exchange rate fundamentals forecasting and speculation bayesian models in black markets summary although speculative activity is central to black markets for currency the out of sample performance of structural models in those settings is unknown we substantially update the literature on empirical determinants of black market rates and evaluate the out of sample performance of linear models and non parametric bayesian treed gaussian process btgp models against the random walk benchmark fundamentals based models outperform the benchmark in out of sample prediction accuracy and trading rule profitability measures given future values of fundamentals in simulated real time trading exercises however the btgp achieves superior realized profitability accuracy and market timing while linear models do no better than a random walk copyright 2013 john wiley sons ltd

portfolio resampling review and critique a well understood fact of asset allocation is that the traditional portfolio optimization algorithm is too powerful for the quality of the inputs recently a new concept called resampled efficiency has been introduced into the asset management world to deal with estimation error the objective of this article is to describe this new technology put it into the context of established procedures and point to some peculiarities of the approach even though portfolio resampling is a thoughtful heuristic some features make it difficult to interpret by the inexperienced portfolio resampling review and critique a comment

the out of sample success of term structure models as exchange rate predictors a step beyond abstract a large literature suggests that standard exchange rate models cannot outperform a random walk forecast and that the forward rate is not an optimal predictor of the spot rate however there is evidence that the term structure of forward premia contains valuable information for forecasting future spot exchange rates and that exchange rate dynamics display nonlinearities this paper proposes a term structure forecasting model of exchange rates based on a regime switching vector equilibrium correction model which is novel in this context our model significantly outperforms both a random walk and to a lesser extent a linear term structure vector equilibrium correction model for four major dollar rates across a range of horizons

a general mean variance approximation to expected utility for short holding periods the mean variance model is precisely consistent with the expected utility hypothesis only in the special cases of normally distributed security returns or quadratic utility functions there is little evidence however that security returns follow normal distributions see 13 for references and quadratic preferences can be shown to generate implausible results exhibiting increasing absolute risk aversion in the pratt ll arrow 1 2 sense and displaying negative marginal utility after some finite wealth level in addition hakansson 4 has shown that single period mean variance efficient portfolios can have disastrous consequences over time even when return distributions are stationary such criticisms of the mean variance approach within the von neumann morgenstern framework have prompted several writers to suggest that investors maximize the expected value of utility functions with more realistic properties while others have criticized the single period focus of the model one popular alternative utility function is the logarithmic function which exhibits decreasing absolute risk aversion and conveniently leads to myopic decision processes through time i e investors treat each period as if it were the last basing investment decisions on that period s wealth and return distributions only 8 4 other utility functions with constant relative risk aversion such as the power function also imply myopic decision rules within a multiperiod setting

spot and forward volatility in foreign exchange this paper investigates the empirical relation between spot and forward implied volatility in foreign exchange we formulate and test the forward volatility unbiasedness hypothesis which is the volatility analogue to the extensively researched hypothesis of unbiasedness in forward exchange rates using a new data set of spot implied volatility quoted on over the counter currency options we compute the forward implied volatility that corresponds to the forward contract on future spot implied volatility known as a forward volatility agreement we nd statistically signi cant evidence that forward implied volatility is a systematically biased predictor that overestimates future spot implied volatility the bias in forward volatility generates high economic value to an investor exploiting predictability in the returns to volatility speculation and indicates the presence of predictable volatility term premiums in foreign exchange

the speculative efficiency hypothesis the hypothesis that forward prices are the best unbiased forecast of future spot prices is often presented in the economic and financial analysis of futures markets this paper considers the hypothesis independently of its implications for rational expectations or market efficiency and in order to stress this fact the term speculative efficiency is used to characterize the state envisaged under the hypothesis if a market is subject to efficient speculation the supply of speculative funds is infinitely elastic at the forward price that is equal to the expected future spot price the expected future spot price is a market price determined as the solution to the underlying rational expectations macroeconomic model although the paper is primarily concerned with testing this hypothesis in the foreign exchange market the methodology introduced in the paper is of general application to all futures markets this abstract was borrowed from another version of this item

currency premia and global imbalances we show that a global imbalance risk factor that captures the spread in countries external imbalances and their propensity to issue external liabilities in foreign currency explains the cross sectional variation in currency excess returns the economic intuition is simple net debtor countries offer a currency risk premium to compensate investors willing to finance negative external imbalances because their currencies depreciate in bad times this mechanism is consistent with exchange rate theory based on capital flows in imperfect financial markets we also find that the global imbalance factor is priced in cross sections of other major asset markets

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

an exploration of the forward premium puzzle in currency markets a standard empirical finding is that expected changes in exchange rates and interest rate differentials across countries are negatively related implying that uncovered interest rate parity is violated in the data this article provides new empirical evidence that suggests that violations of uncovered interest rate parity and its economic implications depend on the sign of the interest rate differentially a framework related to term structure models is developed to account for the puzzling relationship between expected changes in exchange rates and interest rate differentials estimation results suggest that a particular term structure model can account for the puzzling empirical evidence article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

overnight information and stochastic volatility a study of european and us stock exchanges abstract this paper provides a comprehensive evaluation of the predictive ability of information accumulated during nontrading hours for a set of european and us stock indexes we introduce a stochastic volatility model which conditions on lagged overnight information distinguishes between the nontrading periods of weeknights weekends holidays and long weekends and allows for an asymmetric leverage effect on the impact of overnight news we implement bayesian methods for estimation and ranking of the empirical models and find two key results i there is substantial predictive ability in financial information accumulated during nontrading hours and ii the performance of stochastic volatility models improves considerably by separating the asymmetric impact of positive and negative news made available over weeknights weekends holidays and long weekends

disadvantage and discrimination in self employment caste gaps in earnings in indian small businesses using the 2004 2005 india human development survey data we estimate and decompose the earnings of household businesses owned by historically marginalized social groups known as scheduled castes and tribes scsts and non scsts across the earnings distribution we find clear differences in characteristics between the two types of businesses with the former faring significantly worse the mean decomposition reveals that as much as 55 of the caste earnings gap could be attributed to the unexplained component quantile regressions suggest that gaps are higher at lower deciles providing some evidence of a sticky floor finally quantile decompositions reveal that the unexplained component is greater at the lower and middle deciles than higher suggesting that scst owned businesses at the lower and middle end of the conditional earnings distribution face greater discrimination

forward and spot exchange rates in a multi currency world separate literatures study violations of uncovered interest parity uip using regression based and portfolio based methods we propose a decomposition of these violations into a cross currency a between time and currency and a cross time component that allows us to analytically relate regression based and portfolio based facts and to estimate the joint restrictions they put on models of currency returns subject to standard assumptions on investors information sets we find that the forward premium puzzle fpp and the dollar trade anomaly are intimately linked both are driven almost exclusively by the cross time component by contrast the carry trade anomaly is driven largely by cross sectional violations of uip the simplest model that the data do not reject features a cross sectional asymmetry that makes some currencies pay permanently higher expected returns than others and larger time series variation in expected returns on the u s dollar than on other currencies importantly conventional estimates of the fpp are not directly informative about expected returns because they do not correct for uncertainty about future mean interest rates once we correct for this uncertainty we never reject the null that investors expect high interest rate currencies to depreciate not appreciate

where are the gains from international diversification eafe and international marketlike mandates are popular with u s institutional fund sponsors the rationale seems to be that the international equity market has higher expected returns than the u s equity market and can substantially diversify u s portfolios the empirical evidence for the 1970 94 period does not support either claim nor does theory help asset pricing models do not argue that risk factors have geographically different expected returns recent research for the u s market shows that two risk factors value and size explain differences in expected returns across equity portfolios preliminary evidence suggests that the same factors work in foreign markets as well international value stocks and international small stocks diversify u s portfolios more than eafe in fact a sensible reason to diversify internationally is to load up on value stocks and small stocks without concentrating in one geographic region if one does not wish to concentrate in such stocks then international di

monetary fundamentals and exchange rate dynamics under different nominal regimes we investigate the dynamic relationship between the us dollar exchange rate and its fundamentals across different exchange rate regimes using data going back to the late 1800s or early 1900s for six industrialized countries for these countries there is evidence of a long run relation between the nominal exchange rate and monetary fundamentals consistent with conventional theories of exchange rate determination we employ a markov switching vector equilibrium correction model that allows for regime shifts in the entire set of parameters and the variance covariance matrix our results suggest that the relative importance of exchange rates and fundamentals in restoring the long run equilibrium level implied by the exchange rate monetary fundamentals model varies significantly over time and is affected by the nominal exchange rate regime in operation

market structure and discrimination the case of small businesses this paper examines bank market structure to draw inferences concerning the role of discrimination in credit markets for small businesses the authors analyze credit application and denial rates loans outstanding and interest rates across demographic groups this set of variables in combination with information on local bank market structure helps them distinguish among borrower preferences lender tastes and inadequate lender information as likely causes of differences in credit market experiences of small business operators from distinct demographic groups the authors find that white men and women can expect similar treatment in credit markets with some benefits to female owned firms located in concentrated banking markets minorities by contrast fare worse than whites moreover by appealing to becker s 1957 classic theories we find some clear evidence to support the view that prejudicial discrimination is at least partly to blame

hedging crude oil using refined product a regime switching asymmetric dcc approach abstract in this paper we explore the strategy on hedging crude oil using refined product we develop a regime switching asymmetric dcc rs adcc model by taking into account both of regime switching and asymmetry in correlations our out of sample findings indicate that rs adcc displays greater hedging effectiveness than some conventional multivariate garch heating oil can better hedge crude oil than gasoline

on the sensitivity of mean variance efficient portfolios to changes in asset means some analytical and computational results tbis paper investigates the sensitivity of meanvariance mv efficientportfolios to changes in the means of individual assets when only a budget constraint is imposed on the investment problem the analytical results indicate that an mv efficient portfolio s weights mean and variance can be extremely sensitive to cbanges in asset means when nonnegativity constraints are also imposed on the problem the computational results confirm that a positively weigbted mv efficient portfolio s weigbts are extremely sensitive to cbanges in asset means but the portfolio s returns are not a surprisingly small increase in the mean of just one asset drives balf the securities from the portfolio yet the portfolio s expected return and standard deviation are virtually uncbanged this paper supersedes should investors hold well diversified portfolios financial support from the natural science and engineering research council of canada is gratefully acknowledged we also acknowledge the most capable assistance of ruth cornale simon ng jean marc potier and frederick shen the paper was presented at simon fraser university and the western finance association meetings in san diego we thank the participants especially stephen brown john herzog john heaney ray koopman and bruce lehmann and the editors jon ingersoll and chester spatt for

introducing new futures contracts reinforcement versus cannibalism abstract in order to assure survival futures exchanges around the world are in constant search of new futures contracts that will generate a profitable level of trading volume introducing new futures contracts may increase or decrease the volume for those contracts already listed using a multi product hedging model in which the perspective has been shifted from portfolio to exchange management we study these effects using data from two exchanges that differ regarding assets traded and market liquidity amsterdam exchanges versus chicago board of trade we show the usefulness of the proposed method the method may also be used to evaluate the benefits for exchanges that plan to internationalize their activities by merging with another exchange or by cross listing other exchanges futures contracts

testing the monetary model of exchange rate determination new evidence from a century of data abstract we test the long run monetary model of exchange rate determination for a collection of 14 industrialized countries using data spanning the late nineteenth or early twentieth century to the late twentieth century interestingly we find support for a simple form of the long run monetary model in over half of the countries we consider for these countries we estimate vector error correction models to investigate the adjustment process to the long run monetary equilibrium in the spirit of meese and rogoff journal of international economics 14 1983 3 24 we also compare nominal exchange rate forecasts based on monetary fundamentals to those based on a naive random walk model

the phillips curve parameter instability and the lucas critique empirical estimation of phillips curve relationships typically indicates the presence of parameter instability this is argued to be due to the fact that the parameters of these equations are reduced form rather than structural parameters estimation of a phillips curve model by methods which allow for time varying parameters permits investigation of the nature and timing of the structural breaks which generate instability this paper estimates such a model by the kalman filter using quarterly data over the period 1972 4 to 1993 3 we find evidence of a gradual decline in the private sector s assessment of the steady state inflation rate during the 1980s but little evidence of the sort of dramatic regime shift predicted by some of the more extreme rational expectations models

carry trades and the performance of currency hedge funds we investigate the performance and risk of currency hedge funds using a large and unique consolidated currency hedge fund dataset we find that a substantial number of hedge funds generate returns that exceed foreign exchange risk premia obtained through carry trades the best alpha generating funds exhibit a performance that persists over a one year horizon this performance persistence is mostly due to compensation for currency risk taking as there is no strong evidence of remuneration for active management the results are robust to biases affecting hedge fund returns alternative carry trade benchmarks and different methodologies used to correct for sample variability

bayes stein estimation for portfolio analysis in portfolio analysis uncertainty about parameter values leads to suboptimal portfolio choices the resulting loss in the investor s utility is a function of the particular estimator chosen for expected returns so this is a problem of simultaneous estimation of normal means under a well specified loss function in this situation as stein has shown the clas sical sample mean is inadmissible this paper presents a simple empirical bayes estimator that should outperform the sample mean in the context of a portfolio simulation analysis shows that these bayes stein estimators provide significant gains in portfolio selection problems

a note on the geometry of shanken s csr t2 test for mean variance efficiency abstract shanken 1985 derives a test for the zero beta capital asset pricing model capm which as he points out is equivalent to a test of the mean variance efficiency of the market portfolio this note illustrates the geometry of shanken s test in the mean variance space

an examination of resampled portfolio efficiency we examined the out of sample performance of using resampled portfolio efficiency an approach proposed in 1998 in international asset allocation strategies for the period january 1983 to may 2000 for most models we used to estimate expected returns using strategies based on resampled portfolio efficiency provided some benefits in terms of improved sharpe ratios and abnormal returns over using traditional mean variance strategies we found little evidence however that active mean variance strategies or resampled efficiency strategies would have generated significantly positive abnormal returns for the time period we considered

bayesian estimation of the global minimum variance portfolio in this paper we consider the estimation of the weights of optimal portfolios from the bayesian point of view under the assumption that the conditional distribution of the logarithmic returns is normal using the standard priors for the mean vector and the covariance matrix we derive the posterior distributions for the weights of the global minimum variance portfolio moreover we reparameterize the model to allow informative andnon informative priors directly for the weights of the global minimum variance portfolio the posterior distributions of the portfolio weights are derived in explicit form for almost all models the models are compared by using the coverage probabilities of credible intervals in an empirical study we analyze the posterior densities of the weights of an international portfolio

sparse and stable portfolio selection with parameter uncertainty a number of alternative mean variance portfolio strategies have been recently proposed to improve the empirical performance of the classic markowitz mean variance framework designed as remedies for parameter uncertainty and estimation errors in portfolio selection problems these alternative portfolio strategies deliver substantially better out of sample performance in this article we first show how to solve a general portfolio selection problem in a linear regression framework then we propose to reduce the estimation risk of expected returns and the variance covariance matrix of asset returns by imposing additional constraints on the portfolio weights with results from linear regression models we show that portfolio weights derived from new approaches enjoy two favorable properties sparsity and stability moreover we present insights into these new approaches as well as their connections to alternative strategies in literature four empirical studies show that the proposed strategies have better

the implications of first order risk aversion for asset market risk premiums abstract in an effort to explain simultaneously the excess return predictability observed in equity bond and foreign exchange markets we incorporate preferences exhibiting first order risk aversion into a general equilibrium two country monetary model when we calibrate the model to us and japanese data we find that first order risk aversion substantially increases excess return predictability however this increased predictability is insufficient to match the data we conclude that the observed patterns of excess return predictability are unlikely to be explained purely by time varying risk premiums generated by highly risk averse agents in a complete markets economy

hedging with futures does anything beat the naive hedging strategy this paper investigates out of sample performance of the naive hedging strategy relative to that of the minimum variance hedging strategy in which the covariance parameters are estimated from 18 e

performance of portfolios optimized with estimation error we explain the poor out of sample performance of mean variance optimized portfolios developing theoretical bias adjustments for estimation risk by asymptotically expanding future returns of portfolios formed with estimated weights we provide closed form non bayesian adjustments of classical estimates of portfolio mean and standard deviation the adjustments significantly reduce bias in international equity portfolios increase economic gains and are robust to sample size and to nonnormality dominant terms grow linearly with the number of assets and decline inversely with the number of past time periods under suitable conditions sharpe ratio maximizing tangency portfolios become more diversified using these approximation methods it may be possible to assess before investing the effect of statistical estimation error on portfolio performance

bayesian asset allocation and u s domestic bias u s investors hold much less international stock than is optimal according to mean variance portfolio theory applied to historical data we investigated whether this home bias can be explained by bayesian approaches to international asset allocation in comparison with mean variance analysis bayesian approaches use different techniques for obtaining the set of expected returns by shrinking the sample means toward a reference point that is inferred from economic theory applying the bayesian approaches to the field of international diversification we found that a substantial home bias can be explained when a u s investor has a strong belief in the global mean variance efficiency of the u s market portfolio and in this article we show how to quantify the strength of this belief we also found that one of the bayesian approaches leads to the same implications for asset allocation as the mean variance tracking error criterion in both cases the optimal portfolio is a combination of the u s market por

discrimination in the small business credit market we use data from the 1993 and 1998 national surveys of small business finances to examine the existence of racial discrimination in the small business credit market we conduct an econometric analysis of loan outcomes by race and find that black owned small businesses are about twice as likely to be denied credit even after controlling for differences in creditworthiness and other factors a series of specification checks indicates that this gap is unlikely to be explained by omitted variable bias these results indicate that the racial disparity in credit availability is likely caused by discrimination

on the equivalence of quadratic optimization problems commonly used in portfolio theory abstract in the paper we consider three quadratic optimization problems which are frequently applied in portfolio theory i e the markowitz mean variance problem as well as the problems based on the mean variance utility function and the quadratic utility conditions are derived under which the solutions of these three optimization procedures coincide and are lying on the efficient frontier the set of mean variance optimal portfolios it is shown that the solutions of the markowitz optimization problem and the quadratic utility problem are not always mean variance efficient the conditions for the mean variance efficiency of the solutions depend on the unknown parameters of the asset returns we deal with the problem of parameter uncertainty in detail and derive the probabilities that the estimated solutions of the markowitz problem and the quadratic utility problem are mean variance efficient because these probabilities deviate from one the above mentioned quadratic optimization problems are not stochastically equivalent the obtained results are illustrated by an empirical study

economic momentum and currency returns abstract past trends in fundamentals linked to economic activity and inflation predict currency returns we find that a trading strategy that goes long currencies with strong economic momentum and short currencies with weak economic momentum exhibits an annualized sharpe ratio of 0 70 and yields a significant alpha when controlling for standard carry momentum and value strategies the economic momentum strategy subsumes the alpha of carry trades suggesting that differences in past economic trends capture cross country differences in carry

good day sunshine stock returns and the weather psychological evidence and casual intuition predict that sunny weather is associated with upbeat mood this paper examines the relationship between morning sunshine in the city of a country s leading stock exchange and daily market index returns across 26 countries from 1982 to 1997 sunshine is strongly significantly correlated with stock returns after controlling for sunshine rain and snow are unrelated to returns substantial use of weather based strategies was optimal for a trader with very low transactions costs however because these strategies involve frequent trades fairly modest costs eliminate the gains these findings are difficult to reconcile with fully rational price setting

the statistics of sharpe ratios the building blocks of the sharpe ratio expected returns and volatilities are unknown quantities that must be estimated statistically and are therefore subject to estimation error this raises the natural question how accurately are sharpe ratios measured to address this question i derive explicit expressions for the statistical distribution of the sharpe ratio using standard asymptotic theory under several sets of assumptions for the return generating process independently and identically distributed returns stationary returns and with time aggregation i show that monthly sharpe ratios cannot be annualized by multiplying by 12 except under very special circumstances and i derive the correct method of conversion in the general case of stationary returns in an illustrative empirical example of mutual funds and hedge funds i find that the annual sharpe ratio for a hedge fund can be overstated by as much as 65 percent because of the presence of serial correlation in monthly returns and once this

home bias in open economy financial macroeconomics standard theory would predict that investors hold a well diversified portfolio of equities across the world but despite the process of financial globalization investors still hold a disproportionate share of local equities in their portfolio the equity home bias french and poterba 1991 we review the various explanations of this puzzling phenomenon in the context of recent developments in macroeconomic modelling that have allowed to incorporate sophisticated international portfolio choices in standard two country general equilibrium models we refer to this literature as open economy financial macroeconomics we focus on three broad classes of explanations i hedging motives in frictionless financial markets real exchange rate and non tradable income risk ii asset trade costs in international financial markets such as transaction costs differences in tax treatments between national and foreign assets iii informational frictions and behavioural biases these recent developments raise the need for new portfolio facts beyond the equity home bias and we will present some new evidence on cross border asset holdings across different types of assets equities bonds and bank lending we also present some new micro data on institutional holdings of equity at the fund level these data should inform macroeconomic modelling of the open economy and a growing literature of models of delegated investment

financial and legal constraints to growth does firm size matter using a unique firm level survey database covering 54 countries we investigate the effect of financial legal and corruption problems on firms growth rates whether these factors constrain growth depends on firm size it is consistently the smallest firms that are most constrained financial and institutional development weakens the constraining effects of financial legal and corruption obstacles and it is again the small firms that benefit the most there is only a weak relation between firms perception of the quality of the courts in their country and firm growth we also provide evidence that the corruption of bank officials constrains firm growth

the monetary exchange rate model as a long run phenomenon abstract pure time series based tests fail to find empirical support for monetary exchange rate models in this paper we apply pooled time series estimation on a forward looking monetary model resulting in parameter estimates which are in compliance with the underlying theory based on a panel version of the engle and granger engle r f granger c w j 1987 co integration and error correction representation estimation and testing econometrica 55 251 276 two step procedure we find that the residuals of the panel based estimated monetary model are stationary this indicates that on a pooled time series level there is cointegration between the exchange rate and the macroeconomic fundamentals of this monetary model

factor pricing in a finite economy abstract prior theoretical derivations of the arbitrage pricing theory apt bound an aggregate measure of the deviation of mean asset returns from that predicted by a linear pricing equation it is conceivable given this bound that some assets might be badly mispriced by the model in this paper a more intuitive derivation of the factor pricing equation is presented which describes the deviation on an asset by asset basis the deviation is shown to be small for assets in a realistic finite economy and is arbitrarily close to zero for those assets with arbitrarily small size relative to aggregate wealth it follows that the linear pricing equation provides a good approximation for the mean returns of all traded assets

the relationship between oil prices and exchange rates revisiting theory and evidence abstract this paper reviews existing theoretical and empirical research on the relationship between oil prices and exchange rates we start with theoretical transmission channels which point to bi directional causality empirical research is classified and shows that the evidence varies substantially depending on sample country choice and empirical method yet there are some common patterns i strong links between exchange rates and oil prices are frequently observed over the long run and ii either exchange rates or oil prices are a potentially useful predictor of the other variable in the short run but the effects are strongly time varying we also identify some important avenues for future research

accounting for forward rates in markets for foreign currency absteract forward and spot exchange rates between major currencies imply large standard deviations of both predictable returns from currency speculation and of the equilibrium price measure the intertemporal marginal rate of substitution representative agent theory with time additive preferences cannot account for either of these properties we show that the theory does considerably better along these dimensions when the representative agent s preferences exhibit habit persistence but that the theory fails to reproduce some of the other properties of the data in particular the strong autocorrelation of forward premiums since the advent of flexible exchange rates in the early 1970s a large body of statistical work has established that forward rates for major currencies are not optimal predictors of future spot rates relevant evidence is reported in studies by baillie lippens and mcmahon 1983 bekaert 1991 bilson 1981 boothe and longworth 1984 cumby 1988 cumby and obstfeld 1984 fama 1984 gregory and mccurdy 1984 hansen and hodrick 1983 hodrick and srivastava 1984 and korajczyk and viallet 1990 a more complete list of references is provided by hodrick 1987 these papers indicate that returns from speculation in forward and spot currency markets are predictable and that the predictable components vary considerably over time a number of alternative explanations have been offered for the predictable variation in foreign currency market excess returns kaminsky 1988 korajczyk 1985 and krasker 1980 suggest that infrequent extreme events may make returns appear predictable in small samples the so called peso problem lewis 1989 argues that rational learning following infrequent changes in the process governing equilibrium prices can explain part of the ex post predictability of currency returns froot and frankel 1989 and froot and thaler 1990 examine the hypothesis that market forecasts of future spot

anomalies foreign exchange most all behavior can be explained by assuming that agents have stable well defined preferences and make rational choices consistent with those preferences in markets that eventually clear an empirical result qualifies as an anomaly if it is difficult to rationalize or if implausible assumptions are necessary to explain it within the paradigm this column will present a series of such anomalies readers are invited to suggest topics for future columns by sending a note with some reference to or better yet copies of the relevant research comments on anomalies printed here are also welcome the address

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

error correction modelling and dynamic specifications as a conduit to outperforming the random walk in exchange rate forecasting the proposition that dynamic exchange rate models can outperform the random walk in out of sample forecasting in the sense that they produce lower mean square errors is examined and disputed by using several dynamic versions of three macroeconomic exchange rate models it is demonstrated that dynamic specifications outperform the corresponding static models but improvement in the forecasting power may not be sufficient for the dynamic models to perform better than the random walk the results are explained by suggesting that any dynamic specification or transformation of the static model leads to the introduction of a lagged dependent variable which in effect is a random walk component the analysis leads to the conclusion that it is implausible to aim at beating the random walk by augmenting a static model with a random walk component

a utility based comparison of some models of exchange rate volatility abstract when estimates of variances are used to make asset allocation decisions underestimates of population variances lead to lower expected utility than equivalent overestimates a utility based criterion is asymmetric unlike standard criteria such as mean squared error to illustrate how to estimate a utility based criterion we use five bilateral weekly dollar exchange rates 1973 1989 and the corresponding pair of eurodeposit rates of homoskedastic garch autoregressive and non parametric models for the conditional variance of each exchange rate garch models tend to produce the highest utility on average a mean squared error criterion also favors garch but not as sharply

unanticipated monetary policy and real economic activity some cross regime evidence abstract classical equilibrium models of business cycles predict several consequences of policy regime shift this paper examines these predictions using evidence from the post 1979 period and by comparing several pre war monetary regimes the policy invariance proposition and the lucas hypothesis receive some support from the evidence although some discrepancies remain

do lenders discriminate against minority and woman entrepreneurs abstract this paper draws on a conceptual analysis of discrimination to improve the methodology for estimating discrimination in small business credit markets and to provide some evidence about the possible causes of discrimination in these markets using a variety of statistical enhancements to existing studies we find statistically significant evidence of substantial discrimination in loan approval against black owned and hispanic owned businesses in 1998 we also find some hints that this discrimination takes the form of statistical discrimination driven by lenders stereotypes about the ability of black and hispanic owned businesses to succeed under some circumstances although we find no discrimination on average in interest rates on approved loans we also find that black owned businesses do face discrimination in interest rates when they borrow from finance companies and businesses such as mutual fund companies and leasing companies with a primary mission other than lending these findings suggest that federal financial regulatory agencies should re double their efforts to uncover and prosecute lenders who discriminate against black and hispanic owned businesses and that new tools may be needed to find discrimination by firms not well covered by the existing fair lending enforcement system

the role of asymmetries and regime shifts in the term structure of interest rates we examine the relationship between interest rates of different maturities for the us germany and japan over the period 1982 2000 using a general multivariate vector equilibrium correction modelling framework capable of simultaneously allowing for asymmetric adjustment and regime shifts this approach has a very general underlying theoretical rationale that allows for time varying term premia and other short run deviations from the expectations model of the term structure the resulting nonlinear models provide good in sample fits display regime switches closely related to key state variables driving monetary policy decisions and have satisfactory out of sample forecasting properties

the sampling error in estimates of mean variance efficient portfolio weights this paper presents an exact finite sample statistical procedure for testing hypotheses about the weights of mean variance efficient portfolios the estimation and inference procedures on efficient portfolio weights are performed in the same way as for the coefficients in an ols regression ols t and f statistics can be used for tests on efficient weights and when returns are multivariate normal these statistics have exact t and f distributions in a finite sample using 20 years of data on 11 country stock indexes we find that the sampling error in estimates of the weights of a global efficient portfolio is large

why is it so difficult to outperform the random walk an application of the meese rogoff puzzle to stock prices some economists suggest that the meese rogoff puzzle is equally applicable to the stock market in the sense that no model of stock prices can outperform the random walk in out of sample forecasting we argue that this is not a puzzle and that we should expect nothing but this result if forecasting accuracy is measured by the root mean square error rmse and similar metrics that take into account the magnitude of the forecasting error only we demonstrate by using two models for dividend paying and nondividend paying stocks that as price volatility rises the rmse of the random walk rises but the rmse of the model rises even more rapidly making it unlikely for the model to outperform the random walk

on biases in the measurement of foreign exchange risk premiums abstract the hypothesis that the forward rate is an unbiased predictor of the future spot rate has been consistently rejected in recent empirical studies this paper examines several sources of measurement error and misspecification that might induce biases in such studies although previous inferences are shown to be robust to a failure to construct true returns and to omitted variable bias arising from conditional heteroskedasticity in spot rates we show that the parameters were not stable over the 1975 89 sample period estimation that allows for endogenous regime shifts in the parameters demonstrates that deviations from unbiasedness were more severe in the 1980s jel f31

the economic value of volatility timing using a range based volatility model abstract there is growing interest in utilizing the range data of asset prices to study the role of volatility in financial markets in this paper a new range based volatility model was used to examine the economic value of volatility timing in a mean variance framework we compared its performance with a return based dynamic volatility model in both in sample and out of sample volatility timing strategies for a risk averse investor it was shown that the predictable ability captured by the dynamic volatility models is economically significant and that a range based volatility model performs better than a return based one

the time variation of risk and return in foreign exchange markets a general equilibrium perspective this article successively introduces variable velocity durability and habit persistence in a standard two country general equilibrium model and explores their effects on the variability of exchange rate changes forward premiums and the foreign exchange risk premium a new feature of the model is that agents make decisions at a weekly frequency and face conditionally heteroskedastic shocks nevertheless even the most complex model fails to deliver sufficiently variable risk premiums without causing forward premiums and exchange rates to be excessively variable unlike previous models the model can roughly match the persistence of forward premiums article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

an economic evaluation of empirical exchange rate models this paper provides a comprehensive evaluation of the short horizon predictive ability of economic fundamentals and forward premiums on monthly exchange rate returns in a framework that allows for volatility timing we implement bayesian methods for estimation and ranking of a set of empirical exchange rate models and construct combined forecasts based on bayesian model averaging more importantly we assess the economic value of the in sample and out of sample forecasting power of the empirical models and find two key results 1 a risk averse investor will pay a high performance fee to switch from a dynamic portfolio strategy based on the random walk model to one that conditions on the forward premium with stochastic volatility innovations and 2 strategies based on combined forecasts yield large economic gains over the random walk benchmark these two results are robust to reasonably high transaction costs

full bayesian inference for garch and egarch models a full bayesian analysis of garch and egarch models is proposed consisting of parameter estimation model selection and volatility prediction the bayesian paradigm is implemented via markov chain monte carlo methodologies we provide implementation details and illustrations using the general index of the athens stock exchange

posterior predictive and utility based approaches to testing the arbitrage pricing theory abstract to provide a framework for judging the economic significance of departures from the arbitrage pricing theory we adopt a utility based metric based on optimal portfolio choices this measure is examined using both predictive and posterior analysis our predictive analysis shows very large and economically significant departures from the model restrictions however the high level of parameter uncertainty suggests that we cannot conclusively either affirm or reject the apt our conclusions differ markedly from other studies which employ traditional significance testing procedures and in many instances fail to reject the apt restrictions

uncertainty aversion in a heterogeneous agent model of foreign exchange rate formation this paper provides what we believe to be the first empirical test of whether investors in the foreign exchange market are uncertainty averse we do this using a heterogeneous agents model in which fundamentalist and chartist beliefs of the exchange rate co exist and are allowed to be either uncertainty neutral or uncertainty averse uncertainty aversion is modelled using the maxmin expected utility approach we find significant evidence of uncertainty aversion in the fx market where in particular fundamentalists are found to be largely uncertainty neutral while chartists are mainly uncertainty averse inclusion of uncertainty averse agents significantly improves the performance of the model

international portfolio diversification with estimation risk international portfolio diversification has long been advocated as a way of enhancing average returns while reducing portfolio risk for the investor who considers diversifying into foreign securities this proposition however relies on the assumption that the required inputs to the classical mean variance analysis are known with certainty typically expected returns variances and covariances are simply replaced by their ex post sample values and the optimal portfolio is derived without mentioning the uncertainty inherent in these parameter values but the rational investor should take this uncertainty into account when forming expectations and probably will consider estimators that are less subject to estimation error than the classical sample mean this paper investigates alternative estimators of expected returns and their implications for the alleged gains from diversification an important observation is the crucial influence that errors in estimating expected returns have on portfolio analysis a closer examiprevious studies of international portfolio diversification have relied on ex post meanvariance analysis without considering the problem of estimation risk typically past averages are substituted for expected returns and no allowance is made for the uncertainty inherent in these parameter values first i demonstrate the shortcomings of such an approach and second i investigate another method of estimating expected returns initially proposed by stein by shrinking the sample averages toward a common mean i find that the out of sample performance of the optimal portfolio is substantially increased one of the implications of this method is that the classical conclusions vastly overestimate the possible gains in average returns instead benefits from diversification are more likely to accrue from a reduction in risk this paper draws on part of my dissertation at the university of chicago i am grateful to arnold zellner michael mussa george constantinides and especially john bilson for useful discussions and comments numerous improvements were also suggested by the referee this research received the generous financial support of the college interuniversitaire d etudes doctorales dans les sciences du management

the taylor rule and forecast intervals for exchange rates in this paper we examine the meese rogoff puzzle from a different perspective out of sample interval forecasting while most studies in the literature focus on point forecasts we apply semiparametric interval forecasting to a group of exchange rate models forecast intervals for 10 oecd exchange rates are generated and the performance of the empirical exchange rate models are compared with the random walk our contribution is twofold first we find that in general exchange rate models generate tighter forecast intervals than the random walk given that their intervals cover out of sample exchange rate realizations equally well our results suggest a connection between exchange rates and economic fundamentals economic variables contain information useful in forecasting distributions of exchange rates we also find that the benchmark taylor rule model performs better than the monetary ppp and forward premium models and its advantages are more pronounced at longer horizons second the bootstrap inference framework proposed in this paper for forecast interval evaluation can be applied in a broader context such as inflation forecasting

caste and credit a woeful tale this paper examines caste based differences in farmers access to bank loans in rural india we investigate whether banks practice taste based discrimination on the basis of caste in order to identify potential discrimination we consider loan applications and approval decisions separately we find significant inter caste differences in application rates and evidence of discrimination against scheduled tribe borrowers at the approval stage to rule out the role of statistical discrimination we simulate unobserved credit histories with various distributions evidence for taste based discrimination persists despite accounting for unobservables however we find that this discrimination does not affect small farmers

the adaptive markets hypothesis evidence from the foreign exchange market we analyze the intertemporal stability of excess returns to technical trading rules in the foreign exchange market by conducting true out of sample tests on previously studied rules the excess returns of the 1970s and 1980s were genuine and not just the result of data mining but these profit opportunities had disappeared by the early 1990s for filter and moving average rules returns to less studied rules also have declined but have probably not completely disappeared high volatility prevents precise estimation of mean returns these regularities are consistent with the adaptive markets hypothesis lo 2004 but not with the efficient markets hypothesis

access to credit by small businesses how relevant are race ethnicity and gender this paper employs data from the 1998 and 2003 survey of small business finances to analyze whether after controlling for observable factors that influence loan decisions there is a significant difference in the loan approval rate and the interest rate charged on approved loans for businesses owned by minority or white females and firms owned by white males

risk premia carry trade dynamics and economic value of currency speculation in this paper we derive the dynamics and assess the economic value of currency speculation by formalizing the concept of a trader inaction range we show that exchange rate returns comprise a time varying risk premium and that uncovered interest parity uip holds in a speculative sense the often cited forward bias puzzle originates from the omission of the risk premium in standard uip tests consistent with its popularity among market professionals the carry trade strategy can be rationalized as it systematically collects risk premia and generates economic value when applied in multi currency portfolios

gender gap in peer to peer lending evidence from china abstract this paper documents and analyzes the gender gap in the online credit market using data from renrendai a leading peer to peer lending platform in china we show that lending to female borrowers is associated with better loan performance including a lower probability of default a higher expected profit and a lower expected loss than for their male peers however despite the higher creditworthiness we don t find any measurable gender impact on funding success rate meaning that female borrowers have to compensate lenders by providing higher profitability to achieve a similar funding probability these evidences indicate the existence of a gender gap that discriminate against female borrowers further analysis implies that this gender gap is independent of the amount of information disclosed by borrowers

the benefits of lending relationships evidence from small business data this paper empirically examines how ties between a firm and its creditors affect the availability and cost of funds to the firm we analyze data collected in a survey of small firms by the small business administration the primary benefit of building close ties with an institutional creditor is that the availability of financing increases we find smaller effects on the price of credit attempts to widen the circle of relationships by borrowing from multiple lenders increases the price and reduces the availability of credit in sum relationships are valuable and appear to operate more through quantities rather than prices

recent changes in macro policy and its effects some time series evidence has the macroeconomic policy regime changed in the united states in the last few years if so has this change had an effect on macroeconomic relationships and in particular on the relationship between inflation and unemployment these two questions have been on the minds of most macroeconomists since the october 1979 switch from interest rates to reserves as an intermediate target for the federal reserve and the explicit endorsement of monetarism by the reagan administration in early 1981 the questions are important not only for predicting the course of the economy in the future but also for assessing the practical significance of the lucas critique according to this critique a change in policy regime should cause changes in the way the economy operates comparing economic relations before and after a change in regime should provide a test of the critique the approach in many recent studies has been to assume that the answer to the first question is yes that there has been a significant change in the macroeconomic policy regime and to look for changes in the phillips curve as a test of the lucas critique thus far the results have been mixed otto eckstein 1983 steven englander and cornelis los 1983 and george perry 1983 conclude that there has been no significant change in the phillips curve relationship phillip cagan and william fellner 1983 and wayne vroman 1983 find some evidence of a change wage inflation has come down more quickly especially in 1982 and early 1983 than would be predicted from a phillips curve however the assumption that there has been a regime change has received little empirical attention the october 1979 switch from interest rate targetting to reserve targetting at the fed is usually taken as prima facie evidence of a significant change in policy regime but such changes in operating procedures per se do not necessarily entail a change in policy regime relevant for macroeconomic purposes if they did then the renewed emphasis on interest rates rather than reserves starting in late 1982 should be cited as evidence of a return to the old regime a view which few researchers have taken in fact studies have shown that either interest rates or reserves can be used as intermediate targets for controlling the money supply and ultimately aggregate demand the choice between the two depends on whether shocks to the money markets are from the demand side or the supply side the issue of importance for assessing whether a regime change has taken place is how much the fed reacts by adjusting the money supply appropriately defined in response to conditions in the economy the procedure it uses to bring about this response is irrelevant 2 implicit in a macroeconomic policy regime is a rule relating the money supply to economic con 404 woodrow wilson school princeton university princeton nj 08544 this research was supported by a grant from the national science foundation at the national bureau of economic research and conducted in part at the federal reserve bank of philadelphia i am grateful to steve fries for research assistance and to steven englander and comelis los for comments on an earlier draft see robert lucas 1976 william fellner s 1978 credibility hypothesis is similar to the lucas critique in this context and has been tested in similar ways 2some have argued that for political reasons by focusing on reserves the fed would be able to let interest rates go higher than under interest rate targetting with reserve targetting fed officials could shift the blame for high interest rates elsewhere

barking up the wrong tree measuring gender gaps in firm s access to finance abstractthe literature on gender based discrimination in credit markets is recently expanding but the results are not yet definitive and have not been generally agreed upon this paper exploits a new dataset on barbados jamaica and trinidad and tobago which provides detailed information about female ownership and management in firms for investigating the existence of a gender gap in access to finance the evidence presented herein suggests that more precise measures of the gender composition of the firm show that women led businesses are more likely to be financially constrained than other comparable firms

gender bias and credit access we extract an exogenous measure of gender bias from survey responses by descendants of u s immigrants on questions about the role of women in society we then use data on around 6 000 small business firms from 17 countries and find that in high gender bias countries female entrepreneurs are more likely to opt out of the loan application process and to resort to informal finance even though banks do not appear to actively discriminate against them these results are not driven by credit risk differences between female and male owned firms or by any idiosyncrasies in the set of countries in our sample

optimal and naive diversification in currency markets demiguel et al demiguel v garlappi l uppal r 2009 optimal versus naive diversification how inefficient is the 1 n portfolio strategy rev financial stud 22 5 1915 1953 showed that in the stock market it is difficult for an optimized portfolio constructed using mean variance analysis to outperform a simple equally weighted portfolio because of estimation error in this paper we demonstrate that portfolio optimization can be made to work in currency markets the key difference between the two settings is that in currency markets interest rates provide a predictor of future returns that is free of estimation error which permits the application of mean variance analysis we show that over the last 26 years a mean variance efficient portfolio constructed in this fashion has a sharpe ratio of 0 91 versus only 0 15 for the equally weighted portfolio we also consider the practical implementation of this strategy this paper was accepted by neng wang finance

the past present and future of macroeconomic forecasting he reports of the death of large scale macroeconomic forecasting models are not exaggerated but many observers interpret the failure of the early models as indicative of a bleak future for macroeconomic forecasting more generally such is not the case although the large scale macroeconomic forecasting models didn t live up to their original promise they nevertheless left a useful legacy of lasting contributions from which macroeconomic forecasting will continue to benefit they spurred the development of powerful identification and estimation theory computational and simulation techniques comprehensive machinereadable macroeconomic databases and much else moreover past failures do not necessarily imply a bleak future we learn from our mistakes just as macroeconomics has benefitted from rethinking since the 1970s so too will macroeconomic forecasting understanding the future of macroeconomic forecasting requires understanding the interplay between measurement and theory and the corresponding evolution of the nonstructural and structural approaches to forecasting nonstructural macroeconomic forecasting methods attempt to exploit the reduced form correlations in observed macroeconomic time series with little reliance on economic theory structural models in contrast view and interpret economic data through the lens of a particular economic theory structural econometric forecasting because it is based on explicit theory rises and falls with theory typically with a lag structural keynesian macroeconomic forecasting based on postulated systems of decision rules enjoyed a golden age in the 1950s and 1960s following the advances in keynesian theory in the 1930s and 1940s

the price variability volume relationship on speculative markets this paper concerns the relationship between the variability of the daily price change and the daily volume of trading on the speculative markets our work extends the theory of speculative markets in two ways first we derive from economic theory the joint probability distribution of the price change and the trading volume over any interval of time within the trading day and second we determine how this joint distribution changes as more traders enter or exit from the market the model s parameters are estimated by fiml using daily data from the 90 day t bills futures market the results of the estimation can reconcile a conflict between the price variability volume relationship for this market and the relationship obtained by previous investigators for other speculative markets this paper concerns the relationship between the variability of the daily price change and the volume of trading on speculative markets previous empirical studies 2 3 6 12 14 16 of both futures and equity markets always find a positive association between price variability as measured by the squared price change ap2 and the trading volume 2 there are two explanations for the relationship clark s 2 explanation which is secondary to his effort to explain why the probability distribution of the daily price change is leptokurtic emphasizes randomness in the number of within day transactions in clark s model the daily price change is the sum of a random number of within day price changes the variance of the daily price change is thus a random variable with a mean proportional to the mean number of daily transactions clark argues that the trading volume is related positively to the number of within day transactions and so the trading volume is related positively to the variability of the price change the second explanation is due to epps and epps 6 their model examines the mechanics of within day trading the change in the market price on each within day transaction or market clearing is the average of the changes in all of the traders reservation prices epps and epps assume there is a positive relationship between the extent to which traders disagree when they revise their reservation prices and the absolute value of the change in the market price that is an increase in the extent to which traders disagree is associated with a larger absolute price change the price variability volume relationship arises then because the volume of trading is positively related to the extent to which traders disagree when they revise their reservation prices

assessing the lucas critique in monetary policy models empirical estimates of monetary policy rules suggest that the behavior of u s monetary policymakers changed during the past few decades however for that same time period statistical analyses of lagged representations of the economy such as vars often have not rejected the null of structural stability these two sets of empirical results appear to contradict the lucas critique this paper reconciles these results with the lucas critique by showing that the apparent policy invariance of reduced forms is consistent with the magnitude of historical policy shifts and the relative insensitivity of the reduced forms of plausible forward looking macroeconomic specifications to policy shifts

the term structure of forward exchange premiums and the forecastability of spot exchange rates correcting the errors we develop a framework to extract information regarding subsequent spot rate movements from the term structure of forward exchange premiums while admitting possible deviations from rationality and