lessons from the tequila crisis abstract this paper draws several important lessons from the tequila crisis of 1994 and 1995 the overriding lesson is that the dynamics of financial crises in emerging market countries differ from those in industrialized countries because institutional features of their debt markets differ several policy lessons for emerging market countries also emerge from the analysis 1 pegged exchange rate regimes are extremely dangerous 2 strong prudential supervision of the banking system is critical for prevention of financial crises 3 financial liberalization must be managed extremely carefully and 4 different policies are needed to promote recovery in emerging market countries than those that are applicable to industrialized countries

on the link between exchange rate regimes capital controls and monetary policy autonomy in small european countries 1979 2000 we investigate international monetary policy transmission under different exchange rate and capital account regimes in eleven small open economies during the 1980s and 1990s we find no systematic link between ex post monetary policy autonomy and exchange rate regimes capital controls appear to have provided a degree of temporal insulation from foreign monetary policy shocks though not strict autonomy the results are consistent both with short term autonomy for small countries even under fixed exchange rates and an open capital account and with long term dependence under flexible exchange rates and an independent stability target results also indicate that euro area market interest rates are significantly more responsive to the development of the corresponding us rate than were the previous national rates

a review of some of the economic contributions of robert a mundell winner of the 1999 nobel memorial prize in economics introduction robert mundell richly deserves a nobel memorial prize in economics his contributions to the field of international monetary economics were path breaking and have stood the test of time well he chose his problems with great foresight and penetrating intuition imagining economies with features like perfect capital mobility floating exchange rates and supra national currencies at a time when these assumptions would have seemed literally fantastic to most his work remains extraordinarily influential among academics and policy makers as with many great scientists mundell s contributions have been unevenly spread over his lifetime from the late 1950s through the mid 1960s mundell produced an astonishing crop of creative work that remains influential through the present day much of his most significant work was collected in his justly celebrated treatise international economics published in 1968 three of mundell s achievements are particularly worthy of note he single handedly invented the concept of an optimum currency area perhaps

option profit and loss attribution and pricing a new framework this paper develops a new top down valuation framework that links the pricing of an option investment to its daily profit and loss attribution the framework uses the black merton scholes option pricing formula to attribute the short term option investment risk to variation in the underlying security price and the option s implied volatility taking risk neutral expectation and demanding no dynamic arbitrage result in a pricing relation that links an option s fair implied volatility level to the underlying volatility level with corrections for the implied volatility s own expected direction of movement its variance and its covariance with the underlying security return

the economics of exchange rate regimes a review essay the exchange rate regime issue has taken centre stage in discussions of international economic policy much of the profession appears to have been converted to the hypothesis of the vanishing middle regime for countries well integrated into world capital markets there is little if any middle ground between floating exchange rates and monetary unification this paper considers the exchange rate regime issue in the context of recent books on the subject by w max corden and morris goldstein both authors prescribe managed floating exchange rates supplemented with inflation targeting for emerging market economies under managed floating and with a credible monetary policy the public finances in order and strengthened debt management and prudential regulation the exchange rate is free to act as a market gauge for assessing policies and as a mode of conflict resolution both authors also argue however that no exchange rate regime is a holy grail ultimately a credible exchange rate regime depends upon the trust evoked by governments there is no exchange rate regime whether of the managed floating or hard fix variety that can eradicate a history of failed stabilisation attempts

a conditional variance tale from an emerging economy s freely floating exchange rate this article studies daily return and volatility dynamics in the exchange rate of an emerging market economy turkey over the recent floating period we use generalized autoregressive conditional heteroscedastic garch and fractionally integrated garch figarch models with various error distributions findings show that a parsimonious figarch model with an asymmetric error distribution characterizes the daily turkish lira tl returns against us dollar and euro considerably well we find statistically significant asymmetry and peakedness in conditional returns and time varying volatility with long range dependence in conditional volatility long memory finding is robust to different specifications for the conditional returns as well as possible shifts in the return and volatility dynamics over sub periods results in the article show that despite the decline in volatility over the course of the recent float tl returns are still wild compared to developed economies exchange rates during the same period

measuring the pricing error of the arbitrage pricing theory this article provides an exact bayesian frame work for analyzing the arbitrage pricing the ory apt based on the gibbs sampler we show how to obtain the exact posterior distributions for functions of interest in the factor model in particular we propose a measure of the apt pricing deviations and obtain its exact posterior distribution using monthly portfolio returns grouped by industry and market capitalization we find that there is little improvement in reduc ing the pricing errors by including more factors beyond the first one as an important extension of the asset pricing model of sharpe 1964 and lintner 196 5 ross 1976 1977 derived the arbitrage pricing theory apt which addresses a fundamental problem in finance to char acterize the expected return on a security the apt implies that the expected return is approximately a

the behavior of risk and market prices of risk over the nasdaq bubble period we exploit the information in the options market to study the variations of return risk and market prices of different sources of risk during the rise and fall of the nasdaq market we specify a model that accommodates fluctuations in both risk levels and market prices of different sources of risk and we estimate the model using the time series returns and option prices on the nasdaq 100 tracking stock our analysis reveals three key variations during the period from march 1999 to march 2001 first return volatility increased together with the rising nasdaq index level even though the two tend to move in opposite directions second although the market price of diffusion return risk averages around 1 82 over the whole sample the estimates reached negative territory at the end of 1999 the estimates reverted back to highly positive values after the collapse of the nasdaq market third the market price of jump risk increased with the rising nasdaq valuation and this increase in market price coincided with an increased imbalance in open interest between put and call options

blame game politics in a coalition government abstract delays in the adoption of reforms is an important question in political economics this paper explores this issue in the context of a representative democracy where the government is a coalition and citizens observe neither the decision making process nor politicians preferences for a reform we show that a coalition member who favors a reform may nonetheless choose to veto its adoption thus delaying it until after the next election and let his coalition partners share the blame for the non adoption we refer to this strategy as blame game politics we then identify three reasons for a politician to play the blame game one is to make an issue salient in the next election a second reason is to avoid a split in his electorate which is accomplished by hiding his stance on an issue a third reason is to enhance bargaining power during the formation of the next government

reciprocated unilateralism in trade reforms with majority voting this paper shows how unilateral liberalization in one country can increase the voting support for reciprocal reduction in trade barriers in a partner country when trade policies are determined simultaneously in the two countries we show the possibility of multiple political equilibria one in which the countries are both protectionist and another in which they trade freely with each other starting with trade protection in both countries a unilateral reform in one country is shown to bring about a free trade equilibrium that obtains majority support in both countries

why the middle is unstable the political economy of exchange rate regimes and currency crises the contribution of sticky exchange rates to the rash of currency crises over the past decade has become a major topic of international monetary analysis and policy discussion while there is widespread agreement among economists that the middle of the exchange rate spectrum adjustable pegs is highly crisis prone in a world of substantial capital mobility jeffrey frankel has recently argued that surprisingly we lack a clear theoretical rationale for why this is so this paper attempts to fill that void it argues that frankel is correct in terms of economic analysis alone but that when political economy considerations are introduced then a satisfactory explanation is at hand key aspects of this political economy perspective are laid out and implications for exchange rate policy are considered the analysis suggests that for promoting currency stability the traditionally debated distinctions between crawling bands and managed floats are likely less important than the political environments in which they are operated

parametric inference and dynamic state recovery from option panels we develop a new parametric estimation procedure for option panels observed with error we exploit asymptotic approximations assuming an ever increasing set of option prices in the moneyness cross sectional dimension but with a fixed time span we develop consistent estimators for the parameters and the dynamic realization of the state vector governing the option price dynamics the estimators converge stably to a mixed gaussian law and we develop feasible estimators for the limiting variance we also provide semiparametric tests for the option price dynamics based on the distance between the spot volatility extracted from the options and one constructed nonparametrically from high frequency data on the underlying asset furthermore we develop new tests for the day by day model fit over specific regions of the volatility surface and for the stability of the risk neutral dynamics over time a comprehensive monte carlo study indicates that the inference procedures work well in empirically realistic settings in an empirical application to s p 500 index options guided by the new diagnostic tests we extend existing asset pricing models by allowing for a flexible dynamic relation between volatility and priced jump tail risk importantly we document that the priced jump tail risk typically responds in a more pronounced and persistent manner than volatility to large negative market shocks

credibility of policies versus credibility of policymakers standard models of policy credibility defined as the expectation that an announced policy will be carried out emphasize the preferences of the policymaker and the role of tough policies in signaling toughness and raising credibility whether a policy is carried out however will also reflect the state of the economy we present a model in which a policymaker maintains a fixed parity in good times but devalues if the unemployment rate gets too high our main conclusion is that if there is persistence in unemployment observing a tough policy in a given period may lower rather than raise the credibility of a no devaluation pledge in subsequent periods we test this implication on ems interest rates and find support for our hypothesis

systematic risk and the price structure of individual equity options this study demonstrates the impact of systematic risk on the prices of individual equity options the option prices are characterized by the level and slope of implied volatility curves and the systematic risk is measured as the proportion of systematic variance in the total variance using daily option quotes on the s and p 100 index and its 30 largest component stocks we show that after controlling for the underlying asset s total risk a higher amount of systematic risk leads to a higher level of implied volatility and a steeper slope of the implied volatility curve thus systematic risk proportion can help differentiate the price structure across individual equity options the author 2008 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please email journals permissions oxfordjournals org oxford university press

exports and economic growth in bangladesh this study investigates the effect of exports on economic growth in bangladesh based on a two sector growth model using annual data for the period 1961 92 the article estimates an autoregressive conditional heteroscedastic model of economic growth which is found to capture the volatility of the bangladesh economy the results suggest that an increase in the share of investment in gdp significantly increases the growth rate of gdp in normal years but negligibly increases gdp growth in abnormal years abnormalities in the economy arise from war political turmoil and natural disasters the key finding is that export growth has significantly increased economic growth through its positive impact on total factor productivity in the economy the contribution of exports to economic growth was more pronounced during 1982 90 when the government pursued a policy of trade liberalisation and structural reform and political turmoil was not persistent this finding is not sensitive to the choice of the model or t

do call prices and the underlying stock always move in the same direction this article empirically analyzes some properties shared by all one dimensional diffusion option models using sp options are not redundant securities nor ideal hedging instruments puts and the underlying asset prices may go down together much of the extant knowledge about option pricing is based on the assumption that the underlying asset price follows a one dimensional diffusion process examples of such option pricing models include the classic black scholes 1973 merton 1973 the cox ross 1976 constant elasticity of variance the ones studied in derman and kani 1994 rubinstein 1994 bergman grundy and wiener 1996 bakshi cao and chen 1997 2000 and dumas fleming and whaley 1998 all models in the one dimensional diffusion class share three basic properties first call prices are monotonically increasing and put prices are monotonically decreasing in the underlying asset price the monotonicity property second as the underlying asset price is the sole source of uncertainty for all of its options option prices must be perfectly correlated with each other and with the underlying asset the perfect

the new theory of optimum currency areas highbrow opinion is like a hunted hare if you stand long enough it will come back to the place it started from dennis robertson

distributional implications of macroeconomic policy theory and applications to el salvador abstract this article offers a theoretical framework for designing macroeconomic strategy for el salvador that will both respect stabilization and structural adjustment needs and enhance social equity after outlining the largely negative distributional implications of the orthodox policies followed by el salvador in recent years we argue that stabilization and efficiency could actually be improved by increased equity and sketch out the elements of an alternative approach that would be distributionally sensitive and thereby help consolidate the peace

mean variance theory in complete markets two paradigms in the pricing of risky assets are the complete markets model of arrow and debreu and mean variance pricing as embodied in the capital asset pricing model capm the former is primarily of theoretical interest in fact prior to the recent work of banz and miller 1978 and breeden and litzenberger 1978 there was little thought or hope of practical applications on the other hand the hegemony of the capm is due mostly to its apparent ease of applicability and to a lesser extent its empirical justification in a competitive market with no taxes transactions costs or institutional constraints on portfolio holdings the allocation of the available assets will be pareto optimal the end of period distribution of wealth or the consumption goods however will typically be pareto optimal only when there is available an arrow debreu security for each contingency since by definition a pareto superior reallocation is weakly preferred by all investors a complete set of arrow debreu markets should naturally arise provided they are not too costly to establish the complete markets model of arrow and debreu and the meanvariance capital asset pricing model capm are two paradigms of risky asset markets this paper provides an integration of these two theories we prove that the standard meanvariance separation theorem obtains in a complete market only if all investors have quadratic utility in addition the familiar capm pricing relation can hold for all assets in a complete market only if arbitrage opportunities exist on the positive side we show that the validity of this relation for the primary assets in a complete market is unaffected by the distribution of returns on the created financial assets

a primer on monetary and fiscal policy monetary policy can be constrained by fiscal policy if fiscal deficits grow large enough to require monetization of government debt that fact implies that the administrative independence of central banks does not by itself imply that monetary policy is independent of the fiscal decisions of governments this essay describes limitations possibilities and suitable goals for monetary policy within the existing pattern of institutional responsibilities the economic limitations of what can be achieved by monetary policy are summarized in six propositions developed in the paper

labor adjustment and gradual reform when is commitment important we analyze a model in which a government uses a second best policy to affect the reallocation of labor following a change in relative prices we consider two extreme cases in which the government has either unlimited or negligible ability to commit to future actions we discuss the factors that determine the importance of commitment ability and provide numerical examples the degree of commitment ability can alter the equilibrium policy both quantitatively and qualitatively in both extreme cases the dying sector is protected during the transition to a free market in order to decrease the amount of unemployment

economic and monetary union in europe the european council s maastricht agreement maps out a precise route to monetary union and the eventual introduction of a common currency my discussion begins with a look at the general arguments for and against monetary union i shall then discuss the proposed constitution of the european central bank and whether it is likely to be conducive to monetary stability together with some of the problems posed by the transition to the new regime finally i will turn to the issue of rules for the conduct of fiscal policy and the question of fiscal federalism

resistance to reform status quo bias in the presence of individual specific uncertainty comment why do governments so often fail to adopt policies which economists consider to be efficiency enhancing our answer to this question relies on uncertainty regarding the distribution of gains and losses from reform we show that there is a bias towards the status quo and hence against efficiency enhancing reforms whenever some of the individual gainers and losers from reform cannot be identified beforehand there are reforms which once adopted will receive adequate political support but would have failed to carry the day ex ante the argument does not rely on risk aversion irrationality or hysteresis due to sunk costs jel d72 f13 why do governments so often fail to adopt policies that economists consider to be efficiency enhancing this is one of the fundamental questions of political economy the answer usually relies on what may be

international financial crises causes prevention and cures dale jorgenson has bestowed a great honor and no small challenge by inviting me to give this lecture a great honor because of the distinguished list of economists who have preceded me a challenge because of the standard they have set and because there is no greater challenge for any economist than providing a coherent account of significant events to his scientific peers i am sometimes asked by friends about the differences between academic life and life as a public official there are many two stand out first as an academic the gravest sin one can commit is to sign one s name to something one did not write as a public official it is a mark of effectiveness to do so as often as possible second as an academic if a problem is too hard and does not admit of a satisfactory solution there is an obvious response work on a different problem that is not a luxury that one has in government i have been reminded of this often in recent years as we have grappled with financial crises in a number of what had previously been considered emerging markets with unrestrained futures anyone who doubts the social importance of what economists do should consider the debates surrounding these crises hundreds of millions of people who expected rapidly rising standards of living have seen their living standards fall hundreds of thousands if not millions of children have been forced to drop out of school and go to work hundreds of billions of dollars of apparent wealth has been lost the stability of large nations as nations has been called into question and the united states has made its largest nonmilitary foreign policyrelated financial commitments since the marshall plan almost all the issues involved in understanding preventing and mitigating these crises are the stuff of economics courses and research fixed versus flexible exchange rates moral hazard and multiple equilibria speculation and liquidity fiscal and monetary policies regulation and competition what economists think say and do has profound implications for the lives of literally billions of their fellow citizens whether it is discussing the role of derivatives in signaling exchange rate commitments with chinese premier zhu rongji or discussing an nber working paper on inflation targeting with the brazilian central bank governor arminio fraga or discussing alternative approaches to bankruptcy law with indonesia s economic team or optimal debt durations with the mexican authorities i am consistently struck by the impact of the kind of research discussed at the aea meetings the future well being of the world s people in large part will depend on how the ongoing process of global integration works out this is a strong statement but one that is supported by the global economy s post world war i failure and its post world war ii success central to global integration is financial integration the flow of funds and of capital across international borders and as the events of the late 1920 s and early 1930 s remind us central to global disintegration can be international financial breakdowns today i want to reflect on the issue of global financial integration in light of the dramatic and largely unpredicted events of recent years it is perhaps a good time for reflection there has been enough repair that priority can shift from u s department of the treasury 1500 pennsylvania avenue washington dc 20005 this lecture reflects many things i have learned from experiences i have shared with colleagues in the united states government and governments around the world i thank brad delong marty feldstein stephanie flanders ken rogoff andrei shleifer and ted truman for useful comments and suggestions i am especially grateful to nouriel roubini and stephanie flanders for valuable discussions and assistance in the preparation of this lecture the usual disclaimer applies

the role of the variance premium in jump garch option pricing models abstract we develop a discrete time option pricing model incorporating a variance dependent pricing kernel of christoffersen et al 2013 under an economic framework allowing for dynamic volatility and jump intensity based on the model we examine the role of the variance premium and jump risk premium in explaining s p 500 index option prices and returns according to the results the variance premium is equally important as the jump risk premium in explaining the empirical option data whereas the incorporation of the jump risk premium improves the model fit on option prices the incorporation of the variance premium improves the fit on option returns in particular the variance premium can explain both 1 month holding period returns of 2 month maturity straddles which are significantly negative and call returns which decrease according to moneyness the model incorporating the jump risk premium only has a limitation in explaining the above two stylized returns the outperformance of the model incorporating the variance premium on option returns stems from its ability to capture the wedge between physical and risk neutral volatilities

how effective are capital controls a number of authors have recently argued that in order to avoid financial instability emerging countries should rely on capital controls two type of controls have been considered controls on capital outflows and controls on capital inflows in this paper i review the historical evidence on the effectiveness of these two type of controls i argue that controls on outflows have been ineffective they are circumvented and breed corruption i also analyze chile s recent experience with controls on inflows and i argue that their effectiveness has been exaggerated

corporatism trade liberalization and sectoral responses the case of venezuela 1989 99 abstract the venezuelan manufacturing sector unlike agriculture cooperated with state s efforts to liberalize trade in the 1990s despite the economic costs it absorbed and the political opportunities to sabotage the reforms this paper offers two explanations for this which modify and conciliate traditional interest based and corporatist theories of state society relations high levels of sectoral autonomy from the bureaucracy and political parties and hence congress together with low levels of involvement in profit making on the part of the associations representing the sector encourage sectoral cooperation with costly and risky state policies in addition traditional corporatist instruments used by states inducements and constraints hurt rather than enhance state sector cooperation

internationalization institutions and political change many analysts associate internationalization of markets with wide ranging changes in domestic politics an open polity approach shows how extant domestic institutions mediate in this relationship between internationally induced changes in domestic actors policy preferences on the one hand and national policy and institutional outcomes on the other the nature of labor unions and formal political institutions often results in political outcomes that differ significantly from those that would ensue if outcomes simply mirrored preference changes in addition while existing institutions may sometimes constrain governments from pursuing policies that would improve long term economic performance governments will often fail to change these institutions because of short term political considerations

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

a political economic critique on the theory of optimum currency areas and the implications for east asia in recent years dynamic debate has arisen as to the desirability and feasibility of creating a monetary union in east asia while the debate has relied heavily on the theory of optimum currency areas this theory has weaknesses in explaining the actual formation of monetary unions at this point political economy analysis appears to demonstrate stronger explanatory power this paper provides a systematic review of the main developments in the literature on optimum currency area theory and in the political economy literature on monetary union in addition it addresses the feasibility of an east asian monetary union by applying the findings in these two academic strands to the region it finds that even though formation of an east asian monetary union may be to some extent feasible from an economic perspective the region s political situation does not appear favourable for the creation of one

the rise of fund managers in foreign exchange will fundamentals ultimately dominate this paper analyses the behaviour and motivation of fund managers in foreign exchange markets reflected in questionnaire evidence we find that fund managers and fx dealers differ significantly fund managers rely more on fundamentals basically due to their longer forecasting horizons and reject non fundamental influences on exchange rates more than fx dealers however neither can fund managers be considered as pure fundamentalists non fundamentalist positions markedly influence short term decision making they inspire ambivalent views about market imperfections and these views seem to become stronger over time this latter change counterbalances the strengthening fundamental influences resulting from the rise of fund managers

have north south growth linkages changed abstract this paper provides econometric evidence suggesting that the traditional tradebased business cycle linkages between the north and the south have changed many countries in the south particularly in asia appear to have become more resilient to cyclical movements in the north and play a more significant role in sustaining global activity a number of factors may have contributed to these changes improved domestic policies and more open trade and exchange regimes closer financial linkages with the north and a substantial increase in capital flows a marked rise in intraregional trade and greater diversification of the exports of the south

chicago harvard and the doctrinal foundations of monetary economics the relationship between milton friedman s monetary economics and the views espoused by chicago and non chicago quantity theorists during the years 1930 36 is examined contrary to recent interpretations chicago economists advanced the efficacy of monetary policy as the means of escaping from the great depression provided that such a policy was implemented by the use of budget deficits to generate monetary expansion the use of the quantity theory of money to provide a theoretical rationale for budget deficits distinguished the chicago economists from other quantity theorists and left them less susceptible to the keynesian revolution the claim that harvard was an important center for monetary research in the early 1930s is refuted

seigniorage and the case for national money in countries with high rates of inflation there is typically movement away from the use of the local currency the paper analyzes the costs and benefits of using a local currency with emphasis on the seigniorage foregone by using a foreign money even if it should be desirable for a country to fix its exchange rate it still loses seigniorage if it does not use its own money the case for using a foreign money then turns largely on the superior discipline imposed on domestic policymakers by removing their control over the money supply alternative methods of imposing discipline are discussed estimates of the amount of seigniorage raised by different governments are presented seigniorage amounts in some cases to about 10 percent of government revenue estimates are also presented of both the annual flow and one time stock costs of giving up use of domestic currencies and instead using the dollar the flow cost is typically about 1 percent of gnp and the stock cost is around 10 percent of gnp

towards an equilibrium level of market reform how politics affects the dynamics of policy change in this article we examine the dynamics of economic reforms that are implemented by incumbent policy makers interested in maintaining their political power we use a sample of 86 countries over a time period going from 1980 to 2001 and find that the achievement of an equilibrium level of market liberalization is highly costly our results are robust to endogenity and model specification

assessing trade and welfare effects of trade liberalization abstract several numerical model experiments are used to contrast computable general equilibrium cge models explicitly incorporating imperfect competition with on the one hand textbook comparative advantage models and on the other hand competitive models based on the armington approach imperfect competition has significant effects on inter industry trade and welfare effects of trade liberalization less aggressive competition reduces elasticities of equilibrium quantities so that comparative advantage is not fully exploited the armington approximation is found to be a poor substitute for explicit incorporation of oligopolistic interaction and product differentiation at the firm level

the price of a smile hedging and spanning in option markets the volatility smile changed drastically around the crash of 1987 and new option pricing models have been proposed to accommodate that change deterministic volatility models allow for more flexible volatility surfaces but refrain from introducing additional risk factors thus options are still redundant securities alternatively stochastic models introduce additional risk factors and options are then needed for spanning of the pricing kernel we develop a statistical test based on this difference in spanning using daily s p 500 index options data from 1986 95 our tests suggest that both in and out of the money options are needed for spanning the findings are inconsistent with deterministic volatility models but are consistent with stochastic models that incorporate additional priced risk factors such as stochastic volatility interest rates or jumps article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

a nonlinear factor analysis of s p 500 index option returns growing evidence suggests that extraordinary average returns may be obtained by trading equity index options and that at least part of this abnormal performance is attributable to volatility and jump risk premia this paper asks whether such priced risk factors are alone sufficient to explain these average returns to provide an answer in as general as possible a setting i estimate a flexible class of nonlinear models using all s p 500 index futures options traded between 1986 and 2000 the results show that priced factors contribute to these expected returns but are insufficient to explain their magnitudes particularly for short term out of the money puts in a recent paper c oval and shumway 2001 examine the returns on deltahedged option positions focusing on the at the money straddle and find average returns close to minus 3 per week since over short time horizons these positions are approximately invariant to movements in the underlying index coval and shumway argue that their capm betas should be near zero and their expected returns close to the risk free rate they conclude that large deviations from the capm are the norm which they suggest is evidence that some other systematic factor such as stochastic volatility might be priced by the market similar conclusions are made by jackwerth 2000 who finds risk adjusted profitability from selling puts and by bakshi and kapadia 2003 who find that the volatility risk premium contributes significantly to higher prices for calls and puts buraschi and jackwerth 2001 concur suggesting that more than one priced risk factor is necessary to explain option prices a less direct set of evidence is the now standard observation that the black scholes implied volatilities of equity index options are upward biased predictors of future realized volatility numerous studies such as fleming ostdiek and whaley 1995 and christensen and prabhala 1998 document that implied volatilities of short term at the money equity index options are on average several percentage points higher than the volatilities realized over the option s

the relation between implied and realized volatility abstract previous research finds the volatility implied by s p 100 index option prices to be a biased and inefficient forecast of future volatility and to contain little or no incremental information beyond that in past realized volatility in contrast we find that implied volatility outperforms past volatility in forecasting future volatility and even subsumes the information content of past volatility in some of our specifications our results differ from previous studies because we use longer time series and nonoverlapping data a regime shift around the october 1987 crash explains why implied volatility is more biased in previous work

cumulative prospect theory option returns and the variance premium the variance premium and the pricing of out of the money otm equity index options are major challenges to standard asset pricing models we develop a tractable equilibrium model with cumulative prospect theory cpt preferences that can overcome both challenges the key insight is that the variance premium can be written as the expected return on a portfolio of otm call and put options and the probability weighting feature of cpt can explain the puzzlingly low returns observed for these options using gmm on a sample of u s index option returns between 1996 and 2010 we show that the cpt model ts well observed option prices and therefore the variance premium in a dynamic setting probability weighting and time varying equity return volatility combine to match the observed time series pattern of the variance premium

the benefit of crises for economic reforms when expenditures consistently outrun revenue the resulting inflation may have the effect of convincing the public and government that taxes must be raised to finance public investment in the advanced industrial countries income taxation and big spurts in taxation generally have become possible only under the impact of major emergency and crisis mostly in wartime in a number of developing countries in

understanding index option returns this paper studies the returns from investing in index options previous research documents significant average option returns large capm alphas and high sharpe ratios and concludes that put options are mispriced we propose an alternative approach to evaluate the significance of option returns and obtain different conclusions instead of using these statistical metrics we compare historical option returns to those generated by commonly used option pricing models we find that the most puzzling finding in the existing literature the large returns to writing out of themoney puts is not even inconsistent with the black scholes model moreover simple stochastic volatility models with no risk premia generate put returns across all strikes that are not inconsistent with the observed data at the money straddle returns are more challenging to understand and we find that these returns are not inconsistent with explanations such as jump risk premia peso problems and estimation risk

a new approach to international arbitrage pricing this paper uses a nonlinear arbitrage pricing model a conditional linear model and an unconditional linear model to price international equities bonds and forward currency contracts unlike linear models the nonlinear arbitrage pricing model requires no restrictions on the payoff space allowing it to price payoffs of options forward contracts and other derivative securities only the nonlinear arbitragepricing model does an adequate job of explaining the time series behavior of a cross section of international returns the idea that a few relevant state variables explain expected returns is the main driving force of the seminal papers of merton 1973 and ross 1976 these seminal ideas have been extended to the pricing of international assets by ikeda 1991 ross and walsh 1983 solnik 1974 1983 and stulz 1981 among others the key implication of these arbitrage pricing models is that only risks related to these factors state variables are relevant in determining asset prices testable implications of these international asset pricing models have been derived either by placing restrictions on the payoff structure i e payoffs are linear in factors as in ikeda 1991 ross and walsh 1983 and solnik 1983 or on the joint distributions of the payoffs and state variables as in constantinides 1989 these restrictions lead to the testable implication that expected asset returns are linear in the conditional covariances with the factor payoffs in what follows we refer to these models as linear arbitrage models or linear models

understanding economic policy reform one of the eventual consequences of the global debt crisis was a wave of market oriented economic reforms this paper discusses the state of our knowledge on the political economy of this process why were inefficient and often unsustainable policies maintained for so long why are so many governments reforming now after decades of adherence to policies of an opposite kind have the reformers internalized the correct lessons from the east asian experience finally are there any helpful rules for reformers to follow in guiding their policies through complicated political terrain

verifying exchange rate regimes credibility and transparency are at the core of the current debate on exchange rate regimes among the reasons why intermediate regimes have fallen out of favor a possibly important one is that they are not transparent it is difficult to verify them this paper investigates how difficult it is for investors to verify from observable data if the authorities are in fact following the exchange rate regime that they claim to be following of the various intermediate regimes the authors focus on the case of basket pegs with bands statistically it can take a surprisingly long span of data for an econometrician or an investor to verify whether such a regime is actually in operation the authors find that verification becomes more difficult as the regime s bands widen and or more currencies enter in the basket peg the authors analyze regimes announced as free floating and find that in some cases the observed exchange rate data validate the announced regime

distinguished lecture on economics in government exchange rate regimes is the bipolar view correct the choice of appropriate exchange rate regime which for economies with access to international capital markets increasingly means a move away from the middle ground of pegged but adjustable fixed exchange rates towards the two corner regimes of either flexible exchange rates or a fixed exchange rate supported if necessary by a commitment to give up altogether an independent monetary policy lawrence h summers 2000 p 8

rain emotions and voting for the status quo abstract do emotions affect the decision between change and the status quo we exploit exogenous variation in emotions caused by rain and analyze data on more than 870 000 municipal vote outcomes in switzerland to address this question the empirical tests are based on administrative ballot outcomes and individual postvote survey data we find that rain decreases the share of votes for political change our robustness checks suggest that this finding is not driven by changes in the composition of the electorate and changes in information acquisition in addition we provide evidence that rain might have altered the outcome of several high stake votes we discuss the psychological mechanism and document that rain reduces the willingness to take risks a pattern that is consistent with the observed reduction in the support for change

historical research on international lending and debt the parallels between debt crises past and present have attracted a large number of social scientists to the history of foreign lending and default in this article i describe the findings of the recent literature on the subject the questions posed have obvious relevance to the current policy debate over the debt of less developed countries what features of international capital markets have long rendered them vulnerable to generalized crisis what events tend to spawn debt servicing difficulties and to provoke default what have been the consequences of default for lenders and borrowers what approaches historically have proven most effective at clearing away the residue of debt crises i concentrate on 20th century experience on the lending of the 1920s on the debt crisis of the 1930s and on the recovery of capital markets after world war ii

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

the benefits and costs of monetary union in southern africa a critical survey of the literature with the 14 members of the southern african development community sadc having set the objective of adopting a common currency for the year 2018 an expanding empirical literature has emerged evaluating the benefits and costs of a common currency area in southern africa this paper reviews that literature focusing on two categories of studies 1 those that assume that a country s characteristics are invariant to the adoption of a common currency and 2 those that assume that a monetary union alters an economy s structure resulting in trade creation and credibility gains the literature reviewed suggests that a relatively small group of countries typically including south africa satisfies the criteria necessary for monetary unification the literature also suggests that in a monetary union comprising all sadc countries and a regional central bank that sets monetary policy to reflect the average economic conditions e g fiscal balances in the region the potential losses i e higher inflation from giving up an existing credible national central bank a relevant consideration for south africa could outweigh any potential benefits of trade creation resulting from a common currency

optimal option portfolio strategies deepening the puzzle of index option mispricing traditional methods of asset allocation such as mean variance optimization are not adequate for option portfolios because the distribution of returns is non normal and the short sample of option returns available makes it difficult to estimate their distribution we propose a method to optimize a portfolio of european options held to maturity with a myopic objective function that overcomes these limitations in an out of sample exercise incorporating realistic transaction costs the portfolio strategy delivers a sharpe ratio of 0 82 with positive skewness this performance is mostly obtained by exploiting mispricing between options and not by loading on jump or volatility risk premia

a tractable framework for option pricing with dynamic market maker inventory and wealth we develop a tractable dynamic model of an index option market maker with limited capital we solve for the variance risk premium and option prices as a function of the asset dynamics and market maker option holdings and wealth the market maker absorbs end users positive demand and requires a more negative variance risk premium when she incurs losses we estimate the model using returns options and inventory and find that it performs well especially during the financial crisis the restrictions imposed by nested existing reduced form stochastic volatility models are strongly rejected in favor of the model with a market maker

floating fixed or super fixed dollarization joins the menu of exchange rate options debate on relative merits of alternative exchange rate regimes was revived in the 1990 s by a succession of exchange rate crises and associated global contagion despite waning enthusiasm for market determined rates most developed countries continued to float with only limited intervention the major exception is the european union after a period of crises that accompanied attempts to keep rates within predefined bands 11 eu members opted for a common regional currency issued by a regional central bank a choice not even on the policy menu at the start of the decade developing and transition economies were likewise divided between those willing to cope with a marketdetermined rate and those choosing to fix rates the newest twist for countries with fixed rates concerns minimizing the risk of crisis especially crisis via contagion traditional crisis prevention emphasizes sound macroeconomic fundamentals bolstered by adequate international reserves and emergency lines of credit indeed the international monetary fund s original mandate was to provide supplementary balance of payments finance as needed to maintain official par values including defense against speculative attack while countries get their fundamentals back in order but the crises of the 1990 s delivered a disheartening message neither sound fundamentals nor seemingly adequate reserves and credit lines offered reliable protection against determined speculators hence there has been increased attention to an alternative approach to crisis prevention making a fixed rate entirely credible and thus uninteresting to speculators in search of targets for attack by establishing a currency board or even dollarization i e official adoption of another country s currency these options are hardly new the u s dollar has been panama s official currency since 1904 unofficial dollarization also known as currency substitution is common in developing and transition economies whose national currencies are subject to a high inflation tax currency boards were once standard arrangements in british colonies mauritius had the first in 1849 john williamson 1995 however currency boards and dollarization are now increasingly promoted as tools for reducing the risk of exchange rate crises for countries with fixed exchange rates our purpose is to clarify this new role and to recast the familiar fixed versus flexible rate discussion by distinguishing adjustable pegs from rates that are more permanently fixed through a currency board or dollarization the decision to create the regional euro raises many of the same issues however the euro is already the subject of an enormous literature we therefore focus on the considerations most relevant for developing and transition economies

the case for trade liberalization in developing countries in a broad swing of the pendulum developing countries have been shifting from severe and destructive protection to free trade fever many of the notable examples are in latin america mexico after a major unilateral trade liberalization is now negotiating a free trade agreement with canada and the united states chile traditionally a highly protected country is a leading example of reducing trade barriers argentina and brazil have entered free trade agreements a free trade area for the americas is becoming a serious possibility the enthusiasm for more openness of the economy is not limited to latin america for example korea and turkey are cases of highly successful liberalization there are also cases in africa for example ghana and botswana to demonstrate the possibility and the benefits of opening up this new enthusiasm for freer trade stems from four overlapping sources anti statism the world has seen a broad intellectual swing away from emphasizing the beneficial role of the state in the 1980s and protection is seen as one of the manifestations of an overly intrusive state of course a shift to a liberal trade regime has not always been the by product of a more democratic society chile under pinochet or korea in its liberalizing phase were under authoritarian rule two cheers for the market but not three the saying goes today the market gets at least three cheers which may be at least one too many poor economic performance many developing countries have suffered dismal economic performance and declining productive potential much of the reason can be traced to populist macroeconomic policies that engendered debt crises and hyperinflation of course part of the reason was also a very adverse external environment but since the days of plentiful external credit are gone

approximating the asset pricing kernel this article tests a simple consumption based asset pricing model by approximating the true asset pricing kernel using low order orthonormal polynomials based on the model s state variables approximated kernels based solely on next period s consumption growth are not rejected by overall measures of model fit but they produce statistically and economically large pricing errors approximated kernels based on two quarters of future consumption growth and technology shocks have substantially improved overall fit in particular the best of these kernels are capable of eliminating the small firm effect a conventional approach to examining the implications of dynamic asset pricing models is to assume that markets are complete the economy is in equilibrium and that the unique state price deflator can be interpreted as the intertemporal marginal rate of substitution of a representative consumer given assumptions about the form of this unobservable utility function and on the observability of aggregate consumption the model can be tested by examining the conditional or unconditional covariation of estimated intertemporal marginal rates of substitution with measured asset returns the fact that this method of testing dynamic models requires strong assumptions is in and of itself not particularly troubling however the fact that these attempts have been almost uniformly inconsistent with the data on asset returns and consumption is problematic for example when the utility function is assumed to be time and state separable the absolute and relative levels of the real returns on risk free and risky securities see for example mehra and prescott 1985 and weil 1989 are inconsistent with the model s predictions the primary finding from a large literature testing consumption based models is that measured consumption is too smooth to rationalize the observed level and variability of asset returns for reasonable parameterizations of time separable utility functions an alternate approach pursued in this paper is to approximate the stateprice deflator or asset pricing kernel using orthonormal polynomials in a

emission intensive growth and trade in the era of the association of southeast asian nations asean integration an empirical investigation from asean 8 abstract this paper attempts to shed some light on the energy consumption and associated emissions linking recent trade integration for eight economies in the asean region brunei darussalam cambodia indonesia malaysia philippines singapore thailand and vietnam considering the heterogeneity across the panel of countries a long run relationship is established between output energy trade and emissions over a period of three decades the role of transportation is considered in this respect the overall findings indicate that the environmental consequences of economic growth are alarming for most of the countries in the panel and non renewable energy consumption is the key contributing factor towards environmental deterioration in the asean region of the eight it is further established that five economies from the region cambodia indonesia malaysia thailand and vietnam predominantly engage in emission intensive trade and an increase in future energy demand and environmental degradation is projected for these countries we suggest that the implementation of economic and trade policies in future should align with the energy sector in this respect renewable energy sources will play a greater role in sustainable growth and development across the countries

the world price of jump and volatility risk abstract we study international integration of markets for jump and volatility risk using index option data for the main global markets to explain the cross section of expected option returns we focus on return based multi factor models for each market separately we provide evidence that volatility and jump risk are priced risk factors there is little evidence however of global unconditional pricing of these risks we show that uk and us option markets have become increasingly interrelated and using conditional pricing models generates some evidence of international pricing finally the benefits of diversifying jump and volatility risk internationally are substantial but declining

returns of claims on the upside and the viability of u shaped pricing kernels abstract when the pricing kernel is u shaped then expected returns of claims with payout on the upside are negative for strikes beyond a threshold determined by the slope of the u shaped kernel in its increasing region and have negative partial derivative with respect to strike in the increasing region of the kernel using returns of i s p 500 index calls ii calls on major international equity indexes iii digital calls iv upside variance contracts and v a theoretical construct that we denote as kernel call we find broad support for the implications of u shaped pricing kernels a possible theoretical reconciliation of our empirical findings is explored through a model that accommodates heterogeneity in beliefs about return outcomes and short selling

endogenous choice of trade policy instruments abstract recently developed theories of endogenous trade policy formation have attempted to explain tariffs as the result of economic interest seeking by individuals or groups this note demonstrates that tariffs will not emerge as a policy choice if income is redistributed solely through trade policy induced factor price changes a production tax cum subsidy will be adopted as both gainers and losers are better off than with a tariff

the dynamics of a newly floating exchange rate the turkish case in recent years many emerging market economies have switched or are in the process of switching to a floating exchange rate regime most of these economies have a history of high inflation and a high level of foreign currency denominated debt therefore the stability of the exchange rate and the dynamics of its volatility are more crucial than before this paper analyses the dynamics of exchange rate in turkey in the aftermath of recent float in february 2001 the turkish experience is a particularly important one and provides valuable lessons for other countries as the central bank is trying to simultaneously contain the volatility of exchange rate and pursue an implicit inflation targeting policy the reported findings indicate that the central bank policies accompanied with favourable external factors were effective in taming the volatility of the exchange rate in a relatively short period of time however there is a significant real appreciation of the currency during the same period given the

option prices under bayesian learning implied volatility dynamics and predictive densities abstract this paper shows that many of the empirical biases of the black and scholes option pricing model can be explained by bayesian learning effects in the context of an equilibrium model where dividend news evolve on a binomial lattice with unknown but recursively updated probabilities we derive closed form pricing formulas for european options learning is found to generate asymmetric skews in the implied volatility surface and systematic patterns in the term structure of option prices data on s p 500 index option prices is used to back out the parameters of the underlying learning process and to predict the evolution in the cross section of option prices the proposed model leads to lower out of sample forecast errors and smaller hedging errors than a variety of alternative option pricing models including black scholes and a garch model

valuation of american futures options theory and empirical tests this paper reviews the theory of futures option pricing and tests the valuation principles on transaction prices from the s p 500 equity futures option market the american futures option valuation equations are shown to generate mispricing errors which are systematically related to the degree the option is in the money and to the option s time to expiration the models are also shown to generate abnormal risk adjusted rates of return after transaction costs the joint hypothesis that the american futures option pricing models are correctly specified and that the s p 500 futures option market is efficient is refuted at least for the sample period january 28 1983 through december 30 1983 futures option contracts now trade on every major futures exchange and on a wide variety of underlying futures contracts the chicago mercantile exchange the chicago board of trade the new york futures exchange and the commodity exchange now collectively have more than twenty options written on futures contracts where the underlying spot commodities are financial assets such as stock portfolios bonds notes and eurodollars foreign currencies such as west german marks swiss francs and british pounds precious metals such as gold and silver livestock commodities such as cattle and hogs and agricultural commodities such as corn and soybeans moreover new contract applications are before the commodity futures trading commission and should be actively trading in the near future with the markets for these new contingent claims becoming increasingly active it is appropriate that the fundamentals of futures option valuation be reviewed and tested black 5 provides a framework for the analysis of commodity futures options although his work is explicitly directed at pricing european options on forward contracts it applies to european futures contracts as well if the riskless rate of interest is constant during the futures option life 1 the options currently

stochastic risk premiums stochastic skewness in currency options and stochastic discount factors in international economies abstract we develop models of stochastic discount factors in international economies that produce stochastic risk premiums and stochastic skewness in currency options we estimate the models using time series returns and option prices on three currency pairs that form a triangular relation estimation shows that the average risk premium in japan is larger than that in the us or the uk the global risk premium is more persistent and volatile than the country specific risk premiums and investors respond differently to different shocks we also identify high frequency jumps in each economy but find that only downside jumps are priced finally our analysis shows that the risk premiums are economically compatible with movements in stock and bond market fundamentals

is free trade passe abstract if there were an economist s creed it would surely contain the affirmations i understand the principle of comparative advantage and i advocate free trade yet the case for free trade is currently more in doubt than at any time since the 1817 publication of ricardo s principles of political economy and this is due to changes that have recently taken place in the theory of international trade while new developments in international trade theory may not yet be familiar to the profession at large they have been substantial and radical in the last ten years the traditional constant returns perfect competition models of international trade have been supplemented and to some extent supplanted by a new breed of models that emphasizes increasing returns and imperfect competition these new models call into doubt the extent to which actual trade can be explained by comparative advantage they also open the possibility that government intervention in trade via import restrictions export subsidies

the origins and sustainability of mexico s free trade policy standard explanations for trade liberalization do not fully account for mexico s turn toward free trade during the 1980s to a large extent the initiative came from within the country even many mexican entrepreneurs whose sectors seem likely to lose from increased competition now support trade liberalization four conditions lowered the political cost benefit ratio for policymakers and entrepreneurs first mexico s leaders dispersed implementation into several financial ministries thereby better insulating this policy from lobbying by the likely losers second potential losers were less well informed than were likely winners third under these conditions the liberal ideological biases of mexican elite policymakers and investors flourished prompting them to accept a higher political cost than would have been tolerated otherwise finally many mexicans came to perceive trade liberalization as a necessary tool in the fight against inflation each of these hypotheses however also flags a possible threat to the policy s future political survival

invested interests the politics of national economic policies in a world of global finance capital moves more rapidly across national borders now than it has in at least fifty years and perhaps in history this article examines the effects of capital mobility on different groups in national societies and on the politics of economic policymaking it begins by emphasizing that while financial markets are highly integrated within the developed world many investments are still quite specific with respect to firm sector or location it then argues that contemporary levels of international capital mobility have a differential impact on socioeconomic groups over the long run increased capital mobility tends to favor owners of capital over other groups in the shorter run owners and workers in specific sectors in capital exporting countries bear much of the burden of adjusting to increased capital mobility these patterns can be expected to lead to political divisions about whether or not to encourage or increase international capital market integration the article then demonstrates that capital mobility also affects the politics of other economic policies most centrally it shifts debate toward the exchange rate as an intermediate or ultimate policy instrument in this context it tends to pit groups that favor exchange rate stability against groups that are more concerned about national monetary policy autonomy and therefore less concerned about exchange rate stability similarly it tends to drive a wedge between groups that favor an appreciated exchange rate and groups that favor a depreciated one these divisions have important implications for such economic policies as european monetary and currency union the dollar yen exchange rate and international macroeconomic policy coordination

underreaction overreaction and increasing misreaction to information in the options market this paper investigates options market reaction to changes in the instantaneous variance of the underlying asset there are three main findings first options market investors underreact to individual daily changes in instantaneous variance second these same investors overreact to periods of mostly increasing or mostly decreasing daily changes in instantaneous variance third they tend to underreact overreact to current daily changes in instantaneous variance that are preceded mostly by daily changes of the opposite same sign the third finding can reconcile the first two and is also consistent with well established cognitive biases