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52. 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
53. Bank Integration and Financial Constraints: Evidence from U.S. Firms
- Author:
- Ricardo Correa
- Publication Date:
- 03-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- This paper uses data on publicly-traded firms in the U.S. to analyze the effect of interstate bank integration on the financial constraints borrowers face. A firm-level investment equation is estimated in order to test if bank integration reduces the sensitivity of capital expenditures to the level of internal funds. The staggered deregulation of cross-state bank acquisitions that took place in the U.S. between 1978 and 1994 helps estimate the model. Integration decreases financing constraints for bank-dependent firms. The change in firms' access to external finance is explained by an increase in the share of locally headquartered geographically diversified banks.
- Topic:
- Economics and International Trade and Finance
- Political Geography:
- United States
54. 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
55. 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
56. Interpreting Long-Horizon Estimates in Predictive Regressions
- Author:
- Erik Hjalmarsson
- Publication Date:
- 04-2008
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- This paper analyzes the asymptotic properties of long-horizon estimators under both the null hypothesis and an alternative of predictability. Asymptotically, under the null of no predictability, the long-run estimator is an increasing deterministic function of the short-run estimate and the forecasting horizon. Under the alternative of predictability, the conditional distribution of the long-run estimator, given the short-run estimate, is no longer degenerate and the expected pattern of coefficient estimates across horizons differs from that under the null. Importantly, however, under the alternative, highly endogenous regressors, such as the dividend-price ratio, tend to deviate much less than exogenous regressors, such as the short interest rate, from the pattern expected under the null, making it more difficult to distinguish between the null and the alternative.
- Topic:
- Economics
57. 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
58. 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
59. 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
60. 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