INCEIF Knowledge Repository (INCEIF University)
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Current account, exchange rate dynamics and the predictability: the experience of Malaysia and Singapore
No full textThe East Asian financial crisis indicated that one of the factors that played a critical role in affecting the exchange rate of a country was its current account balance. This paper attempts to investigate this hypothesis. The Singaporean dollar (SD) and the Malaysian ringgit (RM) against the yen are taken as case studies. Our analysis is based on the recent cointegration method and we examine two issues. First, whether the exchange rates are cointegrated with the fundamentals as predicted by economic theory.
Our focus was to investigate whether the exchange rate movements are affected by the economic fundamentals, particularly the current account balance. Our findings suggest that the model fits the data well. Secondly, we wanted to test the validity of our model for forecasting future exchange rates. The findings show that the model does produce good in-sample as well as out-of-sample forecasts
Taxation, risk-taking and growth: a continuous-time stochastic general equilibrium analysis with labor-leisure choice
No full textThis paper investigates the equilibrium relationship between taxation, portfolio choice (risk-taking) and capital accumulation. Specifically, it examines how taxes affect risk-taking and capital accumulation. We extend the existing literature by relaxing two crucial assumptions in modelling risk-taking behavior: (i) that the investment opportunity set is fixed and (ii) that there is no distinction between attitudes towards risk and behavior towards intertemporal substitution. We extend the investment opportunity set of individuals through optimally determined human capital; and distinguish intertemporal substitution from attitudes towards risk via a recursive utility function. In the presence of these extensions, the paper successfully derives a closed-form solution to the stochastic growth model with stochastic wage income
FOREX risk premia and policy uncertainty: a recursive utility analysis
No full textWe compare actual and calibrated values for the foreign exchange risk premium based on the definition in [J. Int. Econ. 32 (1992) 305]. Calibrated values are found from within a dynamic stochastic general equilibrium model of a small open economy consisting of risk averse optimizing agents with unconventional preferences. We find that the equilibrium foreign exchange risk premium is a function of exogenous shocks in the model and is sensitive to assumed attitudes towards risk. Furthermore, various forms of policy uncertainty improve the capacity of the model to generate values closer to those found in the data
Common stochastic trends and the dynamic linkages driving european stock markets: evidence from pre- and post-october 1987 crash eras
No full textGiven the impact of the October 1987 crash pre-empting fears of a deep-seated financial collapse, there is now much scope for assessing its importance quantitatively. In this paper, time series techniques are used to analyse the dynamic linkages and propagation of shocks among five European stock markets. While we do not find any long-run relationship of stock markets over the entire sample ped, evidence is found in support of a unique cointegrating vector over each of the pre- and post-crash samples. Furthermore, the dynamic analysis reveals that the lead-lag relationships changed quite significantly over the sample following the crash
Macroeconomic announcements, volatility, and interrelationships: an examination of the UK interest rate and equity markets
No full textThis study investigates the intraday and daily pricing behavior of UK interest rate and equity index futures contracts. The paper initially examines the response of Short Sterling, Long Gilt, and FTSE100 to the release of scheduled macroeconomic announcements before employing dynamic time series techniques in order to reveal the nature of causal transmission patterns between these variables. In brief, short-term interest rates were found to be highly sensitive to indicators of prevailing economic conditions. However, the release of data important in the formation of inflationary expectations had a relatively subdued impact on long-term rates. Announcement effects appear somewhat ambiguous for the stock market. The analysis also reveals the bid ask bounce and swift mean reversion in volatility to be important behavioral features of the return-generating process. Whilst the three variables appear to be bound by two cointegrating relationships, the tests for lead/lag relationships produce mixed results
Quantum finance: path integrals and Hamiltonians for options and interest rates
No full textThis book applies the mathematics and concepts of quantum mechanics and quantum field theory to the modelling of interest rates and the theory of options. Particular emphasis is placed on path integrals and Hamiltonians. Financial mathematics is dominated by stochastic calculus. The present book offers a formulation that is completely independent of that approach. As such many results emerge from the ideas developed by the author. This work will be of interest to physicists and mathematicians working in the field of finance, to quantitative analysts in banks and finance firms and to practitioners in the field of fixed income securities and foreign exchange
Remedy for banking crises: what Chicago and Islam have in Common: a comment
No full textRepeated failure of banks led some economists to believe that the banking and financial system may be suffering from structural problems and is in need of fundamental reform. The Islamic monetary system is known to consider demand and investment deposits as two distinct contracts. Demand deposits are merely loans that are fully guaranteed by banks and must be returned on demand. Investment deposits are given to banks on a profit-and-loss sharing basis. They are clearly associated with risk-taking and have specific maturities which, in principle, are not revocable. Compared to conventional finance, this sounds like narrow banking. Garcia, Marino and Cibils (2000) find similarities between narrow banking and Islamic banking. As narrow banking seems to be an uncommon concept among specialists in Islamic economics, this comment is rather expanded to explain the what and why of narrow banking. The paper concludes that narrow banking bears similarities with Islamic banking. Under narrow banking, the role of investment banks would carry features similar to Islamic banking when the relationship between savers and banks are considered. However, when it comes to financing investment, Islamic banks avoid trading future for present money, while conventional investment banks stick to the interest-based modes of finance
An analysis of option pricing under systematic consumption risk using GARCH
No full textAn issue in the pricing of contingent claims is whether to account for consumption risk. This is relevant for contingent claims on stock indices, such as the FTSE 100 share price index, as investor's desire for smooth consumption is often used to explain risk premiums on stock market portfolios, but is not used to explain risk premiums on contingent claims themselves. This paper addresses this fundamental question by allowing for consumption in an economy to be correlated with returns. Daily data on the FTSE 100 share price index are used to compare three option pricing models: the Black-Scholes option pricing model, a GARCH (1, 1) model priced under a risk-neutral framework, and aGARCH(1, 1) model priced under systematic consumption risk. The findings are that accounting for systematic consumption risk only provides improved accuracy for in-the-money call options. When the correlation between consumption and returns increases, the model that accounts for consumption risk will produce lower call option prices than observed prices for in-the-money call options. These results combined imply that the potential consumption-related premium in the market for contingent claims is constant in the case of FTSE 100 index options
Futures trading volume as a determinant of prices in different momentum phases
No full textRecent studies contend that trading volume has predictive power for ex ante stock prices, particularly small stocks that do not react quickly to macroeconomic information. This study postulates that a significant amount of macro-information that flows on to stock markets is derived from derivative markets. We examine the impact of short-term futures trading volume and prices on cash stock prices using a case study of 15-min data from the Australian stock index futures market which reports actual trading volume. After applying vector error correction modelling (VECM), variance decomposition and impulse functions, we conclude that futures prices provide a short-term information lead to stock prices that dominates trading volume effects. We also observe asymmetric changes in the impact of trading volume between bull and bear price momentum phases and after large trading volume shocks. These results suggest that, in future, studies on trading volume should control for the cross-correlation impact from derivative prices and the differential impact of trading phases
Fractional cointegration, low frequency dynamics and long-run purchasing power parity: an analysis of the Australian dollar over its recent float
No full textA relatively new but generalized concept of fractional cointegration is applied to shed some light on the validity of purchasing power parity (PPP) as a long-run equilibrium condition, by examining the long-run relationship between quarterly consumer price indices and bilateral exchange rates of the Australian dollar and seven major OECD trading partners, over Australia's recent float. The paper demonstrates that relaxing the condition that the residual from the cointegration equation must be a I(0) process, provides a wide range of cases of parity-reversion with processes that are CI(1,d ) with 0<d<1. Findings tend to suggest that, while standard tests of cointegration fail to support cointegration between nominal exchange rates, domestic and foreign prices, and thus the empirical favour for PPP as a long-run phenomenon, the fractional cointegration analysis permits deviations from equilibrium to follow a fractionally integrated process and hence captures a much wider class of parity or mean-reversion behaviour. Results are mainly supportive of long-run PPP. Furthermore, an analysis of the short-run dynamics propelling the long-run relationship (through a VECM) reveals that domestic prices are consistently the initial receptor of an exogenous shock to the equilibrium and the long-run equilibrium is restored through the short-run adjustment of the nominal exchange rates. These findings are shown to hold clear policy implications