset prices, mainly those of sovereign bonds, responded strongly to unconventional monetary policy announcements, these responses were not outsized with respect to a model that takes into account each country's time-varying vulnerability to U.S. interest rates affected by monetary policy shocks.
Topic:
Economics, Emerging Markets, Foreign Exchange, Markets, Monetary Policy, Exchange Rate Policy, Interest Rates, and Stock Markets
Political Geography:
North America and United States of America

5. The Domestic and International Effects of Interstate U.S. Banking

Author:
Matteo Cacciatore, Fabio Ghironi, and Viktors Stebunovs
Publication Date:
08-2014
Content Type:
Commentary and Analysis
Institution:
Board of Governors of the Federal Reserve System
Abstract:
This paper studies the domestic and international effects of national bank market integration in a two-country, dynamic, stochastic, general equilibrium model with endogenous producer entry. Integration of banking across localities reduces the degree of local monopoly power of financial intermediaries. The economy that implements this form of deregulation experiences increased producer entry, real exchange rate appreciation, and a current account deficit. The foreign economy experiences a long-run increase in GDP and consumption. Less monopoly power in financial intermediation results in less volatile business creation, reduced markup countercyclicality, and weaker substitution effects in labor supply in response to productivity shocks. Bank market integration thus contributes to moderation of firm-level and aggregate output volatility. In turn, trade and financial ties allow also the foreign economy to enjoy lower GDP volatility in most scenarios we consider. These results are consistent with features of U.S. and international fluctuations after the United States began its transition to interstate banking in the late 1970s.
Topic:
Markets, Monopoly, Fiscal Policy, Banking, and Interstate Cooperation
Political Geography:
North America and United States of America

6. Returns to Active Management: The Case of Hedge Funds

Author:
Maziar Kazemi and Ergys Islamaj
Publication Date:
08-2014
Content Type:
Commentary and Analysis
Institution:
Board of Governors of the Federal Reserve System
Abstract:
Do more active hedge fund managers generate higher returns than their less active peers? We attempt to answer this question. Using Kalman Filter techniques, we estimate the risk exposure dynamics of a large sample of live and dead equity long-short hedge funds. These estimates are then used to develop a measure of activeness for each hedge fund. Our results show that there exists a nonlinear relationship between activeness and performance. Using raw returns as a measure of performance, it is found that more active funds outperform the less active ones. However, when risk adjusted returns are used to measure performance, we find the opposite results; that is, activeness is inversely related to returns. Still, we find that a few very active managers outperform the moderately active funds and generate higher returns. We conclude that the most active managers use their skills to manage the riskiness of their portfolios and are, therefore, able to provide higher risk adjusted returns. Finally, we find that compared to the least active managers, the most active managers are less homogeneous and, therefore, due diligence is far more important when selecting an active manager.
Topic:
Markets, Risk, Business Management, and Stock Markets
Political Geography:
North America and United States of America

7. Estimating U.S. Cross-Border Securities Positions: New Data and New Methods

Author:
Carol C. Bertaut
Publication Date:
08-2014
Content Type:
Commentary and Analysis
Institution:
Board of Governors of the Federal Reserve System
Abstract:
The role of capital flows in the buildup to the global financial crisis and the potential vulnerabilities posed by capital flows to emerging market economies highlight the importance of reliable and timely measures of cross-border investment activity to better monitor developments as they unfold. We present new monthly estimates of U.S. cross-border securities investment, combining information from detailed annual Treasury International Capital (TIC) surveys with new information from the TIC form SLT. We also show how changes in the new monthly data can be decomposed into flows, estimated valuation changes, and a residual "gap". These decompositions can provide a richer and timelier view of developments in both foreign portfolio investment in the U.S. and U.S. portfolio investment abroad than available from transactions data or survey data alone. Data on cross-border holdings through December 2013, by country, are available for download; we also provide advice on how to construct estimates going forward. These data can be combined with the existing Bertaut-Tryon monthly estimates of securities holdings (now updated through 2011) to generate consistent monthly time series of positions.
Topic:
Emerging Markets, Markets, Global Financial Crisis, Capital Flows, and Investment
Political Geography:
Global Focus

8. Generating Options-Implied Probability Densities to Understand Oil Market Events

Author:
Deepa Dhume Datta, Juan M. Londono, and Landon J. Ross
Publication Date:
10-2014
Content Type:
Commentary and Analysis
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We investigate the informational content of options-implied probability density functions (PDFs) for the future price of oil. Using a semiparametric variant of the methodology in Breeden and Litzenberger (1978), we investigate the fit and smoothness of distributions derived from alternative PDF estimation methods, and develop a set of robust summary statistics. Using PDFs estimated around episodes of high geopolitical tensions, oil supply disruptions, and macroeconomic data releases, we explore the extent to which oil price movements are expected or unexpected, and whether agents believe these movements to be persistent or temporary.
Topic:
Energy Policy, International Trade and Finance, Markets, Oil, Economic Theory, and Models
Political Geography:
Global Focus

9. A Robust Neighborhood Truncation Approach to Estimation of Integrated Quarticity

Author:
Torben G. Andersen, Dobrislav Dobrev, and Ernst Schaumburg
Publication Date:
04-2013
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
We provide a first in-depth look at robust estimation of integrated quarticity (IQ) based on high frequency data. IQ is the key ingredient enabling inference about volatility and the presence of jumps in financial time series and is thus of considerable interest in applications. We document the significant empirical challenges for IQ estimation posed by commonly encountered data imperfections and set forth three complementary approaches for improving IQ based inference. First, we show that many common deviations from the jump diffusive null can be dealt with by a novel filtering scheme that generalizes truncation of individual returns to truncation of arbitrary functionals on return blocks. Second, we propose a new family of efficient robust neighborhood truncation (RNT) estimators for integrated power variation based on order statistics of a set of unbiased local power variation estimators on a block of returns. Third, we find that ratio-based inference, originally proposed in this context by Barndorff-Nielsen and Shephard (2002), has desirable robustness properties in the face of regularly occurring data imperfections and thus is well suited for empirical applications. We confirm that the proposed filtering scheme and the RNT estimators perform well in our extensive simulation designs and in an application to the individual Dow Jones 30 stocks.
Topic:
Economics, Markets, Models, and Stock Markets
Political Geography:
Global Focus

10. Firm Characteristics and Em

Author:
Leonid Kogan and Mary Tian
Publication Date:
12-2012
Content Type:
Working Paper
Institution:
Board of Governors of the Federal Reserve System
Abstract:
"A three-factor model using the standardized-unexpected-earnings and cashflow-to-price factors explains 15 well-known asset pricing anomalies." Our data-mining experiment provides a backdrop against which such claims can be evaluated. We construct three-factor linear pricing models that match return spreads associated with as many as 15 out of 27 commonly used firm characteristics over the 1971-2011 sample. We form target assets by sorting firms into ten portfolios on each of the chosen characteristics and form candidate pricing factors as long-short positions in the extreme decile portfolios. Our analysis exhausts all possible 351 three-factor models, consisting of two characteristic-based factors in addition to the market portfolio. 65% of the examined factor models match a larger fraction of the target return cross-sections than the CAPM or the Fama-French three-factor model. We find that the relative performance of the complete set of three-factor models is highly sensitive to the sample choice and the factor construction methodology. Our results highlight the challenges of evaluating empirical factor models.
Topic:
Economics, Markets, Economic Theory, Data, and Models
Political Geography:
Global Focus