a behavioral framework for time diversification the box of factors that we call risk is both too large and too small the box is large enough to include many sometimes conflicting measures of risk variance and semivariance probabilities of losses and their amounts but the box is too small to include factors that affect choices but fall outside the boundaries of risk frames and cognitive errors self control and regret we explore the role of these factors in time diversification the belief that time diversification reduces risk underlies the current drive to invest social security funds in stocks but is such investment prudent we discuss the role of advisors in providing prudent advice changes in the standards of prudence over time the use of time diversification in guiding investors to prudent portfolios and its use in the current debate on social security

estimation of de facto flexibility parameter and basket weights in evolving exchange rate regimes a new technique for estimating countries de facto exchange rate regimes synthesizes two approaches one approach estimates the implicit de facto basket weights in an ols regression of the local currency value rate against major currency values here the hypothesis is a basket peg with little flexibility the second estimates the de facto degree of exchange rate flexibility by observing how exchange market pressure is allowed to show up here the hypothesis is an anchor to the dollar or some other single major currency but with a possibly substantial degree of exchange rate flexibility around that anchor it is important to have available a technique that can cover both dimensions inferring anchor weights and the flexibility parameter we test the synthesis technique on a variety of fixers floaters and basket peggers we find that real world data demand a statistical technique that allows parameters and regimes to shift frequently accordingly we here take the next step in estimation of de facto exchange rate regimes endogenous estimation of parameter breakpoints following bai and perron jel numbers f31 f41

temporal aggregation in political budget cycles electoral cycles have been widely debated since the pioneering studies of the 1970s on monetary and fiscal policy 1 drazen sums up the evidence in terms of active fiscal policy and passive monetary policy while expansionary fiscal policy is the main impulse behind electoral cycles monetary policy has an accommodating role 2 recently there has been a flurry of empirical work on political budget cycles pbcs using cross country panels the most influential works concentrate on the budget surplus because it can capture both increases in expenditures and tax cuts before elections and is thus the most sensitive indicator of aggregate pbcs 3a drawback of these extant studies is their reliance on annual observations since elections take place between january and december annual data do not allow one to identify the election year precisely to get around this problem other schemes have been proposed for example by the rule of the semester the previous year is counted as the election year if elections take place before july 4 what are the consequences of temporal aggregation for the measurement of pbcs instead of being concentrated in the election year pre electoral effects may be spread out over the two years leading up to elections more important if the sign of policies is reversed after elections lower frequency data may mask pbcs because the effects in the election year cancel out as akhmedov and zhuravskaya point out in their country study of russia 5to illustrate the differences between using annual and quarterly data to identify the election year imagine that elections take place in june furthermore assume there is a pre electoral deterioration in the budget surplus surplus 1 during the four quarters running up to elections followed by an improvement surplus 1 the next four quarters in the calendar year in which elections take place the net effect on the budget surplus is zero elections are not always in june of course what happens if elections are evenly spread out over the year table 1 presents a simulation where y 0 is the calendar year of elections y 1 is the year before and y 1 is the year after for elections in the first quarter of the election year namely y 0 q 1 our textbook example of a pre electoral expansion in the deficit during the four quarters prior to elections followed by a contraction the next four quarters implies that the surplus equals 1 from y 1 q 2 to y 0 q 1 it equals 1 from y 0 q 2 to y 1 q 1 and it equals 0 otherwise when the budget surplus is at its average value normalized here at zero the same procedure is followed for elections in the other three quarters if we aggregate the effects by calendar year there is a serious underestimation of pbcs in the election year since pre electoral expansions are almost cancelled out by post electoral contractions leaving a net expansive effect that is only 25 percent of the total stimulus before elections the least affected by temporal aggregation are post electoral fiscal adjustments since 62 5 percent of the total effect is reflected the year after elections on the other hand if there were no post electoral fiscal adjustments the problem of temporal aggregation would be much less severe since 62 5 percent of the total expansive effect would be reflected the calendar year of elections and 37 5 percent the year before this paper tackles the issue of temporal aggregation in pbcs head on we build a cross country panel with annual and quarterly data from nineteen latin american countries and twenty member states of the organization for economic cooperation and development oecd over the 1980 2005 period 6 quarterly data allow us to identify the election year more precisely with annual data the election year is the calendar year in which elections take place with quarterly data the election year comprises the election quarter plus the three prior quarters we introduce two nonstandard features in our analysis

risk rationality and time diversification the validity of the concept of time diversification is the subject of long running debate supporters of the concept argue that risk decreases as investment horizon increases detractors suggest that the concept is false on the face of it we argue that time diversification is consistent both theoretically and empirically with current conceptions of risk and rationality and we also note the implications of changes in investment horizon for stock market behavior

on the risk of stocks in the long run a note in a recent article in this journal zvi bodie used a simplified black scholes model to prove that the cost of insuring a long term stock portfolio against earning less than the risk free rate increases over time bodie believes that this means the risk of investing in common stocks increases over time and that the conventional wisdom of the investment community concerning time diversification is a fallacy bodie s proof relies on a constant standard deviation for common stock over all holding periods this assumption however may not be appropriate for long term stock portfolios this article is not available online

predicting exchange rate crises mexico revisited abstract this paper predicts ex ante probabilities of currency crises and sizes of expected devaluations month by month for mexico between 1980 and 1986 the forces contributing to speculative attacks on the mexican peso include domestic fiscal and monetary shocks external credit shocks and relative price shocks reducing domestic credit growth increasing the uncertainty surrounding this growth and reducing the size and perhaps increasing the frequency of currency realignments might have greatly reduced the amount of currency speculation against the peso between 1980 and 1986 anticipated external credit supply shocks played a relatively minor role during mexico s balance of payments crises

factor and spread analysis of the convertible securities market factor decomposition demonstrates that during certain time periods the convertible market has offered excess returns over a well allocated bond equity portfolio moreover because the magnitude of these returns spans a wide range of values investors can use this valuation framework as a tool for estimating the relative attractiveness of convertibles compared with their underlying equity and fixed income components analysis of yield spreads demonstrates the changing nature of valuation levels embedded in convertible securities a factor analysis of a market weighted equity index underlying convertibles shows that their equity component is well diversified across two major dimensions value versus growth and large cap versus small cap

pegged exchange rate regimes a trap this paper studies the empirical and theoretical association between the duration of a pegged exchange rate and the cost experienced upon exiting the regime we confirm empirically that exits from pegged exchange rate regimes during the past two decades have often been accompanied by crises the cost of which increases with the duration of the peg before the crisis we explain these observations in a framework in which the exchange rate peg is used as a commitment mechanism to achieve inflation stability but multiple equilibria are possible we show that there are ex ante large gains from choosing a more conservative not only in order to mitigate the inflation bias from the well known time inconsistency problem but also to steer the economy away from the high inflation equilibria these gains however come at a cost in the form of the monetary authority s lesser responsiveness to output shocks in these circumstances using a pegged exchange rate as an anti inflation commitment device can create a trap whereby the regime initially confers gains in anti inflation credibility but ultimately results in an exit occasioned by a big enough adverse real shock that creates large welfare losses to the economy we also show that the more conservative is the regime in place and the larger is the cost of regime change the longer will be the average spell of the fixed exchange rate regime and the greater the output contraction at the time of a regime change

the political economy of inflation and stabilization in developing countries the traditional literature on inflation in developing countries has focused on three main determinants of inflationary pressures a money creation b fiscal imbalances and c cost push elements while the first two factors have been emphasized by authors of a monetarist persuasion cost factors have played a crucial role in the structuralist theories developed during the 1950s and 1960s however more recent analyses on inflation and stabilization have shifted their attention away from traditional direct economic causes of inflation such as money creation toward political and institutional determinants of inflationary forces this new literature which has come to be known as the political economy approach to macroeconomic policy has built on some important insights of game theory and the theory of public choice trying to explain why some governments decide to run large fiscal deficits and to rely heavily on the inflation tax typically in answering these questions this recent strand of the literature has emphasized the role of political instability credibility reputation and political cycles 2 in spite of providing some important new insights into the determinants of inflation this new literature is subject to two limitations first until recently most of the contributions have been theoretical without providing empirical tests on their most important implications and second the emphasis has been almost exclusively on the industrialized countries ignoring the developing nations the purpose of this article is to discuss selectively some of the most important insights of this new literature on policy making from the developing countries perspective i will emphasize the policy implications of this approach to inflationary analysis and discuss some of the limited empirical results

explaining currency crises a duration model approach abstract in this paper we estimate a duration model for oecd countries during the 1970 97 period we use semiparametric methods to estimate a model with unrestricted base line hazards and test if the time length already spent on a tranquil period is a determinant of the probability of exit into a currency crisis state the results indicate first that increases in export growth bank deposits growth and openness decrease the probability of exit into a currency crises state whereas increases in import growth claims on government and foreign port folio investment and appreciated reer increase the probability of currency crises and second the existence of a highly significant negative duration dependence the highest probability of exit into a currency crash state is given at the initial of the tranquil period

can leading indicators assess country vulnerability evidence from the 2008 09 global financial crisis abstract we investigate whether leading indicators can help explain the cross country incidence of the 2008 09 financial crisis rather than looking for indicators with specific relevance to the recent crisis the selection of variables is driven by an extensive review of more than eighty papers from the previous literature on early warning indicators our motivation is to address suspicions that indicators found to be useful predictors in one round of crises are typically not useful to predict the next round the review suggests that central bank reserves and past movements in the real exchange rate were the two leading indicators that had proven the most useful in explaining crisis incidence across different countries and episodes in the past for the 2008 09 crisis we use six different variables to measure crisis incidence drops in gdp and industrial production currency depreciation stock market performance reserve losses and participation in an imf program we find that the level of reserves in 2007 appears as a consistent and statistically significant leading indicator of who got hit by the 2008 09 crisis in line with the conclusions of the pre 2008 literature in addition to reserves recent real appreciation is a statistically significant predictor of devaluation and of a measure of exchange market pressure during the current crisis we define the period of the global financial shock as running from late 2008 to early 2009 which probably explains why we find stronger results than earlier papers such as obstfeld et al 2009 2010 and rose and spiegel 2009a b 2010 2011 which use annual data

capital controls and balance of payments crises abstract the theory of balance of payments crises shows that under perfect foresight a system of fixed exchange rate is not sustainable in the presence of diverging economic policies in this paper it is shown how and why capital controls succeed in maintaining the principle of a fixed but adjustable parity both cases of a devaluation and a revaluation are considered and a condition for a parity change to be credible is presented

electoral business cycles in oecd countries studies of oecd countries have generally failed to detect real economic expansions in the pre election period casting doubt on the existence of opportunistic political business cycles we develop a theory that predicts a substantial portion of the economy experiences a real decline in the pre election period specifically the political uncertainty created by elections induces private actors to postpone investments with high costs of reversal the resulting declines referred to as reverse electoral business cycles are larger the more competitive the electoral race and the greater the polarization between major parties we test these predictions using quarterly data on private fixed investment in ten oecd countries between 1975 and 2006 the results suggest that reverse electoral business cycles exist and as expected depend on electoral competitiveness and partisan polarization moreover simply by removing private fixed investment from gross domestic product gdp we uncover robust evidence of opportunistic cycles

inequality and real exchange rates kocherlakota and pistaferri 2007 describe two different models private information pareto optimal and incomplete markets of how households partially insure themselves against idiosyncratic shocks they demonstrate that the models differ in terms of their implications for real exchange rates in this paper we use data from a wide range of countries and document that there is a statististically significant relationship between real exchange rate growth and between country differences in the growth rates of right tail but not left tail inequality growth this finding is consistent with the private information pareto optimal model of partial insurance but not the incomplete markets model jel f31 d30 d91

who can adjust to the euro this study estimates potential exchange rate variation among 26 european countries during 1992 1998 as a proxy for the potential magnitude of adjustment they face to euro block membership using the instrumental variable iv method applying least squares cross section regression analysis based on optimal currency area theory a currency union among belgium denmark france germany ireland malta the netherlands and slovenia is found to entail a relatively light burden of adjustment for its members the current membership of other countries in the euro block is potentially very demanding on their societies in the long term this study also compares currency boards and independent central banks as alternative monetary frameworks for disinflation policies based on a pooled time series cross section dataset of the same countries and years currency boards are found to be more effective in reducing inflation in all countries except belgium balancing emu s credibility gains against its adjustment costs finland greece italy portugal and spain seem like unstable members of the euro block for all new eu member states except the czech republic malta slovenia and slovakia the advice is to stay out of the euro block until their economies are liberalised and flexible enough to withstand major adjustments and their societal interest groups supportive enough of these adjustments

sudden stops and phoenix miracles in emerging markets a decade has passed since the salvos from mexico s tequila crisis of 1994 1995 echoed around the financial world since then many more crises have taken place in emerging market economies ems furthermore crises have tended to bunch together bringing to the forefront the systemic nature of these events true every new crisis has its own idiosyncratic features but useful policy lessons must be derived from robust empirical regularities this is the research strategy we have pursued in the last few years we will report on two types of regularities that strike us as highly robust across em crises a sudden stops of capital inflows and b phoenix miracles a sudden stop is a sharp fall in capital inflows relative to their past trajectory sudden stops are not a common feature in developed economies and display a large degree of temporal bunching suggesting that global capital market turmoil acts as a coordinating factor external to ems as shown in section i however balance sheet effects namely the interaction of large changes in the real exchange rate during sudden stops and liability dollarization i e foreign exchange denominated debts are key in influencing the likelihood of a sudden stop thus even though the initial shock is in principle exogenous to the economy whether or not it materializes into a sudden stop depends on domestic financial vulnerabilities on the other hand a phoenix miracle is defined as a case in which output recovers relatively quickly from a sharp collapse with virtually no recovery in credit or capital inflows and a very weak recovery in investment hence the reference to the mythical bird rising from the ashes the existence of phoenix like recoveries suggests that financial frictions play a key role in pushing economies to the abyss from which in some way or another they can crawl back to safe ground by means less than apparent to the conventional observer looking for standard fundamentals and thus may appear miraculous interestingly the great depression of the 1930s shares some of the key features of phoenix miracles in ems but shows salient differences as well that suggest nominal labor market rigidities are not crucial in explaining output collapse in ems understanding these regularities could and we believe does shed light on policies aimed at preventing crises and attenuating their effects

choosing an exchange rate system abstract the focus of academic discussions of exchange rate policy has shifted in recent years the new literature on exchange rate regime choice emphasizes considerations relating to the problems of credibility in exchange rate targeting and the connections between exchange rate regime choices and choices of monetary and fiscal policy arguments for exchange rate targeting are reviewed under most circumstances and for most countries a system of freely floating exchange rates is likely to be a better choice than attempting to peg the exchange rate

time diversification and estimation risk the recommendation that investors with long investment horizons tilt their portfolios toward stocks is commonplace we used a nonparametric bootstrap approach to investigate whether in a mean variance efficient portfolio the weights for u s stocks and u s t bills vary in a systematic manner with investment horizon this approach allowed us to analyze the impact of estimation risk on the optimal weights of stocks and fixed income securities the results show that an investor can gain from time diversification the weights for stocks in an efficient portfolio were significantly larger for long investment horizons than a one year horizon

elections and the timing of devaluations this paper presents a rational political budget cycle model where devaluation acts as a tax on consumption due to a cash in advance constraint competent governments can signal their competency by reducing the rate of devaluation prior to elections when voters also ignore the degree to which governments are opportunistic i e the extent to which they are willing to distort the economy for electoral gain an incompetent opportunistic incumbent can reduce the rate of devaluation in the run up to an election the main theoretical implication in either setup that the rate of devaluation is significantly higher in the months following an election is consistent with evidence drawn from 26 countries in latin america d 2003 elsevier b v all rights reserved

guaranteeing individual accounts global aging is prompting workers and taxpayers everywhere to recognize their vulnerability to the inherent uncertainty of unfunded social security systems this has generated an international wave of social security reforms over the last two decades prompting more than 20 countries to establish individual account ia plans in the united states the idea of individual accounts has attracted recent interest with the release of the final report of the president s commission to strengthen social security csss here voluntary individual accounts were proposed as a key element of a reformed national old age system see commission to strengthen social security 2001 john f cogan and mitchell 2003 strengths of ia s include the fact that participants gain ownership in their accounts and diversify their pension investments nevertheless ia participants also must bear capital market risk recent market volatility has reminded investors of the importance of capital market fluctuations and their potential impact on retirement income in response some policymakers have suggested that guarantees be designed to help protect ia investments abroad such guarantees have been adopted in several latin american countries undergoing reform and most recently in japan and germany mitchell and kent smetters 2003 sensible public policy recommending the adoption of guarantees must identify their costs and who will pay for them in this paper we discuss how to evaluate such costs in the context of a social security reform that includes ia s along with ways to finance them

exploring different views of exchange rate regime choice the empirical distinction between de facto and de jure exchange rate regimes raises a number of interesting questions which factors may induce a de facto peg why do countries enforce a peg but do not announce it why do countries break their promises we show that a stable socio political environment and an efficient political decision making process are a necessary prerequisite for choosing a peg and sticking to it challenging the view that sees the exchange rate as a commitment device policymakers seem rather concerned with regime sustainability in the face of adverse economic and socio political fundamentals

exchange rate regime durability and performance in developing versus advanced economies abstract drawing on new data and advances in exchange rate regimes classification we find that countries appear to benefit by having increasingly flexible exchange rate systems as they become richer and more financially developed for developing countries with little exposure to international capital markets pegs are notable for their durability and relatively low inflation in contrast for advanced economies floats are distinctly more durable and also appear to be associated with higher growth for emerging markets our results parallel the baxter and stockman classic exchange regime neutrality result though pegs are the least durable and expose countries to higher risk of crisis

currency crises and institutions abstract this study furthers recent literature on currency crises and institutions the main objective is to re evaluate the causes of currency crises by focusing on the role played by a broader array of institutional factors and crisis episodes than have previously been considered while at the same time controlling for economic factors our dataset consists of over 30 countries covering 13 institutional factors for the period 1984 2002 two questions are addressed they are 1 what mix of institutions may contribute to or set the stage for a currency crisis and 2 what mix of institutions may affect the depth of currency crises as measured by a decline in output our findings reveal that institutional as well as economic factors affect the probability of currency crises and that worse institutions are associated with bigger contractions in output during the crisis in general our strongest results regarding institutions show that corruption a de facto fixed exchange rate regime weak government stability and weak law and order increase the probability of a currency crisis we find mixed evidence that deposit insurance the removal of capital controls a lack of central bank independence financial liberalization and civil law increase the chance of crisis we find a similar set of factors worsens the contraction in output during a crisis except for deposit insurance which we find moderates the contraction in output

temporary stabilization predetermined exchange rates the paper analyzes the impact of a stabilization policy based on a temporary reduction in the rate of devaluation against a background in which a constant rate of devaluation has no real effects it is shown that the temporary policy does and furthermore that the real effects tend to become bigger in absolute value as the horizon of the temporary policy is shortened the central discussion is carried out in terms of a one good cash in advance model with perfect capital mobility and ramsey type consumers results are extended to account for home goods and variable velocity the roles of capital mobility and banking liberalization are briefly discussed

equilibrium political budget cycles political business cycle theories generally rely on nominal rigidities and voter myopia this paper offers an equilibrium theory that preserves some basic insights from earlier models though with significant refinements the political budget cycle emphasized here is in fiscal policy rather than output and inflation it arises via a multidimensional signal process one can consider the welfare implications of proposals to mitigate the cycle and the effects of altering the electoral structure copyright 1990 by american economic association

asset pricing in a generalized mean lower partial moment framework theory and evidence a new asset pricing model that generalizes earlier results in the downside risk literature is developed and empirically tested using a multivariate approach by specifying risk as deviations below any arbitrary target rate of return the generalized mean lower partial moment mlpm model overcomes the limited appeal of earlier formulations and moreover a large class of extant pricing models using alternative risk measures variance semivariance semideviation probability of loss etc becomes special cases of the new framework empirical tests indicate that the new model cannot be rejected against an unspecified alternative for a large set of target rates of return the traditional capm on the other hand is rejected as a well specified alternative the mlpm target rates inferred from market data appear to be related to equity market mean returns rather than to the riskfree rate the target rate that is implicit in the capm and explicit in earlier downside risk formulations the attractiveness of downside risk measures for decision making purposes has been noted in the financial economic literature for over a quarter of a century 1 risk from this perspective is measured in terms of deviations below some exogenously prespecified target rate of return and a formal analysis of these risk measures for various utility functions has been presented by bawa 1975 in terms of the lower partial moment lpm of the asset distributions the appeal of these risk measures has been based in part on their consistency with the way individuals actually perceive risk notwithstanding its intuitive appeal this area of research has been virtually neglected in recent years we believe that this disaffection with downside risk models tends from two sources first earlier models of this genre exogenously specify the target rate to equal the risk free interest rate in the absence of a satisfactory theory for explaining how investors establish their target rates this assumption as argued herein has been motivated more by technical reasons than economic considerations second empirical tests

pegging emerging currencies in the face of dollar swings the aim of this article is to study ruptures of exchange rate pegs by focusing on the fluctuations of the anchor currency we test for the hypothesis that currencies linked to the usd are more likely to loosen their peg when the usd is appreciating while sticking to it otherwise to this end we estimate smooth transition regression models for a sample of 28 emerging currencies over the 1994 2011 period our findings show that while the real effective exchange rates of most of these countries tend to co move with that of the usd in times of depreciation this relationship is frequently reversed when the us currency appreciates over a certain threshold

the time diversification controversy some financial theorists reject the widely held practitioner belief in time diversification the theorists argue that given serially uncorrelated returns holding a risky asset over longer periods of time will not reduce its inherent riskiness the argument is supported by references to economic models of risk aversion such as mean variance optimization and expected utility theory mean variance optimizers however are not indifferent to investment horizon and investment horizon indifference is only a special case within expected utility theory furthermore to the extent that models reject the notion of time diversification they are inadequate because they are inconsistent with common sense measures of risk at very long horizons

misconceptions about optimal equity allocation and investment horizon our analysis and results offer some resolution to a debate that has continued for 30 years we demonstrate that in contrast to prior claims no conflict exists between the implications of economic models of choice under uncertainty and a rational investor preference for larger equity allocations at longer investment horizons using examples of expected utility of wealth and mean variance utility we show that the effect of a longer horizon on risky asset allocation is consistent with increasing or decreasing optimal equity allocations even under the assumption of constant relative risk aversion

on the risk of stocks in the long run a resolution to the debate in response to the ongoing debate in this journal about whether the risk of investments in the stock market is increased or decreased by lengthening the investment period we show that bodie s attempt to identify market risk with the price of put options leads to a circular argument within the workings of arbitrage free option pricing models thus bodie failed to rebut the conventional view that longer investment horizons may be thought of as less risky bodie s put option prices are relevant however to determining market prices of stock investment insurance

the price consumption puzzle of currency pegs abstract a defining stylized fact associated with exchange rate based stabilization programs is that their initial phase is characterized by several years of continuous expansion in private consumption and a gradual appreciation of the real exchange rate this paper shows that a large class of standard optimizing models is unable to account for this empirical regularity in particular models in this class predict that a gradual appreciation of the real exchange rate must necessarily be accompanied by a declining path of consumption the paper suggests several possible solutions to this problem and develops one in detail namely the relaxation of the assumption of time separability in preferences specifically it shows that under habit formation currency pegs induce a positive comovement between consumption and the real exchange rate the paper also establishes that habit formation provides an explanation for why in failed currency pegs a contraction in aggregate demand sets in before the collapse of the program

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

liquidity loanable funds and real activity abstract this paper develops a general equilibrium model of two traditional explanations of the monetary black box linking money and real activity the liquidity effect and the loanable funds effect these effects are modeled with a monetary production economy in which central bank injections of cash are funnelled into the economy through the credit market since only borrowers have direct access to the newly injected cash monetary injections cause nominal interest rates to fall if firms are borrowers then monetary injections also increase current and future real activity

the role of financial development in exchange rate regime choices abstract we make the first attempt in the literature to empirically investigate the role of financial development in the choice of exchange rate regimes using a binary choice model we first show that financially less developed countries are more likely to adopt a fixed exchange rate to further examine the impact of financial development on the conditional probability of exiting from an existing pegged system to a flexible one we then employ hazard based duration analysis we find strong evidence that countries with higher levels of financial development are more likely to exit a pegged system and interestingly financial development only matters to orderly exits but not disorderly exits our results are robust to controlling for endogeneity and sample selection

an improved immunization strategy m absolute current immunization models have limited power in interest rate risk protection a new approach entitled m absolute is designed to provide powerful and practical single risk measure immunization in particular circumstances m absolute is similar to m square but is derived as a first order lower bound immunization risk model like duration m absolute can be implemented as a simple single risk measure immunization model m absolute of a bond is defined as the weighted average of the absolute distances of the bond s cash flows from a horizon point even though it is a single risk measure m absolute can act effectively to reduce the impacts of several types of interest rate risks rather than hedge against only a single type of term structure shift empirical tests show that m absolute reduces the interest rate risk inherent in the traditional duration model by more than half these results are independent of the particular time period chosen

when to dollarize implicit in the debate over dollarization are two very different views of the sequencing of policy measures one view is that dollarization to work smoothly and yield more benefits than costs must wait on the completion of complementary reforms the other view is that dollarization need not wait on these other reforms because the very act of dollarizing will produce the changes needed to smooth the operation of the new regime in this paper i consider these arguments as they apply to the cases of labor market reform fiscal reform and financial sector reform i conclude that neither theory nor evidence suggests that removing all scope for an independent monetary policy will necessarily accelerate the pace of reform

asset allocation in a downside risk framework 1991 asset allocation in a downside risk framework financial analysts journal vol 47 no 5 pp 28 40

put prices and pen participation rates at longer horizons is equity risk in the eye of the beholder two recent articles in the financial analysts journal address the question of how equity risk changes as investment horizons grow longer both use analyses based on derivatives pricing examples but draw exactly opposite conclusions we reexamine these authors arguments and find the logic of both analyses is flawed we demonstrate that the use of specialized put option prices as proxies for equity risk yields ambiguous conclusions about equity risk changes at longer investment horizons with added information about an investor s required minimum rate of return however we can specify the change in equity risk at longer horizons with these put prices

investments with downside insurance and the issue of time diversification of two insurance policies that guarantee the same minimum rate of return on a portfolio and differ only in their time horizons which is riskier this study shows that if the minimum rate is lower than the risk free rate and if the risk is measured by the cost of insurance then the degree of risk is not a monotonic function of the policy s time horizon for every positive level of concession rate defined as the risk free rate minus the insured rate the cost of such insurance peaks at a finite time horizon this peak cost horizon is typically between 5 and 15 years the higher the concession rate or the lower the volatility of the insured portfolio the shorter this peak cost time horizon is thus although a 5 year insurance policy can be much riskier than a 1 year policy it can also be riskier than a 30 year policy

political business cycles democratization and economic reform the case of africa abstract this paper presents cross country evidence that political business cycles are alive and well in the nascent democracies of the developing world africa provides fertile ground for the study of political business cycles this paper uncovers systematic electorally timed interventions in five monetary and four fiscal policy variables in a panel of african countries these findings are consistent with the predictions of rational opportunistic political business cycle theory if africa s increasingly frequent elections are associated with reversals of fiscal and monetary policy reform there is a potential conflict between political and economic reform

the monetary model strikes back evidence from the world abstract we revisit the dramatic failure of monetary models in explaining exchange rate movements using the information content from 98 countries we find strong evidence for cointegration between nominal exchange rates and monetary fundamentals we also find fundamentals based models very successful in beating a random walk in out of sample prediction

explaining the duration of exchange rate pegs abstract this paper is an empirical investigation of the duration of exchange rate pegs in 16 latin american countries and jamaica we identify factors that influence peg duration using logit analysis the real exchange rate and the level of international liquidity are significant determinants of the monthly likelihood of devaluation structural variables such as the openness of an economy and its geographical trade concentration and political variables such as changes in the executive also significantly affect the likelihood of a devaluation there is some evidence that the likelihood of a devaluation first rises and subsequently declines during the first year of a peg

second moments in speculative attack models panel evidence abstract the paper tests two popular asset based models of speculative attacks and in particular their emphasis on the second moments of monetary aggregates analyzing monthly panels of appropriate countries in three regions it finds evidence for the importance of money reserve ratios predicted by both models as well as the variance of the ratio of m2 to reserves

fiscal discipline and the choice of a nominal anchor in stabilization abstract the conventional wisdom is that exchange rate based stabilizations induce more fiscal discipline than money based programs the latin american experience does not support this view among the major stabilization programs implemented since 1960 the mean increase in the primary balance to gdp ratio was 3 2 percentage points under money based programs as opposed to only 0 2 percentage points under exchange rate based programs we present a model where fiscal policy is set by an optimizing but non benevolent government that replicates this stylized fact if the policy maker is impatient a money based stabilization provides more discipline and higher welfare for the representative agent than does an exchange rate based stabilization

more on the time consistency of monetary policy abstract we introduce costs of unexpected inflation in a general equilibrium monetary model by changing the timing of the constraints faced by consumers we show that in this environment monetary policy is still time inconsistent but the nature of the inconsistency is very different from the standard result found in the literature in particular we find that the government may find optimal to deviate by choosing inflation rates lower than expected by making a brief review of the monetary literature we argue that the model of this paper is more attractive than the ones proposed before to study the time consistency of optimal monetary policy

macro factors and the affine term structure of interest rates this paper formulates an affine term structure model of bond yields from a dynamic stochastic general equilibrium model with observable macro state variables as the term structure factors model implications for the joint macro term structure dynamics are consistent with the empirical patterns from the var estimation model calibration and simulation exercises also provide clear macroeconomic interpretations of the latent term structure factors as found in the finance literature most of the slope factor movement can be explained by exogenous monetary policy shocks and the level factor movement is closely related to the technology shocks

political stabilization cycles in high inflation economies abstract high inflation economies often exhibit stop go cycles of inflation rather than smooth inflationary processes this paper relates these stop go episodes of inflation to a political cycle the government can try to repress inflation until after the elections in order to increase the chances of being reelected this is modeled as a two period game of incomplete information where voters try to pick the most competent government and inflation which signals lack of competency can be lowered by the government in the short run through foreign debt accumulation several stabilization episodes such as the primavera plan in argentina and the cruzado plan in brazil are used to motivate the model

the dynamics of exchange rate regimes fixes floats and flips the impermanence of fixed exchange rates has become a stylized fact in international finance the combination of the mirage view that pegs do not really peg with the fear of floating view that floats do not really float generates the conclusion that exchange rate regimes are in practice unimportant for the behavior of the exchange rate this is consistent with evidence on the irrelevance of exchange rate regimes for general macroeconomic performance recent studies however show that the exchange rate regime matters this can be understood by considering the dynamics of exchange rate regimes we demonstrate that the mirage view is somewhat misleading and incomplete pegs frequently break but many do last also there is a high degree of flipping that is the re formation of pegs that have broken thus a fixed exchange rate today is a good predictor that one will exist in the future we also investigate the quantitative effect of fixed exchange rates while the fear of floating view suggests little actual difference in fixed and floating rates with respect to exchange rate volatility we show that fixed exchange rates exhibit considerably greater bilateral exchange rate stability than flexible rates both today and in the future 2007 elsevier b v all rights reserved

exchange rate regimes and independent central banks a correlated choice of imperfectly credible institutions theory and empirical evidence show that low inflation is a precondition for economic growth independent central banks and fixed exchange rates are institutional mechanisms that help keep inflation low by lending monetary policy credibility to governments however the two institutions are commonly analyzed as substitutes that tie the hands of inflation prone governments thus the literature has difficulties describing why governments would adopt both institutions and the interaction between them this paper presents a model that allows policymakers the simultaneous choice of monetary institutions and shows that imperfectly credible institutions will overlap when exchange rates are fixed but adjustable and central bank independence is not fully ascertainable governments choose both institutions more generally the paper generates hypotheses about the conditions that make fixed exchange rates and independent central banks complements or substitutes thus contributing to an explanation of the diversity of global monetary institutions in the post bretton woods period

financial policy and speculative runs with a crawling peg argentina 1979 1981 abstract in this paper we present a model of a balance of payments crisis and examine the argentine experiment with a crawling peg between december 1978 and february 1981 the approach taken allows us to examine the evolution of a crisis when a collapse is not perfectly foreseen and yields plausible estimates of one month ahead probabilities of a collapse of the crawling peg the results suggest that the viability of an exchange rate regime depends on the consistency of exchange rate policy with domestic credit policy if the two are not consistent confidence in exchange rate policy is undermined

crisis politics in europe why austerity is easier to implement in some countries than in others when countries face balance of payments crises their policy responses vary widely this article argues that the choice between the two main options of internal adjustment i e austerity and stru

labor supply flexibility and portfolio choice in a life cycle model abstract this paper examines the effect of the labor leisure choice on portfolio and consumption decisions over an individual s life cycle the model incorporates the fact that individuals may have considerable flexibility in varying their work effort including their choice of when to retire given this flexibility the individual simultaneously determines optimal levels of current consumption labor effort and an optimal financial investment strategy at each point in his life cycle we show that labor and investment choices are intimately related the ability to vary labor supply ex post induces the individual to assume greater risks in his investment portfolio ex ante

a theory of optimal timing and selectivity abstract we solve an extended optimal portfolio problem in continuous time for any horizon where we allow the mean and variance of returns to be stochastic introduce fund flows to and from the portfolio permit differential investor preferences for dividend versus growth stocks and allow the investor to buy costly information on the random mean and variance of the portfolio to improve his portfolio choice set this model provides analytical results especially useful in understanding the expenditure on timing and selection information a mutual fund undertakes in attempting to improve performance relative to a benchmark we examine this proposition for growth and income funds long and short investment horizons and also account for fund inflows and outflows we also combine our model of costly learning with the traditional model of incomplete information to understand the interaction between costly and costless learning the approach taken is a purely theoretical one and in this regard the paper is normative in spirit we anticipate that the propositions in this paper will provide two byproducts i a framework for fund managers to think about how to allocate information expenses between timing and selection skills and ii give academics especially empirical researchers a theoretical backdrop against which to examine the mutual fund industry

on the risk of stocks in the long run a familiar proposition is that investing in common stocks is less risky the longer an investor plans to hold them if this proposition were true then the cost of insuring against earning less than the risk free rate of interest should decline as the investment horizon lengthens this paper shows that the opposite is true even if stock returns are mean reverting in the long run the case for young people investing more heavily than older people in stocks cannot therefore rest solely on the long run properties of stock returns for guarantors of money fixed annuities the proposition that stocks in their portfolios are a better hedge the longer the maturity of their obligations is unambiguously wrong

time diversification definitions and some closed form solutions abstract we establish general conditions under which younger investors should invest a larger proportion of their wealth in risky assets than older ones in the finite horizon dynamic setting we show that such phenomenon known as time diversification can occur in the presence of human wealth guaranteed consumption or mean reverting stock returns we formalize two alternative notions of time diversification commonly confounded in the literature analytic solutions are provided for both time series and cross sectional forms of time diversification to our best knowledge this paper is the first to solve in closed form the hedging demand for a cara investor with inter temporal consumption and a finite horizon facing mean reverting expected returns our results indicate that horizon can have a significant effect on the portfolio demand of a cara investor due to inter temporal hedging

on the risk of stocks in the long run a comment diametrically opposite conclusions about stocks long term risk follow from bodie s methodology see financial analysts journal may june 1995 bodie s conclusion that stocks risk increases monotonically with the investment horizon is incorrect conventional wisdom about the long term risk of stocks has not been refuted

improving policy credibility is there a case for african monetary unions abstract this paper analyzes experience with monetary policy in africa focusing on countries that have participated in rule based regional monetary agreements cfa zone east african currency board and rand monetary area we show that african countries have generally lacked the political institutions necessary for governments to commit credibly on an individual basis to financial stability we argue that monetary unions can provide an alternative means of credible commitment to sound macroeconomic policies but only under certain conditions first exit from a union must be made costly by the existence of parallel regional agreements and or links to the financial and technical assistance of industrial countries second governance structures of monetary unions must be designed so as to maximize chances for enforcement of monetary rules and third if a state seeks to break the rules of a union other member governments must actively oppose such attempts

emerging market local currency bond yields and foreign holdings a fortune or misfortune the paper shows that foreign holdings of local currency government bonds in emerging market countries ems have reduced bond yields but have somewhat increased yield volatility econometric analyses conducted from a sample of 13 ems demonstrate that these results are robust and causal we use an identification strategy exploiting the geography based measure of ems financial remoteness vis a vis major offshore financial centers as an instrumental variable for the foreign holdings variable the results also show that in countries with weak fiscal positions foreign holdings are greatly associated with increased yield level a case study using poland data elaborates on the cross country findings

collapsing exchange rate regimes some linear examples abstract we construct a pair of linear examples to study the collapse time of a fixed exchange rate regime the first example is a perfect foresight continuous time model which allows calculation of the exact collapse time and the tracking of reserves the second example is a discrete time stochastic model which yields an endogenous probability distribution over the collapse time and produces a forward discount of the exchange rate

time diversification perspectives from option pricing theory despite repeated theoretical arguments to the contrary many investment professionals subscribe to the principle of time diversification this principle states that equity investments become less risky if held for longer periods of time we apply option pricing theory to the question of how the investment horizon affects equity risk financially engineered securities that guarantee a minimum return allow for greater equity market participation if the investor commits to a longer time horizon in other words the fair cost of insuring a minimum return in terms of foregone market participation is lower for longer horizons the lower cost of risk reduction suggests that risk itself is lower consistent with the pervasive practitioner belief in time diversification

international financial remoteness and macroeconomic volatility abstract this paper shows that proximity to major international financial centers seems to reduce business cycle volatility in particular we show that countries that are farther from major locations of international financial activity systematically experience more volatile growth rates in both output and consumption even after accounting for political institutions trade and other controls our results are relatively robust in the sense that more financially remote countries are more volatile though the results are not always statistically significant the comparative strength of this finding is in contrast to the more ambiguous evidence found in the literature

discounting inside the washington d c beltway places more weight on costs and benefits in the near term over costs and benefits in the future the choice of the discount rate is therefore critical in evaluating the merits of many public policy proposals this article focuses on how the choice of discount rate can dramatically affect policy choices these policies include whether to build a bridge whether to privatize a power marketing administration which sells electricity generated by government owned facilities such as dams how much money should be spent on early childhood education or options for reforming social security the ongoing challenge is to discount future costs or benefits in a way that matches the project s level of riskiness we begin by discussing the underlying issues in choosing an appropriate discount rate we then discuss the variety of different discount rates that are actually used by various washington policymakers and the biases they often generate

fixed versus flexible exchange rates which provides more fiscal discipline abstract conventional wisdom holds that fixed rates provide more fiscal discipline than do flexible rates in this paper we show that this wisdom need not hold in a standard model in which fiscal policy is endogenously determined by a maximizing fiscal authority the claim that fixed rates induce more discipline stresses that sustained adoption of lax fiscal policies must eventually lead to an exhaustion of reserves and thus to a politically costly collapse of the peg hence under fixed rates bad behavior today leads to punishment tomorrow under flexible rates bad behavior has costs as well the difference is in the intertemporal distribution of these costs flexible rates allow the effects of unsound fiscal policies to manifest themselves immediately through movements in the exchange rate hence bad behavior today leads to punishment today if fiscal authorities are impatient flexible rates by forcing the costs to be paid up front provide more fiscal discipline and higher welfare for the representative private agent the recent experience of sub saharan countries supplies evidence that matches the predictions of the model

elections exchange rates and reform in latin america abstract in this paper we study the link between real exchange rate rer depreciation and elections in latin america our contribution is threefold first we employ a statistical model that takes into account the pervasive conditional heteroskedasticity found in financial data and includes a wide range of macroeconomic variables as regressors second we test whether the wave of central bank reform that swept the region has had any effect on the existence or strength of the electoral cycle in exchange rates third we test an additional hypothesis namely that financial liberalization may also be an important variable explaining changes in electoral effects on the real exchange rate in a panel of 9 latin american countries with available macroeconomic data and a history of exogenous election dates we confirm the previous findings that real depreciation intensifies after elections even when modeling the significant conditional heteroskedasticity in these data we also show for the first time in the literature that post election exchange rates are significantly less predictable we go on to test whether central bank reform has influenced the way in which elections affect the rer in latin america if reform has been effective at reducing political manipulation of the exchange rate then any relationship we see between elections and the rer before central bank reform should be mitigated in the post reform era we find that the relationship disappears after reform and that post reform real exchange rates are also significantly less volatile finally we show that financial liberalization seems to have a stronger effect on the conditional variance of the rer than does central bank reform but reform has a stronger impact on the conditional mean

electoral competition with informed and uninformed voters i present a model of electoral competition in which candidates raise campaign contributions by choosing policies that benefit interest groups and then expend those contributions to influence voters who are uninformed about the policies informed voters however vote based on those policies so candidates face a trade off between choosing a policy to generate funds to attract the uninformed vote and choosing a policy to attract the informed vote electoral equilibria are characterized for two categories of policies particularistic and collective in the case of particularistic policies the equilibrium policies of the candidates are separated if the proportion of uninformed voters is sufficiently high and the degree of separation is an increasing function of that proportion the model is extended to include the public financing of elections and incumbency advantages for the case of collective policies the candidates locate at the median of the ideal points of the informed voters and contributions are zero