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22. A Solution to the Default Risk-Business Cycle Disconnect
- Author:
- Enrique G. Mandoza and Vivian Z. Yue
- Publication Date:
- 03-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- Models of business cycles in emerging economies explain the negative correlation between country spreads and output by modeling default risk as an exogenous interest rate on working capital. Models of strategic default explain the cyclical properties of sovereign spreads by assuming an exogenous output cost of default with special features, and they underestimate debt-output ratios by a wide margin. This paper proposes a solution to this default risk-business cycle disconnect based on a model of sovereign default with endogenous output dynamics. The model replicates observed V-shaped output dynamics around default episodes, countercyclical sovereign spreads, and high debt ratios, and it also matches the variability of consumption and the countercyclical fluctuations of net exports. Three features of the model are key for these results: (1) working capital loans pay for imported inputs; (2) imported inputs support more efficient factor allocations than when these inputs are produced internally; and (3) default on the foreign obligations of firms and the government occurs simultaneously.
- Topic:
- Economics, International Trade and Finance, and Markets
23. Predicting Cycles in Economic Activity
- Author:
- Jane Haltmaier
- Publication Date:
- 04-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- Predicting cycles in economic activity is one of the more challenging but important aspects of economic forecasting. This paper reports the results from estimation of binary probit models that predict the probability of an economy being in a recession using a variety of financial and real activity indicators. The models are estimated for eight countries, both individually and using a panel regression. Although the success of the models varies, they are all able to identify a significant number of recessionary periods correctly.
- Topic:
- Economics and Markets
24. Emerging Market Business Cycles Revisited: Learning about the Trend
- Author:
- Emine Boz, Christian Daude, and Ceyhun Bora Durdu
- Publication Date:
- 04-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- The data reveal that emerging markets do not differ from developed countries with regards to the variance of permanent TFP shocks relative to transitory. They do differ, however, in the degree of uncertainty agents face when formulating expectations. Based on these observations, we build an equilibrium business cycle model in which the agents cannot perfectly distinguish between the permanent and transitory components of TFP shocks. When formulating expectations, they assign some probability to TFP shocks being permanent even when they are purely transitory. This is sufficient for the model to produce "permanent-like" effects in response to transitory shocks. The imperfect information model calibrated to Mexico predicts a higher variability of consumption relative to output and a strongly negative correlation between the trade balance and output, without the predominance of trend shocks. The same model assuming perfect information and calibrated to Canada accounts for developed country business cycle regularities. The estimated relative variance of trend shocks in these two models is similar.
- Topic:
- Economics, Emerging Markets, and Markets
- Political Geography:
- Canada and Mexico
25. Competitive Search Equilibrium in a DSGE Model
- Author:
- David M. Arseneau and Sanjay K. Chugh
- Publication Date:
- 04-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- We show how to implement a competitive search equilibrium in a fully-specified DSGE environment. Competitive search, an equilibrium concept well-understood in labor market theory, offers an alternative to the commonly-used Nash bargaining in search-based macro models. Our simulation-based results show that business cycle fluctuations under competitive search equilibrium are virtually identical to those under Nash bargaining for a broad range of calibrations of Nash bargaining power. We also prove that business cycle fluctuations under competitive search equilibrium are exactly identical to those under Nash bargaining restricted to the popularly-used Hosios condition for search efficiency. This latter result extends the efficiency properties of competitive search equilibrium to a DSGE environment. Our results thus provide a foundation for researchers interested in studying business cycle fluctuations using search-based environments to claim that the sometimes-awkward assumption of bargaining per se does not obscure interpretation of results.
- Topic:
- Economics and Markets
26. Why Do U.S. Cross-Listings Matter?
- Author:
- Francis E. Warnock, John Ammer, Sara B. Holland, and David C. Smith
- Publication Date:
- 05-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- This paper investigates the underlying determinants of home bias using a comprehensive sample of U.S. investor holdings of foreign stocks. We document that U.S. cross-listings are economically important, as U.S. ownership in a foreign firm roughly doubles upon cross-listing in the United States. We explore the cross-sectional variation in this "cross-listing effect" and show that increases in U.S. investment are largest in firms from weak accounting backgrounds and in firms that are otherwise informationally opaque, indicating that U.S. investors value the improvements in disclosure associated with cross-listing. We confirm that relative equity valuations rise for cross-listed stocks, and provide evidence suggesting that valuation increases are due in part to increases in U.S. shareholder demand and in part to the fact that the equities become more attractive to non-U.S. shareholders.
- Topic:
- Economics, International Trade and Finance, and Markets
- Political Geography:
- United States
27. Jackknifing Stock Return Predictions
- Author:
- Erik Hjalmarsson and Benjamin Chiquoine
- Publication Date:
- 06-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- We show that the general bias reducing technique of jackknifing can be successfully applied to stock return predictability regressions. Compared to standard OLS estimation, the jackknifing procedure delivers virtually unbiased estimates with mean squared errors that generally dominate those of the OLS estimates. The jackknifing method is very general, as well as simple to implement, and can be applied to models with multiple predictors and overlapping observations. Unlike most previous work on inference in predictive regressions, no specific assumptions regarding the data generating process for the predictors are required. A set of Monte Carlo experiments show that the method works well in finite samples and the empirical section finds that out-of-sample forecasts based on the jackknifed estimates tend to outperform those based on the plain OLS estimates. The improved forecast ability also translates into economically relevant welfare gains for an investor who uses the predictive regression, with jackknifed estimates, to time the market.
- Topic:
- Economics, International Trade and Finance, and Markets
28. Predicting Global Stock Returns
- Author:
- Erik Hjalmarsson
- Publication Date:
- 06-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- I test for stock return predictability in the largest and most comprehensive data set analyzed so far, using four common forecasting variables: the dividend- and earnings-price ratios, the short interest rate, and the term spread. The data contain over 20,000 monthly observations from 40 international markets, including 24 developed and 16 emerging economies. In addition, I develop new methods for predictive regressions with panel data. Inference based on the standard fixed effects estimator is shown to suffer from severe size distortions in the typical stock return regression, and an alternative robust estimator is proposed. The empirical results indicate that the short interest rate and the term spread are fairly robust predictors of stock returns in developed markets. In contrast, no strong or consistent evidence of predictability is found when considering the earnings- and dividend-price ratios as predictors.
- Topic:
- Economics, International Trade and Finance, and Markets
29. Trade Elasticity of Substitution and Equilibrium Dynamics
- Author:
- Martin Bodenstein
- Publication Date:
- 06-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- The empirical literature provides a wide range of estimates for trade elasticities at the aggregate level. Furthermore, recent contributions in international macroeconomics suggest that low (implied) values of the trade elasticity of substitution may play an important role in understanding the disconnect between international prices and real variables. However, a standard model of the international business cycle displays multiple locally isolated equilibria if the trade elasticity of substitution is sufficiently low. The main contribution of this paper is to compute and characterize some dynamic properties of these equilibria. While multiple steady states clearly signal equilibrium multiplicity in the dynamic setup, this is not a necessary condition. Solutions based on log-linearization around a deterministic steady state are of limited to no help in computing the true dynamics. However, the log-linear solution can hint at the presence of multiple dynamic equilibria.
- Topic:
- Economics, International Trade and Finance, and Markets
30. An Anatomy of Credit Booms: Evidence From Macro Aggregates and Micro Data
- Author:
- Enrique G. Mendoza and Marco E. Terrones
- Publication Date:
- 07-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- This paper proposes a methodology for measuring credit booms and uses it to identify credit booms in emerging and industrial economies over the past four decades. In addition, we use event study methods to identify the key empirical regularities of credit booms in macroeconomic aggregates and micro-level data. Macro data show a systematic relationship between credit booms and economic expansions, rising asset prices, real appreciations, widening external deficits and managed exchange rates. Micro data show a strong association between credit booms and firm-level measures of leverage, firm values, and external financing, and bank-level indicators of banking fragility. Credit booms in industrial and emerging economies show three major differences: (1) credit booms and the macro and micro fluctuations associated with them are larger in emerging economies, particularly in the nontradables sector; (2) not all credit booms end in financial crises, but most emerging markets crises were associated with credit booms; and (3) credit booms in emerging economies are often preceded by large capital inflows but not by financial reforms or productivity gains.
- Topic:
- Economics, Emerging Markets, International Trade and Finance, and Markets