can portmanteau nonlinearity tests serve as general mis specification tests a number of recent papers have employed the bds test as a general test for mis specification for linear and nonlinear models we show that for a particular class of conditionally heteroscedastic models the bds test is unable to detect a common mis specification our results also demonstrate that specific rather than portmanteau diagnostics are required to detect neglected asymmetry in volatility however for both classes of tests reasonable power is only obtained using very large sample sizes

model choice and value at risk performance broad agreement exists among both the investment banking and regulatory communities that the use of internal risk management models is an efficient means for calculating capital risk requirements the determination of model parameters laid down by the basle committee on banking supervision as necessary for estimating and evaluating the capital adequacies however has received little academic scrutiny we investigate a number of issues of statistical modeling in the context of determining market based capital risk requirements we highlight several potentially serious pitfalls in commonly applied methodologies and conclude that simple methods for calculating value at risk often provide superior performance to complex procedures our results thus have important implications for risk managers and market regulators

testing for nonlinear dependence in daily foreign exchange rates the purpose of this article is to investigate whether daily changes in five major foreign exchange rates contain any nonlinearities although the data contain no linear correlation evidence indicates the presence of substantial nonlinearity in a multiplicative rather than additive form further examination reveals that a generalized autoregressive conditional heteroskedasticity model can explain a large part of the nonlinearities for all five exchange rates copyright 1989 by the university of chicago

answering the skeptics yes standard volatility models do provide accurate forecasts a voluminous literature has emerged for modeling the temporal dependencies in financial market volatility using arch and stochastic volatility models while most of these studies have documented highly significant in sample parameter estimates and pronounced intertemporal volatility persistence traditional ex post forecast evaluation criteria suggest that the models provide seemingly poor volatility forecasts contrary to this contention we show that volatility models produce strikingly accurate interdaily forecasts for the latent volatility factor that would be of interest in most financial applications new methods for improved ex post interdaily volatility measurements based on high frequency intradaily data are also discussed

why hasn t tax competition triggered a race to the bottom some quantitative lessons from the eu abstract the integration of european financial markets in the early 1980s created an environment of near perfect capital mobility across countries that had harmonized indirect taxes but maintained large differences in factor taxes the years that followed witnessed several rounds of competition in capital taxes with puzzling results instead of the dreaded race to the bottom in capital taxes the uk lowered its capital tax to a rate closer to those of france germany and italy while capital taxes changed slightly in these countries the uk increased its labor tax marginally but the other countries increased theirs sharply this paper shows that these results are consistent with the quantitative predictions of a dynamic neoclassical general equilibrium model of tax competition that incorporates the key international externalities of tax policy operating via relative prices wealth distribution and fiscal solvency tax competition is modeled as a one shot game over time invariant capital taxes with dynamic payoffs relative to a status quo calibrated to european data the calibration is preceded by an empirical analysis that shows that the relationship linking taxes to labor supply and the investment rate in the model are in line with empirical evidence and that domestic taxes seem to respond to foreign taxes the solutions of the games show that when countries compete over capital taxes adjusting labor taxes to maintain fiscal solvency there is no race to the bottom and the nash equilibrium is close to observed taxes in contrast if consumption taxes adjust to maintain fiscal solvency competition over capital taxes triggers a race to the bottom but this outcome entails large welfare gains surprisingly the gains from coordination are small in all of these experiments

nonlinear nonparametric nonessential exchange rate estimation a wide variety of empirical exchange rate mo dels have been estimated over the years but despite the considerable energies that have been devoted to this work the economics profession has remarkably little to show for itself there is little evidence that conclusively links the bilateral exchange rates of typical oecd countries to fundamental macroeconomic determinants of exchange rates such as money output relative prices or interest differentials coefficient estimates are notoriously unstable and frequently mis signed compared with theoretical predictions exchange rate equations do not fit particularly well and forecast no better than the simplest naive alternatives recently a new class of exchange rate models was introduced by paul krugman 1988 these models provide a potential reason for the poor performance of traditional exchange rate models because they are nonlinear if the exchange rate actually depends in a nonlinear way on exogenous macroeconomic fundamentals linear exchange rate models may work poorly even though the exchange rate is closely linked to fundamentals in this paper we provide a brief sketch of some of this work as well as some preliminary evidence on the actual performance of these nonlinear models in our empirical analysis we use a nonparametric estimator that can handle a wide variety of nonlinear phenomena we examine fixed exchange rate regimes where nonlinearities should be quite easy to detect however we do not find strong empirical support for the hypothesis that the incorporation of nonlinear effects significantly improves models of exchange rate determination in section i we briefly review the theoretical literature on nonlinear target zone exchange rate models linking this work to the tests for intrinsic bubbles we draw heavily on recent papers by kenneth froot and maurice obstfeld 1989a b our methodology and data are discussed in section ii section iii contains new empirical tests for nonlinearities in exchange rate models

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

the effect of asymmetries on optimal hedge ratios there is widespread evidence that the volatility of stock returns displays an asymmetric response to good and bad news this article considers the impact of asymmetry on time varying hedges for financial futures an asymmetric model that allows forecasts of cash and futures return volatility to respond differently to positive and negative return innovations gives superior in sample hedging performance however the simpler symmetric model is not inferior in a hold out sample a method for evaluating the models in a modern risk management framework is presented highlighting the importance of allowing optimal hedge ratios to be both time varying and asymmetric

time irreversibility and egarch effects in us stock index returns in this paper we suggest using a modified version of the time reversibility tr test of chen chou and kuan 2000 as a complementary diagnostic test for time series models the modified cck test is easy to compute and requires weaker moment conditions than existing tests our simulations demonstrate that this test is powerful against asymmetry in volatility but the bds test is not in the empirical study of us stock index returns we first find that these returns are all time irreversible applying the garch and egarch models to these returns we also find that the q and bds tests always accept the null hypothesis and cannot distinguish between these models by contrast the modified cck test accepts only the egarch model with an order that can accommodate the underlying asymmetry in volatility our results suggest that the detected time irreversibility in these return series may be attributed to volatility asymmetry and that such asymmetry may be captured using a proper egarch model copyright 2002 john wiley sons ltd

nonlinearity and intraday efficiency tests on energy futures markets using high frequency data this paper first time comprehensively examines the intraday efficiency of four major energy crude oil heating oil gasoline natural gas futures markets in contrast to earlier studies which focus on in sample evidence and assume linearity the paper employs various nonlinear models and several model evaluation criteria to examine market efficiency in an out of sample forecasting context overall there is evidence for intraday market inefficiency of two of the four energy future markets heating oil and natural gas which exists particularly during the bull market condition but not during the bear market condition the evidence is also robust against the data snooping bias and the model overfitting problem and its economic significance can be very substantial

the statistical properties of daily foreign exchange rates 1974 1983 abstract this paper examines the statistical properties of daily rates of change of five foreign currencies from 1974 to 1983 the main purpose is to discriminate between two competing explanations for the observed heavy tails of the distribution that the data are independently drawn from a heavy tail distribution which remains fixed over time and that the data come from distributions which vary over time evidence point to the rejection of the first hypothesis further investigations show that the rejection can be attributed to changing means and variances in the data which can be described by a simple statistical model

nonlinear dynamics in financial markets evidence and implications daily asset returns exhibit two key statistical properties price changes are not autocorrelated but the absolute values of changes are strongly autocorrelated nonlinear processes can generate this type of behavior linear processes cannot additively nonlinear processes are consistent with the view that expected returns are time varying although much effort has been applied to modeling expected returns there has been little evidence to support the view that time varying expected returns can account for the strong nonlinearity in the observed returns data multiplicatively nonlinear models are consistent with the view that expected volatilities are time varying evidence from price changes as well as options implied volatilities show that volatility is time varying and mean reverting in fact multiplicatively nonlinear models have been able to explain a great deal of the nonlinearity in asset returns thus future volatility can be forecast even though the direction of price changes is difficult

the statistical distribution of exchange rates empirical evidence and economic implications the abundant evidence that changes in exchange rates have distributions with fatter tails than the normal distribution has led researchers to consider non normal distributions including the student the stable paretian and mixtures of distributions this paper compares the empirical fits of three non normal candidates and the normal distribution for daily changes in the logarithms of exchange rates using maximum likelihood estimation of the parameters and chi square goodness of fit tests the student and mixture of two normals provide the best fits but there is evidence that the distribution parameters may vary over time

captial mobility distributive conflict and international tax coordination basic economic theory identifies a number of efficiency gains that derive from international capital mobility but just as with free trade in goods there is no guarantee that capital mobility makes everyone better off consequently capital mobility may be politically unsustainable even though it enhances efficiency this paper discusses how such a dilemma might arise and suggests that international tax coordination might serve as a way out under some circumstances c 2001 published by elsevier science b v

nonlinear dynamics and stock returns simple deterministic systems are capable of generating chaotic output that mimics the output of stochastic systems for this reason algorithms have been developed to distinguish between these two alternatives these algorithms and related statistical tests are also useful in detecting the presence of nonlinear dependence in time series in this article the authors apply these procedures to stock returns and find evidence that indicates the presence of nonlinear dependence on weekly returns from the center for research in security prices value weighted index copyright 1989 by the university of chicago

do euro exchange rates follow a martingale some out of sample evidence abstract traditional autocorrelation and variance ratio tests are based on serial uncorrelatedness rather than martingale difference as such they do not capture potential nonlinearity in mean which could lead to misleading inferences in favor of the martingale hypothesis this paper employs various parametric and nonparametric nonlinear models as well as several model comparison criteria to examine the potential martingale behavior of euro exchange rates in the context of out of sample forecasts the overall evidence indicates that while martingale behavior cannot be rejected for euro exchange rates with major currencies such as the japanese yen british pound and us dollar there is nonlinear predictability in terms of economic criteria with respect to several smaller currencies

a word of caution on calculating market based minimum capital risk requirements this paper demonstrates that the use of garch type models for the calculation of minimum capital risk requirements mcrrs may lead to the production of inaccurate and therefore inefficient capital requirements we show that this inaccuracy stems from the fact that garch models typically overstate the degree of persistence in return volatility a simple modification to the model is found to improve the accuracy of mcrr estimates in both back and out of sample tests given that internal risk management models are currently in widespread usage in some parts of the world most notably the usa and will soon be permitted for ec banks and investment firms we believe that our paper should serve as a valuable caution to risk management practitioners who are using or intend to use this popular class of models

the politics of 1992 fiscal policy and european integration the internal market in europe will greatly increase the international mobility of resources how will this affect fiscal policy in different countries we consider taxation of capital in a two country model where a democratically chosen government in each country chooses tax policy higher capital mobility changes the politico economic equilibrium in two ways on the one hand it leads to more tax competition between the countries this economic effect tends to lower tax rates in both countries on the other hand it alters voters preferences and makes them elect a different government this political effect offsets the increased tax competition although not completely

partisanship and the path to financial openness the effect of traditional left right economic preferences on countries international financial openness is more subtle than existing studies have recognized the authors investigate the role that partisan politics played in the liberalization of international financial markets within 12 western european democracies from 1960 to 1986 the authors find that right governments tended to be active liberalizers of the capital account they were more likely than left governments to enact liberalizations and liberalizations were especially likely when new right governments entered office left governments typically acquiesced to these changes although less likely to enact liberalizations they were no more likely to impose new restrictions the authors findings are consistent with studies that show how financial integration does not undermine welfare states but is still subject to partisan contention

talk softly but carry a big stick transfer pricing penalties and the market valuation of japanese multinationals in the united states corporate income tax law in oecd countries requires multinational enterprises mnes to set their transfer prices according to the arm s length standard in 1990 the united states us government introduced a transfer pricing penalty for cases where mnes deviated substantially from this standard more than two dozen other governments have followed suit our paper uses event study methodology to assess the impact of the us transfer pricing penalty on the stock market valuation of japanese mnes with us subsidiaries in the 1990s we find that the penalty caused a drop in their cumulative market value of 56 1 billion representing 12 6 of their 1997 market value

geographic income shifting by multinational corporations in response to tax rate changes we investigate geographic income shifting by 191 u s multinational corporations in response to worldwide changes in tax rates during 1984 90 between 1984 and 1986 the united kingdom reduced corporate tax rates from a maximum of 45 to 35 and in 1985 france reduced rates from 50 to 45 following these reductions in european rates the united states reduced top corporate tax rates from 46 to 34 between 1986 and 1988 canadian rates increased between 1984 and 1986 and then decreased through 1989 beginning in 1988 numerous countries enacted tax cuts apparently in response to those that occurred earlier in other countries as discussed in section 3 differential changes in tax rates provide incentives for geographic income shifting by multinational firms we identify two subperiods during 1984 90 in which relative tax rate changes

nonlinearity data snooping and stock index etf return predictability abstract this paper examines daily return predictability for eighteen international stock index etfs the out of sample tests are conducted based on linear and various popular nonlinear models and both statistical and economic criteria for model comparison the main results show evidence of predictability for six of eighteen etfs a simple linear autoregression model and a nonlinear in variance garch model but not several popular nonlinear in mean models help outperform the martingale model the allowance of data snooping bias using white s reality check also substantially weakens otherwise apparently strong predictability

can capital income taxes survive in open economies optimal tax theory forecasts that small open economies should not tax capital income yet countries do tax capital income why the inconsistency this paper shows that use of the double taxation convention whereby governments credit taxes paid abroad against domestic taxes helps explain this inconsistency in particular capital income will be taxed if a dominant capital exporter acts as a stackelberg leader when setting its tax policy due to the convention other countries will then tax capital imports making it attractive for the dominant capital exporter to tax capital income without a dominant capital exporter however the model still forecasts no capital income taxes can taxation of capital income survive the increasing integration of world capital markets a number of recent papers suggest not diamond and mirrlees 1971 for example showed that a small open economy would not choose to tax the income generated by the physical capital located within the country this is because production would occur efficiently under an optimal tax system which requires that domestic investments earn the rate of return available on the world capital market in principle a country might still attempt to tax income earned on the savings of its residents however in practice income from savings invested outside the country is virtually impossible for a government to monitor individuals therefore can evade tax on such savings with very little risk as razin and sadka 1989 show such capital flight in theory eliminates any possibility of a tax on savings investors will simply transfer their funds abroad to avoid taxation yet virtually all countries do in fact tax the capital income earned by corporations and individuals located within their borders how can the theoretical forecast of no capital income taxation be reconciled with this simple observation it is difficult to use existing models with any confidence to analyze the implications of changes in capital income tax rates if these same models forecast that countries should never tax capital income

production risk and the functional distribution of income in a developing economy tradeoffs and policy responses abstract we develop a stochastic endogenous growth model to examine the relationship between the volatility of growth and the factor distribution of income our framework incorporates two important features of developing economies the co existence of a modern and a traditional sector and the fact that the income generated in the traditional sector can escape taxation the relationship between volatility and factor distribution is complex depending upon the source of risk and the elasticity of substitution between capital and labor in the formal sector the policy options available to the government for counteracting changes in volatility are analyzed the second best optimal tax structure is also characterized

government regulation and structural change in the corporate acquisitions market the impact of the williams act this paper presents evidence on how the williams act affected the corporate acquisitions market the acquisition process is modeled and three hypotheses about the act s effects are discussed these hypotheses imply differing restrictions on how the act changes the model s parameters parameter changes are estimated but we are unable to reliably discriminate between two of the three hypotheses using the classical statistical testing approach though the third hypothesis is reliably rejected bayesian analysis using a diffuse prior is employed to make formal probability comparisons among the hypotheses the most probable hypothesis according to the results implies that the williams act reduced the expected gross present value of acquisition attempts

implications of nonlinear dynamics for financial risk management this paper demonstrates that when log price changes are not iid their conditional density may be more accurate than their unconditional density for describing short term behavior using the bds test of independence and identical distribution daily log price changes in four currency futures contracts are found to be not iid while there appear to be no predictable conditional mean changes conditional variances are predictable and can be described by an autoregressive volatility model that seems to capture all the departures from independence and identical distribution based on this model daily log price changes are decomposed into a predictable part which is described parametrically by the autoregressive volatility model and an unpredictable part which can be modeled by an empirical density either parametrically or nonparametrically this two step seminonparametric method yields a conditional density for daily log price changes which has a number of uses in financial risk management

the conditional heteroscedasticity of the yen dollar exchange rate this paper examines the conditional heteroscedasticity of the yen dollar exchange rate a model is constructed by extending the asymmetric power autoregressive conditional heteroscedasticity model to a process that is fractionally integrated it is found that unlike the equity markets the appreciation and depreciation shocks of the yen against the dollar have similar effects on future volatilities although the results reject both the stable and the integrated models our analysis of the response coefficients of the past shocks and the application of the models to the estimation of the capital requirements for trading the currencies show that there are no substantial differences between the fractionally integrated models and the stable models 1998 john wiley sons ltd

accurate minimum capital risk requirements a comparison of several approaches in this paper we estimate for several investment horizons minimum capital risk requirements for short and long positions using the unconditional distribution of three daily indexes futures returns and a set of short and long memory stochastic volatility and garch type models we consider the possibility that errors follow a t student distribution in order to capture the kurtosis of the returns series the results suggest that accurate modelling of extreme observations obtained for long and short trading investment positions is possible with an autoregressive stochastic volatility model moreover modelling futures returns with a long memory stochastic volatility model produces in general excessive volatility persistence and consequently leads to large minimum capital risk requirement estimates finally the models predictive ability is assessed with the help of out of sample conditional tests

event studies in management research theoretical and empirical issues we examined the use of event studies in management research and found that there was inadequate attention paid to theoretical and research design issues this lack of attention may lead to false in

linear and nonlinear dependence in turkish equity returns and its consequences for financial risk management abstract this paper investigates the dynamic behaviour of daily aggregate returns of one of europe s largest and fastest growing emerging equity markets the istanbul stock exchange ise it is found that ise returns exhibit significant linear and nonlinear dependence we investigate the nature and source of the nonlinear dependence and find that it is due primarily to linear dependence in the conditional variance of returns rather than nonlinear dependence in the conditional mean we analyse the implications of our findings for financial risk management we show that by exploiting the nonlinear dependence in ise returns the average capital required to cover against unexpected portfolio losses can be considerably reduced in contrast exploiting the linear dependence in ise returns has only a negligible impact on capital requirements

forward and futures prices evidence from the foreign exchange markets empirical studies of the treasury bill markets have revealed substantial differences between the futures price and the implied forward price these differences have been attributed to taxes transaction costs and the settling up procedure employed in the futures market this paper examines the forward and futures prices in foreign exchange in an attempt to distinguish between the competing explanations empirical studies of the treasury bill market have revealed differences between the futures price or rate and the implicit forward price derived from the term structure of interest rates 1 these differences have generally been attributed to market imperfections such as taxes and transaction costs see for example arak 1 capozza and cornell 2 and rendelman and carabini 6 recently however cox ingersoll and ross 3 henceforth cir derived a model in which forward and futures prices need not be equal even in perfect markets without taxes as long as interest rates are stochastic the significance of the cir effect may be hard to investigate using only data from the bill market because of the potentially complicating effects of taxes and transaction costs unique to this market by using data from the foreign exchange market we are able to eliminate the tax effect and reduce the impact of transaction costs the question we address is whether the discrepancies observed in the treasury bill market are also observed in the foreign exchange market if they are then we have evidence that the differences are due to a combination of the cir effect and the transaction costs common to both markets if they are not then either the magnitude of the cir effect is much less in the foreign exchange market or the treasury bill results are due to the unique tax treatment and transaction costs of that market this paper is organized as follows in section i the trading mechanics of the forward and futures markets in foreign exchange are discussed section ii reviews the explanations for the discrepancies between the forward and futures prices for treasury bills the institutional differences between the foreign exchange and bill markets are also summarized to show which of these explanations cannot apply to the foreign exchange market in section iii the data are decribed and the empirical results are presented the conclusions are summarized in the final section

how relevant is volatility forecasting for financial risk management it depends if volatility fluctuates in a forecastable way volatility forecasts are useful for risk management hence the interest in volatility forecastability in the risk management literature volatility forecastability however varies with horizon and different horizons are relevant in different applications moreover existing assessments of volatility forecastability are plagued by the fact that they are joint assessments of volatility forecastability and an assumed model and the results can vary not only with the horizon but also with the assumed model to address this problem we develop a model free procedure for assessing volatility forecastability across horizons perhaps surprisingly we find that volatility forecastability decays quickly with horizon volatility forecastability although clearly of relevance for risk management at the short horizons relevant for say trading desk management may be much less important at longer horizons

model free evaluation of directional predictability in foreign exchange markets we examine directional predictability in foreign exchange markets using a model free statistical evaluation procedure based on a sample of foreign exchange spot rates and futures prices in six major currencies we document strong evidence that the directions of foreign exchange returns are predictable not only by the past history of foreign exchange returns but also the past history of interest rate differentials suggesting that the latter can be a useful predictor of the directions of future foreign exchange rates this evidence becomes stronger when the direction of larger changes is considered we further document that despite the weak conditional mean dynamics of foreign exchange returns directional predictability can be explained by strong dependence derived from higher order conditional moments such as the volatility skewness and kurtosis of past foreign exchange returns moreover the conditional mean dynamics of interest rate differentials contributes significantly to directional predictability we also examine the co movements between two foreign exchange rates particularly the co movements of joint large changes there exists strong evidence that the directions of joint changes are predictable using past foreign exchange returns and interest rate differentials furthermore both individual currency returns and interest rate differentials are also useful in predicting the directions of joint changes several sources can explain this directional predictability of joint changes including the level and volatility of underlying currency returns copyright 2007 john wiley sons ltd