regulation by simulation the role of production cost models in electricity planning and pricing this paper is a case study on the role of complex computer simulation models in the regulation of the electricity industry the analysis focuses on electricity production cost simulation models as they are used to set prices for certain nonutility generators in california this represents an early part of the trend toward markets for electric power and away from pure monopoly supply the introduction of even limited competition creates conditions both favoring and hindering the reliability of cost estimates and demonstrates the sensitivity of results to problem specification and model implementation attention is focused on the representation of power system operational constraints particularly the unit commitment problem in the modeling process and their effect on the prices which result examples from the litigation history illustrate the problem of managing the strategic use and abuse of modeling techniques for competitive advantage highly structured procedures for using models in such situations offer some constraints on manipulation by competing parties otherwise experts are apt to overwhelm regulators

capital flow controls international asset pricing and investors welfare a multi country framework this paper investigates the impact of capital flow restrictions on the pricing of securities on the optimal portfolio composition for investors of different nationalities and on their welfare under capital flow controls the equilibrium price of a security is determined jointly by its international and national risk premiums and investors acquire nationality specific portfolios along with a market wide proxy for the world market portfolio removal of investment barriers generally leads to an increase in the aggregate market value of the affected securities and all investors favor a move toward market integration introduction of different types of index funds in the world market generally increases world market integration and investor welfare in recent years the international capital markets have undergone numerous important changes that have increased the international linkage of national markets these changes include the creation of national index funds e g mexico korea taiwan india france and scandinavia and selective liberalization e g brazil india korea sweden and japan despite their potential impact on the national economies and global finance it is not clear what consequences these integrating changes entail for example is welfare increased by allowing cross border investment that is restricted to purchasing the entire national portfolio of which the national index fund is a class unfortunately with the exception of subrahmanyam 1975a who studies the pricing and welfare effects of fully integrating heretofore completely segmented markets other international asset pricing models that incorporate capital flow restrictions for instance black 1974 stulz 1981b lessard et al 1983 errunza and losq 1985 cooper and kaplanis 1986 and eun and janakiramanan 1986 analyze the pricing but not the welfare effects of investment barriers to analyze systematically the welfare implications of various structural changes in the current market environment this paper follows the lead of subrahmanyam and recasts the analysis in two important respects

portfolio choice and liquidity constraints we study the infinite horizon model of household portfolio choice under liquidity constraints and revisit the portfolio specialization puzzle we show why the puzzle is robust to several model variations and argue that positive correlation between earnings shocks and stock returns is unlikely to provide an empirically plausible resolution we find that relatively small fixed costs for stock market entry are sufficient to deter stockholding because for a plausible range of parameter values households can achieve desired consumption smoothing with small or zero holdings of stocks such costs could arise from informational considerations sign up fees and investor inertia

tastes and technology in a two country model of the business cycle explaining international trade on international financial markets allows people to insure country specific risk and smooth consumption intertemporally equilibrium models of business cycles with trade on global financial markets typically yield international consumption correlations near one and excessive volatility of investment the authors incorporate nontraded goods in the model and find that the implications for aggregate consumption investment and the trade balance are consistent with business cycle properties of industrialized countries however the model driven by technology shocks alone yields counterfactual implications for comovements between consumption and prices at the sectoral level taste shocks produce price quantity relationships more consistent with the data copyright 1995 by american economic association

trying to explain home bias in equities and consumption investors hold a substantially larger proportion of their wealth portfolios in domestic assets than standard portfolio theory would suggest a phenomenon called equity home bias in the absence of this bias investors would optimally diversify domestic output risk using foreign equities therefore consumption growth rates would tend to co move across countries even when output growth rates do not empirically however consumption growth rates tend to have a lower correlation across countries than do output growth rates a phenomenon i call consumption home bias in this paper i discuss these two biases and their potential relationship as suggested by the literature

euro currency risk and the geography of debt flows to peripheral emu abstract the pattern of debt flows to peripheral european monetary union members seems puzzling they are mostly indirect and channeled through the large countries of the emu we examine to what extent the introduction of the euro and the elimination of the intra area currency risk can explain this puzzle we develop a three country dsge framework with endogenous portfolio choice and two currencies in the equilibrium the core members of the emu emerge as the main group of lenders to the peripheral emu outside lenders are pushed out of the periphery debt markets because of currency risk the model generates a pattern of debt flows consistent with the data despite the absence of any exogenous frictions or market segmentations

did china diversify its foreign reserves summary this paper takes a novel approach to detect the latent currency portfolio of chinese foreign exchange reserves and the underlying portfolio management strategies during 2000 and 2007 based on a portfolio accounting identity and the budget constraint of the chinese central bank s holding of foreign assets the monthly growth rate of reserves can be decomposed into monthly rate of return valuation effects of exchange rates and monthly net purchase rate the valuation effect reveals the value share of each currency bayesian inference is adopted to estimate the state space model with a mixture of gaussian distributions the results show that china significantly and dramatically diversified its reserves out of the us dollar in 2002 both the euro s value and quantity shares increased from 5 to more than 20 by the end of 2007 china held about at most 67 3 of its reserves in the us dollar 22 in the euro 2 5 in the japanese yen 4 7 in the australian dollar and 3 5 in the british pound the average annual rate of return was about 3 copyright 2011 john wiley sons ltd

optimal financial market integration and security design 1 we study 2 period pure exchange capital asset pricing model capm economies with incomplete financial markets and restricted participation we characterize the optimal financial market structure and efficient innovations consisting of both the introduction of new assets and the integration of segmented markets welfare gains from innovations are maximal when the endowments of affected agents are negatively correlated uncoordinated innovations lead to efficient market structures if all assets have identical participation structure or the markets being integrated trade identical assets however coordination failure in the introduction of new assets may result when assets have participation structures that overlap only partially

international real business cycles we ask whether a two country real business cycle model can account simultaneously for domestic and international aspects of business cycles with this question in mind we document a number of discrepancies between theory and data the most striking discrepancy concerns the correlations of consumption and output across countries in the data outputs are generally more highly correlated across countries than consumptions in the model we see the opposite

does industrial structure explain the benefits of international diversification abstract we examine the influence of industrial structure on the cross sectional volatility and correlation structure of country index returns for 12 european countries between 1978 and 1992 we find that industrial structure explains very little of the cross sectional difference in country return volatility and that the low correlation between country indices is almost completely due to country specific sources of return variation diversification across countries within an industry is a much more effective tool for risk reduction than industry diversification within a country

is local bias a cross border phenomenon evidence from individual investors international asset allocation abstract extant literature consistently documents that investors tilt their domestic equity portfolios towards regionally close stocks local bias we hypothesize that individual investors local bias is not limited to the domestic sphere but instead also determines their international investment decisions our results confirm the presence of a cross border local bias specifically we show i that the stockholdings of individual investors living within regional proximity to a foreign country display a significantly lower foreign investment bias towards investment opportunities in that country and ii that this drop in foreign investment bias levels is disproportionately driven by investments in regionally close neighbor country companies the impact of cross border local bias on investors bilateral foreign equity investments is economically significant and holds even after controlling for previously identified explanations of international asset allocation

commitment of electric power generators under stochastic market prices a formulation for the commitment of electric power generators under a deregulated electricity market is proposed the problem is expressed as a stochastic optimization problem in which expected profits are maximized while meeting demand and standard operating constraints under an assumption of perfect competition when an electric power producer has the option of trading electricity at market prices a unit commitment schedule can be obtained by optimizing the self commitment of each unit separately subject to stochastic prices three certainty equivalent formulations of the stochastic self commitment problem are provided the procedures involve application of dynamic programming statistical analysis and asymptotic probability computations the price of electricity is represented by a stochastic model depending on demand generating unit reliabilities and temperature fluctuations we use several approximation methods normal edgeworth series expansion and monte carlo simulation for computing the required probability distributions numerical examples are provided for a market consisting of 150 generating units

nontraded goods nontraded factors and international non diversification abstract can the presence of nontraded consumption goods or nontraded factors of production explain the high degree of home bias displayed by investor portfolios we find that the answer is no so long as individuals have access to free international trade in financial assets in particular it is never optimal to exhibit home bias with respect to domestic traded good equities by contrast holdings of nontraded good equities in an optimal portfolio will depend sensitively on the elasticity of substitution between traded and nontraded goods

equity home bias and corporate disclosure abstract i show that more comprehensive corporate disclosure reduces investors uncertainty about domestic companies payoffs at no cost thereby decreasing investors equity home bias toward a country since investors should base their investment decisions on valid and easily interpretable company information only more comprehensive disclosure will reduce the home bias only if domestic securities law is sufficiently stratified and domestic companies use international accounting standards using panel data for 38 countries from 2003 to 2008 i find that more comprehensive disclosure reduces investors home bias though significantly only for countries that sufficiently enforce their securities law and implement international accounting standards

a common currency area for asean issues and feasibility this article examines the feasibility of a common currency area cca for asean and the broader asean 5 using macro economic data for 14 east asian countries over the 34 year period 1970 2003 this article addresses whether a euro style cca would be well suited for these countries issues such as the costs and benefits involved and which countries may be best suited are examined previous literature on currency unions have identified synchronous business cycles similarity in inflation levels and policy congruence to be among essential preconditions a vector autoregression model and correlation analysis is used to examine common linkages among the 14 sample countries impulse response functions and variance decomposition is used to identify potential candidates among the 14 countries the results show an absence of broad based common linkages instead several paired clusters are identified as potential candidates the results imply that while a region wide cca may not now be feasible a strategy of be

estimating quadratic variation using realized variance this paper looks at some recent work on estimating quadratic variation using realised variance rv that is sums of m squared returns this econometrics has been motivated by the advent of the common availability of high frequency financial return data when the underlying process is a semimartingale we recall the fundamental result that rv is a consistent as m estimator of quadratic variation qv we express concern that without additional assumptions it seems difficult to give any measure of uncertainty of the rv in this context the position dramatically changes when we work with a rather general sv model which is a special case of the semimartingale model then qv is integrated variance and we can derive the asymptotic distribution of the rv and its rate of convergence these results do not require us to specify a model for either the drift or volatility functions although we have to impose some weak regularity assumptions we illustrate the use of the limit theory on some exchange rate data and some stock data we show that even with large values of m the rv is sometimes a quite noisy estimator of integrated variance

international portfolio choice liquidity constraints and the home equity bias puzzle this paper solves for optimal international portfolio choice in the presence of liquidity constraints and undiversifiable labor income risk optimal portfolios are internationally diversified while positive correlation between domestic stock market returns and permanent labor income shocks can generate a complete portfolio specialization in foreign stocks nevertheless either small costs associated with investing abroad or a slightly positive domestic to foreign equity premium differential are sufficient to either deter households from participating in a foreign market or generate a substantial bias for home equities the benefits of international diversification are limited because consumption fluctuations can be smoothed with a small amount of buffer stock saving while exchange rate risk makes foreign investments less appealing to risk averse investors

excess capacity monopolistic competition and international transmission of monetary disturbances analyzes the excess capacity monopolistic competition and international transmission of monetary policy disturbances in the united states sheds light on the international impact of monetary policy emphasis on the spillover effects of monetary disturbances similarity of framework used with open economy macroeconomics

restoring rational choice the challenge of consumer financial regulation abstract this lecture considers the case for consumer financial regulation in an environment where many households lack the knowledge to manage their financial affairs effectively the lecture argu

the introduction of the euro and its effects on portfolio decisions abstract examining investment behavior related to the euro introduction we address the relevance of different investment determinants with the advent of the currency union two potential sources of portfolio reallocation can be distinguished first the diminishment of exchange rate risk and transaction costs within the emu second the increase of correlation of emu returns so that diversification benefits decreased we test for structural breaks in the holdings of german investors and estimate a market model to account for the two effects a significant decrease in national and an increase in emu and rest of the world investments can be observed comparing the observed holdings with benchmark portfolios we find that investment home bias has diminished since the euro introduction

electricity spot price dynamics beyond financial models we reveal properties of electricity spot prices that cannot be captured by the statistical models commonly used to model financial asset prices that are increasingly used to model electricity prices using more than eight years of half hourly spot price data from the new zealand electricity market we find that the half hourly trading periods fall naturally into five groups corresponding to the overnight off peak the morning peak daytime off peak evening peak and evening off peak the prices in different trading periods within each group are highly correlated with each other yet the correlations between prices in different groups are lower models adopted from the modeling of security prices that are currently applied to electricity spot prices are incapable of capturing this behavior we use a periodic autoregression to model prices instead showing that shocks in the peak periods are larger and less persistent than those in off peak periods and that they often reappear in the following peak period in contrast shocks in the off peak periods are smaller more persistent and die out perhaps temporarily during the peak periods current approaches to modeling spot prices cannot capture this behavior either

currency matters analyzing international bond portfolios abstract bonds denominated in the investor s currency are special we show this indirectly in a global dataset of bilateral bond holdings indirectly because the global holdings dataset does not differentiate by currency denomination and then more directly in datasets of us holdings of foreign bonds that do differentiate by currency we find that the share of a country s bonds denominated in investors currencies is an important determinant of the amount of cross border investment it receives factors associated with greater or less cross border investment in bonds differ by currency denomination and one phenomenon of international portfolios the ever present home bias in some cases actually disappears when bonds are denominated in the investor s currency suggesting that the home bias is to some extent a home currency bias

home bias and cross border taxation abstract the relationship between cross border taxation and free float home bias is examined this explicitly recognizes that insider shares are unavailable to foreigners other important explanations for home bias information asymmetry behavioural and governance issues are controlled when examining the impact of cross border tax variables in our sample of countries about sixty percent eighty percent withhold taxes on realized capital gains dividends of foreign investors and about thirty percent of the mature economies provide imputation of taxes paid on dividend income by domestic corporations dividend imputation is a statistically significant impediment to cross border equity flows a tax credit variable for foreign taxes paid on dividends is constructed and found to be statistically significant in reducing home bias a relatively high foreign tax rate that cannot be offset by tax credits is found to significantly increase home bias these results hold for float adjusted home bias and traditional international portfolio home bias

risk taking global diversification and growth this paper develops a continuous time stochastic model in which international risk sharing can yield substantial welfare gains through its effect on expected consumption growth the mechanism linking global diversification to growth is an attendant world portfolio shift from safe low yield capital to riskier high yield capital the presence of these two types of capital captures the idea that growth depends on the availability of an ever increasing array of specialized hence inherently risky production inputs calibration exercises using consumption and stock market data imply that most countries reap large steady state welfare gains from global financial integration copyright 1994 by american economic association

pooling risk among countries suppose that international sharing risk worldwide or with large numbers of countries were costly how much risk sharing could be gained in small sets or pools of countries to answer this question we compute the means and variances of poolwide gross domestic product growth for all possible pools of any size drawn from a sample of 74 countries and compare them with the means and variances of consumption growth in each country individually from the difference we infer potential diversification and welfare gains as much as two thirds of the first best full worldwide welfare gains can be obtained in groupings of as few as seven countries the largest potential gains arise from pools consisting of countries in different regions and including countries with weak institutions we argue that international risk sharing fails to emerge because the largest potential gains are among countries that do not trust each other s willingness and ability to abide by international contractual obligations

why do stocks and consumption imply such different gains from international risk sharing abstract estimates of the gains to international risk sharing based upon stock returns tend to find dramatically higher gains than do estimates from consumption based models in this paper i examine the reasons for these differences using a common theoretical framework for both approaches i find that the differences are largely due to the much higher variability of stock returns and its implied intertemporal substitution in marginal utility also contrary to conventional wisdom the differences in gains from the two approaches do not arise from treating stock returns as exogenous rather than endogenous

home bias in equity portfolios inflation hedging and international capital market equilibrium we test whether the home bias in equity portfolios is caused by investors trying to hedge inflation risk the empirical evidence is consistent with this motive only if investors have very high levels of risk tolerance and equity returns are negatively correlated with domestic inflation we then develop a model of international portfolio choice and equity market equilibrium that integrates inflation risk and deadweight costs using this model we estimate the levels of costs required to generate the observed home bias in portfolios consistent with different levels of risk aversion for a level of risk aversion consistent with standard estimates of the domestic equity market risk premium these costs are about a few percent per annum greater than observable costs such as withholding taxes thus the home bias cannot be explained by either inflation hedging or direct observable costs of international investment unless investors have very low levels of risk aversion article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

incorporating fuel constraints and electricity spot prices into the stochastic unit commitment problem the electric power industry is going through deregulation as a result the load on the generating units of a utility is becoming increasingly unpredictable furthermore electric utilities may need to buy power or sell their production to a power pool that serves as a spot market for electricity these trading activities expose utilities to volatile electricity prices in this paper we present a stochastic model for the unit commitment that incorporates power trading into the picture our model also accounts for fuel constraints and prices that may vary with electricity prices and demand the resulting model is a mixed integer program that is solved using lagrangian relaxation and bender s decomposition using this solution approach we solve problems with 729 demand scenarios on a single processor to within 0 1 of the optimal solution in less than 10 minutes our numerical results indicate that significant savings can be achieved when the spot market is entered into the problem and when stochastic policy is adopted instead of a deterministic one

the determinants of cross border equity flows abstract we explore a new panel data set on bilateral gross cross border equity flows between 14 countries 1989 1996 we show that a gravity model explains international transactions in financial assets at least as well as goods trade transactions gross transaction flows depend on market size in source and destination country as well as trading costs in which both information and the transaction technology play a role distance proxies some information costs and other variables explicitly represent information transmission an information asymmetry between domestic and foreign investors and the efficiency of transactions the geography of information is the main determinant of the pattern of international transactions while there is weak support in our data for the diversification motive once we control for the informational friction we broaden the scope of our results by presenting some evidence linking the results on equity transactions to equity holdings

stochastic programming based bounding of expected production costs for multiarea electric power system a bounding based method is developed for estimating the expected operation cost of a multiarea electric power system in which transmission capacity limits interarea flows costs include the expense of power generation and losses suffered by consumers because of supply shortfalls averaged over random generator outage states and varying demand levels the calculation of this expectation termed the distribution problem is a large scale stochastic programming problem rather than solving this problem directly lower and upper bounds to the expected cost are created using two more easily solved models the lower bound is from a deterministic model based on the expected value of the uncertain inputs the upper bound results from a linear program with recourse whose structure permits relatively quick solution by benders decomposition the benders subproblems use probabilistic production costing which can be viewed as a stochastic greedy algorithm to consider random outages and demands these bounds are iteratively tightened by partitioning realizations of the random variables into subsets based on the status of larger generators and a cluster analysis of demands computational examples are described and application issues addressed

the ability of global stock exchange mechanisms to mitigate home bias evidence from euronext this paper examines the effects on equity home bias of two mechanisms adopted by euronext when it was formed by the merger of four european countries stock exchanges in 2002 the two structural mechanisms are the integration of trading platforms across the four predecessor exchanges and the creation of named segments of the integrated exchange on which firms could voluntarily list by precommitting to enhanced disclosure and transparency employing a difference in differences research design using other european union companies as a control group we document that the integration of the euronext market was associated with a reduction in home bias for firms listed on the named segments of the euronext exchange but not for the nonsegment euronext firms our results suggest that the reduction in transaction costs from the integration of the trading platforms did not make the nonsegment euronext firms more attractive to the specific investors for whom the transaction costs were reduced on the other hand the decrease in information costs due to the precommitments to enhanced transparency made the segment firms more attractive to all categories of foreign investors consistent with the information costs hypothesis this paper was accepted by mary barth accounting

what can explain the apparent lack of international consumption risk sharing recent research in international business cycles finds that international consumption comovements do not match the risk sharing predictions of standard complete markets models in this paper i ask whether two different types of explanations can help explain this result 1 nonseparabilities between tradables and nontradable leisure or goods and 2 the effects of capital market restrictions on consumption risk sharing i find that risk sharing cannot be resolved by either explanation alone however when i allow for both nonseparabilities and certain market restrictions risk sharing among unrestricted countries cannot be rejected this evidence suggests that a combination of these two effects may be necessary to explain consumption risk sharing across countries

are correlations of stock returns justified by subsequent changes in national outputs abstract in an integrated world capital market the same pricing kernel is applicable to all securities we apply this idea to the stock returns of different countries we investigate the underlying determinants of cross country stock return correlations first we determine for a given measured degree of commonality of country outputs what should be the degree of correlation of national stock returns we propose a framework that contains a statistical model for output and an intertemporal financial market model for stock returns we then attempt to match the correlations generated by the model with measured correlations our results show that under the hypothesis of market segmentation the model correlations are much smaller than observed correlations however assuming world markets are integrated our model correlations can be matched with observed correlations

loss aversion asymmetric market comovements and the home bias abstract loss aversion has been used to explain why a high equity premium might be consistent with plausible levels of risk aversion the intuition is that the first order different utility impact of wealth gains and losses leads loss averse investors to behave similarly to investors with high risk aversion but if so should those agents not perceive larger gains from international diversification than standard expected utility investors with plausible levels of risk aversion they might not because comovements in international stock markets are asymmetric correlations are higher in market downturns than in upturns this asymmetry dampens the gains from diversification relatively more for loss averse investors we analyze the portfolio problem of such an investor who has to choose between home and foreign equities in the presence of asymmetric comovement in returns perhaps surprisingly in the context of the home bias puzzle we find that loss averse investors behave similarly to those with standard expected utility preferences and plausible levels of risk aversion we argue that preference specifications that appear to perform well with respect to the equity premium puzzle should be subjected to this test

gains from international diversification 1968 85 returns on portfolios of stocks and bonds this paper applies the multi period investment model to a universe of international securities on the basis of the simple probability assessment approach our principal findings are 1 the gains from including non u s asset categories in the universe were remarkably large in some cases statistically significant especially for the highly risk averse strategies 2 the gains from removing the no leverage constraint were more substantial than they were in the absence of non u s securities and 3 there is strong evidence of market segmentation in that the optimal levels of investment in u s securities were mostly zero in the presence of the non u s asset categories

does financial globalization promote risk sharing article i nfo in theory one of the main benefits of financial globalization is that it should allow for more efficient international risk sharing in this paper we provide an empirical evaluation of the patterns of risk sharing among different groups of countries and examine how international financial integration has affected the evolution of these patterns using a variety of empirical techniques we conclude that there is at best a modest degree of international risk sharing and certainly nowhere near the levels predicted by theory in addition only industrial countries have attained better risk sharing outcomes during the recent period of globalization developing countries have by and large been shut out of this benefit even emerging market economies many of which have reduced capital controls and all of which have witnessed large increases in cross border capital flows have seen little change in their ability to share risk we find that the composition of flows may help explain why emerging markets have not been able to realize this presumed benefi to f financial globalization in particular our results suggest that portfolio debt which had dominated the external liability stocks of most emerging markets until recently is not conducive to risk sharing

the home bias of the poor foreign asset portfolios across the wealth distribution abstract this paper documents how the share of foreign stocks in us household portfolios rises with the ratio of financial wealth to non financial income this is both because wealthier households are more likely to participate in foreign asset markets and because portfolio shares of participants increase with financial wealth but decrease with non financial income a simple standard two country general equilibrium model shows that hedging of terms of trade movements and non financial income risk produces non trivial heterogeneity in portfolios across the wealth and income distribution within countries that is qualitatively in line with this evidence

country portfolios under global imbalances abstract this paper studies the composition of country portfolios under global imbalances when countries are identical the optimal portfolio is fully diversified which reflects the cross country symmetric self hedging lucas 1982 assuming a structural country asymmetry in patience we construct a model of portfolio choices that features persistent non zero net foreign assets nfa because the latter opens a gap between gnp and gdp we found that an asymmetric hedging of net portfolio returns emerges in addition to the otherwise only lucas symmetric self hedging in shaping the gross country portfolios which implies a short long position of the local asset in the debtor creditor country the resulting portfolio is home biased we calibrate our model to the u s and china data over 1999 2017 and show that it matches the portfolio data for countries with unbalanced net external positions well

price flexibility in developing countries evidence and implications using data for a sample of 50 developing countries the empirical investigation evaluates determinants and implications of asymmetric price flexibility price inflation is characterized by high flexibility to adjust towards full equilibrium further price inflation accelerates flexibly with unanticipated demand growth in both the upward and downward directions in most of the countries under investigation asymmetry indicates higher upward flexibility compared to downward flexibility in many countries aggregate uncertainty determines the degree of asymmetry such that price flexibility is higher with respect to expansionary demand shocks compared to contractionary shocks the higher the variability of aggregate demand across countries in contrast higher trend price inflation increases downward price flexibility across countries output variability decreases with both upward and downward price flexibility in the face of aggregate demand shocks a the views expressed in this article are those of the a

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

portfolio performance and the euro prospects for new potential emu members abstract entering the emu removes currency risk for assets originating in the euro area while diversification opportunities are likely reduced taking the perspective of an investor in one of the 12 countries that joined the eu in 2004 2007 we contrast actual optimal composition of international equity holdings against two artificial scenarios costless hedging against exchange rate risk and presuming the local market to be part of the emu state specific optimal portfolios are determined from realized covariances for the period 2000 2006 optimized risk is found smaller under currency unification and implied sharp ratios signal significant benefits of emu participation

the dynamic effects of aggregate demand and supply disturbances we interpret fluctuations in gnp and unemployment as due to two types of disturbances disturbances that have a permanent effect on output and disturbances that do not we interpret the first as supply disturbances the second as demand disturbances demand disturbances have a hump shaped mirror image effect on output and unemployment the effect of supply disturbances on output increases steadily over time peaking after two years and reaching a plateau after five years

do trade costs in goods market lead to home bias in equities abstract two of the main puzzles in international economics are the consumption and the portfolio home biases we solve for international equity portfolios in a two country two good stochastic equilibrium model with trade costs in goods markets we show that introducing trade costs as suggested by obstfeld and rogoff obstfeld m rogoff k 2000a the six major puzzles in international macroeconomics is there a common cause nber macroeconomics annual 15 is not sufficient to explain these two puzzles simultaneously on the contrary we find that trade costs create a foreign bias in portfolios for reasonable parameter values this result is robust to the addition of non tradable goods for standard calibrations of the preferences

model misspecification and underdiversification in this paper we study intertemporal portfolio choice when an investor accounts explicitly for model misspecification we develop a framework that allows for ambiguity about not just the joint distribution of returns for all stocks in the portfolio but also for different levels of ambiguity for the marginal distribution of returns for any subset of these stocks we find that when the overall ambiguity about the joint distribution of returns is high then small differences in ambiguity for the marginal return distribution will result in a portfolio that is significantly underdiversified relative to the standard mean variance portfolio

the decoupling of emerging economies theoretical and empirical puzzle with the growing importance of the emerging economies ees in the international scene a lively debate has begun on whether the national economic cycles are converging or the cycles of ees and advanced economies aes are becoming disconnected the so called hypothesis of decoupling of ees from the aes given the important practical implications that decoupling could have for example on the definition of national and international economic policies and on business strategies aimed at investment diversification and risk management the question kindles not only the interest of academics but also policymakers and practitioners are very interested in the issue the decoupling question has been long debated in different circles and from different points of view this survey aims to retrace the steps of this debate and to provide some suggestions for future empirical researches

labour market institutions and household consumption insurance within oecd countries this paper tests empirically whether the effect of idiosyncratic income shocks on aggregate consumption depends on institutional features of national labour markets the results show that in a sample of 15 oecd countries institutional heterogeneity is a significant determinant of the response of household consumption to country specific income shocks this is consistent with the idea that institutionally provided social insurance may help increase income stability when people differ in their ability to access financial markets and smooth consumption fluctuations

strategic financial innovation in segmented markets rohit rahi obtained his ph d in economics from stanford university in 1993 he is a reader in finance and economics and a member of the financial markets group at the london school of economics his research interests are in the theory of financial markets in particular arbitrage in segmented markets security design and asset pricing with asymmetric information and in general equilibrium theory with incomplete markets he has published articles in the review of economic studies journal of economic theory and journal of business he served a nine year term on the editorial board of the review of economic studies jean pierre zigrand is a lecturer at the london school of economics his research interests are asset pricing financial intermediation theory and general equilibrium theory any opinions expressed here are those of the authors and not necessarily those of the fmg the research findings reported in this paper are the result of the independent research of the authors and do not necessarily reflect the views of the lse

welfare gains from international risksharing abstract this paper uses consumption data to compute yet unexploited welfare gains that can be achieved through risksharing among twenty oecd countries there is both aggregate national consumption risk and nondiversifiable individual specific risk countries engage in an optimal risksharing arrangement to pool risk associated with the aggregate consumption endowment streams welfare gains are associated with reduced consumption variability and with the international pricing of the consumption streams of individual countries the paper considers the standard vnm time additive preferences as well as nonexpected utility and habit formation preferences large unexploited gains are found under all sets of preferences leading to an international risksharing puzzle

the effect of emergency liquidity assistance ela on bank lending during the euro area crisis abstract we examine the impact of emergency liquidity assistance ela on bank lending in eleven euro area countries during the financial crisis with the intensification of the crisis ela took on a pivotal role in some countries however assessments of the quantitative impact of ela in the literature are non existent we estimate a structural panel model for the determination of bank lending which includes the amount of ela received by each bank allowing us to investigate the direct effect of ela on lending our model corrects a mis specification found in the prototype model used in the literature we then undertake a var analysis which allows us to address the effect of ela on gdp finally we examine spillover effects among banks indicating that ela generated positive spillovers to other banks

can portfolio rebalancing explain the dynamics of equity returns equity flows and exchange rates we explore whether the pattern of international equity returns equity portfolio flows and exchange rate returns are consistent with the hypothesis that unhedged global investors rebalance their portfolio in order to limit their exchange rate exposure when there are 1 relative equity return and 2 exchange rate shocks we also explore whether 3 equity flow shocks influence the exchange rates and relative equity prices in the estimation of the var system we do not impose any causal ordering upon the primitive shocks but instead identify the system based on theoretical priors about the contemporaneous conditional correlations between the three variables international data for the five largest equity markets are consistent with a theory in which equity returns and portfolio rebalancing are an important source of exchange rate dynamics

asset pricing puzzles and incomplete markets the representative agent theory of asset pricing is modified to incorporate heterogeneous agents and incomplete markets the model features two types of agents who differ up to a nontradable idiosyncratic component in their endowment processes numerical solutions indicate that individuals are able to diversify a substantial portion of their idiosyncratic income risk through riskless borrowing and lending alone restrictions on the variability of intertemporal marginal rates of substitution hansen and jagannathan 1991 are used to argue that incomplete markets as modeled here cannot account for the properties of asset returns that are anomalous from the perspective of representative agent theory a large literature in financial economics has investigated the extent to which variants of the lucas 1978 general equilibrium theory of asset pricing can account for the joint behavior of aggregate u s consumption and asset returns by and large this literature has concluded that a theory based upon frictionless arrow debreu markets and or a representative agent makes strongly counterfactual predictions regarding even the simple unconditional properties of this relationship mehra and prescott 1985 for instance show that the theory drastically underpredicts the average excess rate of return on u s stocks the so called equity premium puzzle weil 1989 points out as did mehra and prescott that the magnitude of the average risk free rate is far below that predicted by the theory this has been dubbed the risk free rate puzzle numerous authors including grossman melino and shiller 1987 and backus gregory and zin 1989 show that the theory cannot account for term premia inherent in the yield curve hodrick 1987 surveys a large literature which documents the theory s shortcomings in accounting for excess expected returns in foreign exchange markets the notion that the representative agent model cannot account for excess returns across a wide array of asset markets can be made more precise by using tools developed by hansen and jagannathan 1991 and shiller 1982

international investment restrictions and closed end country fund prices some closed end country funds trade at large premiums relative to their net asset values this paper examines whether international investment restrictions raise country fund price net asset value ratios by segmenting international capital markets we test whether a relation exists between announcements of changes in investment restrictions and changes in these ratios using weekly data from may 1981 to january 1989 the results provide evidence that some foreign markets are at least partially segmented from the u s capital market

speculative behavior and the dynamics of interacting stock markets abstract we develop a simple agent based financial market model in which heterogeneous speculators apply technical and fundamental analysis to trade in two different stock markets speculators strategy market selections are repeated at each time step and depend on predisposition effects herding behavior and market circumstances simulations reveal that our model is able to explain a number of nontrivial statistical properties of and between international stock markets including bubbles and crashes fat tailed return distributions volatility clustering persistent trading volume coevolving stock prices and cross correlated volatilities against this background our model may be deemed to have been validated

exchange rate volatility and deviations from unbiasedness in a cash in advance model abstract this paper examines time series properties of exchange rate changes the forward premium and the forward bias in the context of a variant of svensson s cash in advance model the model is solved and simulated using realistic forcing processes whose law of motion is estimated from u s japan data and then approximated by a markov chain although method of moments estimation shows that the over identifying restrictions implied by the model are not rejected it fails dramatically in producing a sufficiently variable risk premium on forward market speculation this result is robust to various pertubations to the model s parameters forcing processes and preference structure the model also fails to match exchange rate and forward premium volatility simultaneously

a probability model for the electricity price duration curve under an oligopoly market in this paper we propose a new formulation for the price duration curve pdc using probability considerations and provide a procedure for constructing it this curve is expected to be useful in the long term prediction of market prices and is similar in spirit to the load duration curve it shows the proportion of time over a given time horizon during which the real time market price of electricity is expected to exceed specified dollar amounts the price over a long term is a stochastic quantity that depends on physical factors such as production cost load generation availability unit commitment and transmission constraints it also depends on economic factors such as strategic bidding and load elasticity we illustrate a procedure for constructing a stochastic system based model for the pdc taking into account the randomness associated with load and generator outages the effects of unit commitment transmission congestion and transmission outages are not considered we use two economic models one is due to bertrand and represents perfect competition the other model is due to rudkevich et al who have given a closed form expression for the market clearing price in an oligopoly consisting of several identical firms

using a system model to decompose the effects of influential factors on locational marginal prices locational marginal prices lmps are influenced by various factors such as load uncertainty thermal limit capacity reserve and market power we build a system model to quantitatively analyze the effects of these individual factors and their interactions on the mean and standard deviation of the lmps assuming that the factors are either active or inactive according to the sensitivity analysis results from convex quadratic programming lmps are piecewise linear functions of demand variation which is a key property used in the computation this paper attempts to answer the following types of questions 1 to what extent does market power raise the lmps above the marginal cost 2 what effects will generation or transmission capacity expansion have on relieving high lmps under high demand scenarios an ieee 30 bus test system is used as an example to demonstrate our approach

international diversification a copula approach abstract the viability of international diversification involves balancing benefits and costs this balance hinges on the degree of asset dependence in light of theoretical research linking diversification and dependence we examine international diversification using two measures of dependence correlations and copulas we document several findings first dependence has increased over time second we find evidence of asymmetric dependence or downside risk in latin america but less in the g5 the results indicate very little downside risk in east asia third east asian and latin american returns exhibit some correlation complexity interestingly the regions with maximal dependence or worst diversification do not command large returns our results suggest international limits to diversification they are also consistent with a possible tradeoff between international diversification and systemic risk

dispatch planning using newsvendor dual problems and occupation times application to hydropower abstract we consider price driven dispatch planning under price uncertainty a storable commodity is optimally sold and purchased over time first we consider models where the storage level is constrained in expectation the dual of the corresponding optimization problem is related to the newsvendor problem exact solutions of bang bang type are given the second methodology is for high frequency dispatch decisions in multistage stochastic programming models to overcome the curse of dimensionality prices are modeled by occupation times at price levels in a case study we consider a pumped storage hydropower plant numerical solutions are given which have similar patterns as for the first exactly solvable problems

international portfolio nondiversification and exchange rate variability abstract incomplete international portfolio diversification is implied by an equilibrium models of exchange rates with nontraded goods the model can also explain the greater correlation between consumption and income within a country than between consumption across countries nontraded goods make more stringent the elasticity conditions required to explain exchange rate variability resulting from current productivity disturbances though not from disturbances to fiscal policies or the prospective return to investment the model is also consistent with international real interest rate differentials changes over time in the current account and relative wealth across nations and observed time series properties of exchange rates

optimal price and quantity determination for retail electric power contracts considering the viewpoint of a retailer this paper analyzes the problem of setting up contracts on both the supplier and end user sides to maximize profits while maintaining an acceptable level of settlement risk the proposed stochastic optimization model can assist retailers with these efforts and guide them in their contractual arrangements a realistic example illustrates the capabilities of the methodology proposed

commodity trade and international risk sharing how much do financial markets matter abstract this paper evaluates the social gains from international risk sharing in some simple general equilibrium models with output uncertainty a simulation model calibrated to selected moments of u s and japanese data estimates the incremental loss from a ban on international portfolio diversification to be on the order of 0 20 percent of output per year even the theoretical gains from asset trade may disappear under alternative sets of assumptions on preferences and technology the paper argues that the small magnitude of potential trade gains may help explain the apparently inconsistent findings of empirical studies on the degree of international capital mobility

capital market imperfections and the theory of optimum currency areas this paper studies how within and cross country capital market imperfections affect the welfare effects of forming a currency union the analysis considers a bank only world where intermediaries compete in cournot fashion and monitoring and state verification are costly the first part determines the credit market equilibrium and the optimal number of banks prior to joining the union the second part discusses the benefits from joining a currency union a competition effect is identified and related to the added monitoring costs that banks may incur when operating outside their home country through an argument akin to the brander krugman reciprocal dumping model of bilateral trade however in our framework whether joining a union raises welfare of the home country is ambiguous it depends on the relative strength of investment creation and intermediation diversion effects

on the effects of barriers to international investment a simple model is presented in which it is costly for domestic investors to hold foreign assets the implications of the model for the composition of optimal portfolios at home and abroad are derived it is shown that all foreign assets with a beta larger than some beta plot on either one of two security market lines some foreign assets with a beta smaller than are not held by domestic investors even if their expected return is increased slightly while it is obviously not true that asset markets are completely segmented between countries there is evidence of barriers to international investment although reality seems to lie in that grey area between complete segmentation and no segmentation at all most international asset pricing models are concerned with the extreme case of no barriers to international investment no effort seems to have been made to study the effect on portfolio choice of such barriers which make it costly to hold foreign securities as opposed to domestic securities but which do not in general render international diversification so onerous that investors avoid foreign securities completely casual empiricism suggests that models without barriers to international investment should be suspect those models cannot explain why it appears that in every country investors on average hold more domestic securities than would be required if they held the world market portfolio 2 this paper constructs a model of international asset pricing in which there is a cost associated with holding either long or short risky foreign securities for the sake of simplicity in most of the paper we assume that while domestic investors face barriers to international investment foreign investors face no such barriers it turns out that nothing significant is lost with such an assumption the main conclusions of this paper for the case in which foreign investors face no barriers to international investment are 1 in the presence of barriers to international investment some risky foreign

repatriation of debt in the euro crisis with the beginning of the euro crisis the long standing trend of european financial integration reversed investors unwound cross border positions of debt obligations and increased holdings of locally issued debt in other words debt obligations were repatriated we use data on bank portfolios to document three new empirical regularities of the financial disintegration i repatriation affected mainly debt of crisis countries ii repatriation affected mainly public debt iii the public debt of crisis countries that was not repatriated was reallocated to large and politically influential countries within the euro area we read these results in light of standard theories of cross border portfolio allocation and argue that the sum of these patterns constitutes evidence for the secondary market theory of public debt

segmentation and time of day patterns in foreign exchange markets abstract this paper sheds light on a puzzling pattern in spot foreign exchange markets domestic currencies appreciate depreciate systematically during foreign domestic working hours this phenomenon spans many years and several exchange rates and overrides calendar effects we argue that it is mainly due to liquidity and inventory patterns that emerge from the combination of two factors domestic agents tend to be net buyers of foreign currency and to trade mostly in their country s working hours the prevalence of domestic foreign traders demanding the counterpart currency during domestic foreign working hours implies sell price buy price pressure on the domestic currency during domestic foreign working hours

foreign institutional investment is governance quality at home important abstract this paper examines the investment preferences of foreign institutional investors investing in the u s market we analyse both firm and country level determinants that influence the foreign institutional investors allocation choices at the country level we find that the governance quality in a foreign institutional investor s home country is a determinant of their decision to invest in the u s market our findings indicate that investors who come from countries with governance setups similar to that of the u s invest more in the united states the investment levels though are more pronounced for countries with governance setups just below that of the u s our results are consistent with both the flight to quality and familiarity arguments and help reconcile prior contradictory empirical evidence at the firm level we present unequivocal evidence in favour of the familiarity argument foreign institutional investors domiciled in countries with high governance quality prefer to invest in u s firms with high corporate governance quality this effect is primarily driven by grey non monitoring institutional investors

confidence in the familiar an international perspective one striking feature of intemrnational portfolio investment is the extent to which equity portfolios are concentrated in the domestic equity market of the investor the home bias puzzle i examine the role of investors perception of foreign investment risk on their portfolio choices the expected retumrns and risk of foreign investment are specified through an asset pricing model with the home portfolio being the benchmark asset pastor s 2000 domestic capm the model serves as a reference point around which investors can center their prior beliefs i focus on investors prior beliefs that are consistent with the literature on confidence in the familiar foreign equities in terms of both expected returns and risk being viewed less favorably than domestic equities these prior beliefs are then combined with the data on g7 equities and the revised beliefs are used to obtain the global optimal asset allocation to hold predominantly domestic equities each g7 investor has to believe that the risk of foreign investment is several times higher than the actual risk the home bias is more of a puzzle for a u s investor during the 1970s specifying investors prior beliefs around the world capm does not help resolve the puzzle

evaluating risky consumption paths the role of intertemporal substitutability abstract in dynamic stochastic welfare comparisons a failure clearly to distinguish between risk aversion and intertemporal substitutability can result in misleading assessments of the impact of risk aversion on the welfare costs of consumption risk changes the problem arises in any setting in which uncertainty is propagated over time notably but not exclusively in economies with stochastic consumption trends regardless of the preference setup adopted an increase in risk aversion amplifies the per period costs of risks the weights consumers use to cumulate the per period costs of risks with persistent effects should however depend on intertemporal substitutability as well as on risk aversion under time separable expected utility preferences an increase in the period utility function s curvature therefore alters the welfare effect of risk for reasons that are in part unrelated to risk aversion to illustrate these points i reconsider lucas s estimate of the cost of consumption instability for the postwar united states

market standards in financial contracting the euro s effect on debt securities abstract the introduction of the euro ushered in a rise to dominance of english contract law in european debt securities corporate issuers in the euro zone chose english law significantly more often than a control group from other european countries the euro effect on choice of law is particularly strong for debt securities in local markets that arguably were most affected by the euro the euro effect is not explained by differences in the suitability of english law compared to other laws a change in issuer composition or debt securities types and the greater market share of british and american underwriters we argue that increased standardization benefits network effects from a boost in cross border investment provide the best account of why english law conquered the european debt securities market

monetary policy and foreign price disturbances under flexible exchange rates a stochastic approach the analysis of monetary policy under flexible exchange rates has received extensive treatment during recent years particular attention has been devoted to the role of exchange rate expectations with a general conclusion being that many of the propositions of the traditional static flemingmundell model see fleming 8 and mundell 19 require substantial modification once such expectations are taken into account see 5 21 24 with few exceptions the analysis has been carried out in a deterministic framework the usual assumption made is that any monetary expansion that is introduced is initially ex ante unanticipated but having taken place it is then ex post expected to be permanent this assumption underlies for example the recent contribution by dornbusch 5 and much of the subsequent work that stems from it l this assumption while very natural is also a polar one in practice agents in the economy may attempt to anticipate monetary policy and the policies themselves

is full banking integration desirable abstract we analyze the links between banking integration and economic development for a sample of oecd countries we measure banking integration considering indicators that merge not only openness but also connectedness with other banking systems we plug these indicators into income regressions also controlling for other relevant variables considered by the literature in contrast to previous initiatives this second stage explicitly takes into account the differing levels of economic development of the countries in our sample since the benefits of enhanced banking integration might not be generalizable to this end we implement quantile regression also considering the presence of endogenous regressors results show that bank connectedness is more important for economic development than bank openness but the combined effect i e banking integration overall is positive and significant the quantile regression models used in the second stage show that the effects are stronger for the poorest economies

does home bias affect firm value evidence from holdings of mutual funds worldwide this study finds strong evidence that home bias affects firm valuation at both country and firm levels at the country level increasing the bias of domestic investors toward home equity lowers the market valuation of home equity at the firm level firm value increases as the compositions of local equities held by domestic and foreign investors tend toward the firms global market capitalization weights but decreases as their weights deviate from global weights overall the evidence is consistent with the optimal global risk sharing hypothesis that the greater risk sharing between domestic and foreign investors in international capital markets reduces the cost of capital and hence enhances market valuation

have world country and industry risks changed over time an investigation of the volatility of developed stock markets this paper uses a volatility decomposition method to study the time series behavior of equity volatility at the world country and local industry levels between 1974 and 2001 there is no noticeable long term trend in any of the volatility measures then in the 1990s there is a sharp increase in local industry volatility compared to market and country volatility thus correlations among local industries have declined more assets are needed to achieve a given level of diversification and there is more of a penalty for not being well diversified by industry local industry volatility leads the other volatility measures

network models of spatial oligopoly with an application to deregulation of electricity generation because of the existence of transmission costs and significant scale economies in power production deregulation of electricity generation would lead to spatial oligopolistic markets this paper uses linear programs to obtain short run spatial price equilibria for a deregulated bulk power market in upstate new york these models unlike most previous models of imperfect competition capture spatial variations in production costs and demand functions we present two models one calculates a nash bertrand equilibrium in which each firm believes that rivals will not react to price changes this equilibrium represents the most intense level of competition to be expected the other model yields limit prices that are designed to discourage new firms from entering the market

on the european monetary system the spillover effects of german shocks and disinflation we analyse the disinflationary experience between 1979 93 for two traditionally inflationary countries of the european monetary system france and italy for each country a vector autoregressive model is estimated shocks in the model combine domestic and foreign sources the latter capture the world oil price shocks as well as nominal and real shocks originating in germany under investigation is the hypothesis that shocks originating in germany have a spillover disinflationary effect in france and italy the empirical evidence provides support to the validity of this hypothesis furthermore german shocks account for an important share of the total price variance in france and italy these results indicate that the interaction between countries of the european monetary system has contributed to the success of the disinflationary experiences of the 1980s the evidence sheds therefore some light on potential benefits that may be further realized as countries of the european monetary system move towards

the relative importance of foreign and domestic disturbances for aggregate fluctuations in the open economy switzerland 1964 1981 abstract this paper studies whether the advent of floating exchange rates served to insulate switzerland from economic shocks of foreign origin it estimates a vector autoregression comprising four swiss and three world aggregate time series and interprets the results in terms of the properties of the vector moving average representation implied by the estimates the chief finding is that foreign shocks explain most of the systematic variation of the swiss variables in both regimes

capital flows investment and exchange rates abstract this paper incorporates international capital flows into a two country monetary general equilibrium model of asset prices with investment and production we calculate theoretical covariances between investment the current account the exchange rate and the terms of trade these covariances depend upon the coefficient of relative risk aversion the magnitude and sign of a country s net international indebtedness other properties of tastes and technologies and the stochastic processes on disturbances to productivity and monetary growth rates international capital flows arise from changes in world wealth and its relative composition in foreign and domestic assets