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Ebook Robust Control, Informational Frictions, and International Consumption Correlations

Submitted by puput on Sat, 08/21/2010 - 03:29

A common assumption in international business cycles models is that world financial markets are complete in the sense that individuals in different countries are able to fully insure country-specific income risks using international financial markets. Under this assumption, the models predict that consumption (or consumption growth) is highly correlated across countries, and in some cases the international consumption correlation is equal to 1 regardless of income or output correlations. The intuition is that since consumers are risk averse they will choose to smooth consumption over time by trading in international financial markets. However, in the data cross country consumption correlations are very low and are even lower than corresponding income correlations in many countries. For example, Backus, Kehoe, and Kydland (1992) solve a two-country real business cycles model and argue that the puzzle that empirical consumption correlations are actually lower than output correlations is the most striking discrepancy between theory and data. In the literature, the empirical low international consumption correlations have been interpreted as indicating international financial markets imperfections – for examples, see Kollman (1990), Baxter and Crucini (1995), and Lewis (1996).

Other extensions have been proposed to make the models better fit the data. For example, Devereux, Gregory, and Smith (1992) show that in the perfect risk-sharing model nonseparability between consumption and leisure has the potential to reduce the cross-country consumption correlation. Stockman and Tesar (1995) show that the presence of nontraded goods in the complete market model can also improve the model’s prediction. Fuhrer and Klein (2006) show that habit formation has important implications for international consumption correlations. In particular, they show that with a shock to the interest rate habit formation by itself can generate positive consumption correlations across countries even in the absence of international risk sharing and common income shocks. They then argue that if habit is a good characterization of consumers’ behavior, the absence of international risk sharing is even more striking than standard tests suggest; that is, existing studies may overstate the extent to which common consumption movements across countries reflect international risk sharing because some of them are due to habit.

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Ebook The Impact Of Privatisation On The Banking Sector In The Caribbean

Submitted by puput on Wed, 06/02/2010 - 04:08

With the failure of the import-substituting industrialisation policies of the postwar period, Caribbean countries shifted to an export-promotion strategy in the 1980s. Export promotion inevitably demanded a shifting of the relative price and productivity of tradable goods and services. To provide the necessary incentives for export promotion, countries pursued a mixture of reforms and restructuring to attract investment and to promote the competitiveness of production and exchange. The period also coincided with a shift in the development paradigm of the developed countries and major International Financial Institutions (IFIs). This new development strategy explicitly favoured open markets, a liberalised trading framework and a retreat of the State from productive activity. In fact, the orthodoxy of government failure became so entrenched that many economists argued that the State’s role should be confined to regulation and the provision of infrastructure. As a result, the Welfare State, long championed in the post-war period, was deemed an anachronism. In Europe, in particular, the word ‘sclerosis’ was borrowed from medicine to describe rigidities attributed to ‘overactive’ government intervention in economic activity and rigid, inflexible markets.

The new policy consensus, which was called the “Washington Consensus”, outlined a package of market-oriented policies aimed at resuscitating flagging economies. Important components of the package included price stability, fiscal prudence, trade openness through the reduction of tariffs and elimination of quotas, deregulation and privatisation of State enterprises. Privatisation was established as a particularly crucial plank of the reforms. This was so because it was believed that price incentives would be thwarted if the State were allowed to burden the allocation of resources by siphoning off finance to inefficient State-owned enterprises. Indeed, the evidence in many countries pointed to the crowding out of productive private sector activity by heavy State borrowing on the domestic financial market.

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Ebook Stochastic Behavioral Asset Pricing Models and the Stylized Facts

Submitted by puput on Tue, 05/18/2010 - 03:27

The finance literature hast a somewhat ambiguous approach towards the salient empirical features that characterize financial markets. While they are identified as `stylized facts' in recent surveys (de Vries, 1994; Pagan, 1996), they have more often been christened as `anomalies' in the past (cf. Frankfurter and McGoun, 2001, who argue that the increasing (mis)use of the term `anomaly' in the finance literature is evidence of a propagandistic "effort to imply that ... the reigning paradigm is irreplaceable..." (from their abstract)). The difference in language is perplexing: while the former notion implies an identification of robust features of the data that call for a scientific explanation, the later rather appears to denounce the same features as a minor nuisance for the established theoretical framework. One certainly does not do injustice to a large body of theoretical research in finance by stating that it had almost entirely ignored some of the most pervasive characteristics of financial markets for quite some time. While this does not hold for all of the stylized facts, it is certainly undisputable for two important regularities that have motivated a large part of the empirical finance literature: the fat tails of asset returns and the characteristic time-variation of their fluctuations. To be honest, a few attempts at explaining these features on the base of standard modeling frameworks do exist in recent literature (cf. Vanden, 2005), but at least there has been no systematic theoretical approach towards their explanation within `mainstream' models.

However, it also needs to be emphasized that mainstream finance had not been careless about empirical results altogether: on the contrary, one of the most important empirical findings, the martingale character of prices, is at the heart of its main paradigmatic approach, the efficient market hypothesis. It appears, however, that focusing on the explanation of this single feature, other equally universal findings have been deliberately neglected and marginalized as anomalies. The point that will be made in this chapter is that, from a different perspective, what has been found to be strange and unexpected behavior of markets, might appear as revealing charac-teristics that could guide the scientist towards a candidate explanation of price dynamics in financial markets. The surprising insight here is that when presented in an appropriate format - the stylized facts so well known to econometricians and market practitioners would immediately be identified as scaling laws by natural scientists. Viewed from this perspective, a picture emerges that differs enormously from that of traditional finance: scaling laws in natural science are viewed as imprints of complex systems composed of many interacting subunits that have to be explained as a result of their microscopic interaction.

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