a tale of two regimes theory and empirical evidence for a markov modulated jump diffusion model of equity returns and derivative pricing implications abstract we provide closed form solutions for a continuous time markov modulated jump diffusion model in a general equilibrium framework for options prices under a variety of jump diffusion specifications we further demonstrate that the two state model provides the leptokurtic return features volatility smile and volatility clustering observed empirically for the dow jones industrial average djia and its component stocks using 10 years of stock return data we confirm the existence of jump intensity switching and clustering illustrate transition probabilities and verify superior empirical fit over competing poisson style models

a simplified jump process for common stock returns the specification of a statistical distribution which accurately models the behavior of stock returns continues to be a salient issue in financial economics with the introduction of arithmetic and geometric brownian motion models much attention has recently focused on a poisson mixture of distributions as an appropriate specification of stock returns for example see 12 3 8 10 5 and 1 consistent with empirical evidence these models yield leptokurtic security return distributions and furthermore the specification has much economic intuition in particular one may always decompose the total change in stock price into normal and abnormal components the normal change may be due to variation in capitalization rates a temporary imbalance between supply and demand or the receipt of any other information which causes marginal price changes this component is modelled as a lognormal diffusion process the abnormal change is due to the receipt of any information which causes a more than marginal change in the price of the stock and is usually modeled as a poisson process

an empirical investigation of the effects of rounding on the spf probabilities of decline and output growth histograms i consider the possibility that respondents to the survey of professional forecasters round their probability forecasts of the event that real output will decline in the future as well as their reported output growth probability distributions i make various plausible assumptions about respondents rounding practices and show how these impinge upon the apparent mismatch between probability forecasts of a decline in output and the probabilities of this event implied by the annual output growth histograms i find that rounding accounts for about a quarter of the inconsistent pairs of forecasts

evaluating interval forecasts a complete theory for evaluating interval forecasts has not been worked out to date most of the literature implicitly assumes homoskedastic errors even when this is clearly violated and proceed by merely testing for correct unconditional coverage consequently i set out to build a consistent framework for conditional interval forecast evaluation which is crucial when higher order moment dynamics are present the new methodology is demonstrated in an application to the exchange rate forecasting procedures advocated in risk management

explanations of the inconsistencies in survey respondents forecasts a comparison of the point forecasts and the probability distributions of inflation and output growth made by individual respondents to the us survey of professional forecasters indicates that the two sets of forecasts are sometimes inconsistent we evaluate a number of possible explanations and find that not all forecasters update their histogram forecasts as new information arrives this is supported by the finding that the point forecasts are more accurate than the histograms in terms of first moment prediction c 2009 elsevier b v all rights reserved

normal mixture diffusion with uncertain volatility modelling short and long term smile effects this paper introduces a parameterization of the normal mixture diffusion nmd local volatility model that captures only a short term smile effect and then extends the model so that it also captures a long term smile effect we focus on the binomial nmd parameterization so called because it is based on simple and intuitive assumptions that imply the mixing law for the normal mixture log price density is binomial with more than two possible states for volatility the general parameterization is related to the multinomial mixing law in this parsimonious class of complete market models option pricing and hedging is straightforward since model prices and deltas are simple weighted averages of black scholes prices and deltas but they only capture a short term smile effect where leptokurtosis in the log price density decreases with term in accordance with the stylised facts of econometric analysis on ex post returns of different frequencies and the central limit theorem however the last part of the paper shows that longer term smile effects that arise from uncertainty in the local volatility surface can be modeled by a natural extension of the binomial nmd parameterization results are illustrated by calibrating the model to several euro us dollar currency option smile surfaces

the influence of country risk factors on interest rate differentials on international bank lending to sovereign borrowers 1985 the influence of country risk factors on interest rate differentials on international bank lending to sovereign borrowers applied economics vol 17 no 3 pp 491 507

predicting u s business cycle regimes this article examines the use of logistic classification methods for the identification and prediction of postwar u s business cycle expansion and contraction regimes as defined by the national bureau of economic research nber reference turning point dates we present a coherent theoretical framework for this task using measures of discriminatory information the analysis encompasses model selection parameter estimation and classification decision rules we examine the performance of logistic procedures in reproducing the nber regime classifications and in predicting one and three months ahead using leading indicator variables our models are shown to provide substantially more accurate business cycle regime predictions than markov switching specifications

roughing it up including jump components in the measurement modeling and forecasting of return volatility a rapidly growing literature has documented important improvements in financial return volatility measurement and forecasting via use of realized variation measures constructed from high frequency returns coupled with simple modeling procedures building on recent theoretical results in barndorff nielsen and shephard 2004a 2005 for related bi power variation measures the present paper provides a practical and robust framework for non parametrically measuring the jump component in asset return volatility in an application to the dm exchange rate the s p500 market index and the 30 year u s treasury bond yield we find that jumps are both highly prevalent and distinctly less persistent than the continuous sample path variation process moreover many jumps appear directly associated with specific macroeconomic news announcements separating jump from non jump movements in a simple but sophisticated volatility forecasting model we find that almost all of the predictability in daily weekly and monthly return volatilities comes from the non jump component our results thus set the stage for a number of interesting future econometric developments and important financial applications by separately modeling forecasting and pricing the continuous and jump components of the total return variation process

unemployment equilibria and input prices theory and evidence from the united states the paper develops an efficiency wage model where input prices affect the equlibrium rate of unemployment we show that a simple framework based on only two prices the real price of oil and the real rate of interest is able to explain the main post war movements in the rate of u s joblessnss the equations do well in forecasting unemployment many out of sample and provide evidence that the oil price spike associated with iraq s invasion of kuweit appears to be a component of the mystery recession which followed

skewness in financial returns abstract in this paper the symmetry of daily returns is addressed in eight international stock markets and three spot exchange rates tests of symmetry with the sample skewness seem of little value due to the non normality of the returns under alternative non normal distributions the symmetry of the returns cannot be rejected for most markets distribution free procedures do not detect strong asymmetries in most of the series either however some differences between returns below the mean and returns over the mean are observed in several markets

forecast encompassing tests and probability forecasts we consider tests of forecast encompassing for probability forecasts for both quadratic and logarithmic scoring rules we propose test statistics for the null of forecast encompassing present the limiting distributions of the test statistics and investigate the impact of estimating the forecasting models parameters on these distributions the small sample performance is investigated in terms of small numbers of forecasts and model estimation sample sizes we show the usefulness of the tests for the evaluation of recession probability forecasts from logit models with different leading indicators as explanatory variables and for evaluating survey based probability forecasts copyright c 2010 john wiley sons ltd

oil and the macroeconomy since world war ii all but one of the u s recessions since world war ii have been preceded typically with a lag of around three fourths of a year by a dramatic increase in the price of crude petroleum this does not mean that oil shocks caused these recessions evidence is presented however that even over the period 1948 72 this correlation is statistically significant and nonspurious supporting the proposition that oil shocks were a contributing factor in at least some of the u s recessions prior to 1972 by extension energy price increases may account for much of post opec macroeconomic performance

politics and perceived country creditworthiness in international banking this paper marks a departure from most previous studies of country creditworthiness in international banking because it incorporates systematically generated quantitative indicators of political instability in the analysis the authors empirically test for the effects of political instability on perceived country creditworthiness using data on thirty heavily indebted developing countries for the period 1967 86 in addition to economic factors they examine the effects of three types of political instability regime change political legitimacy and armed conflict the authors also distinguish between proximate instability and chronic instability they find significant effects of proximate instability particularly in governmental regime on indicators of countries perceived creditworthiness copyright 1990 by ohio state university press

estimating the effects of information surprises and trading on stock returns using a mixed jump diffusion model i present a methodology that uses the mixed jump diffusion model for stock returns to estimate the separate effects of information surprises and strategic trading around corporate events using simulation techniques i show that for events with multiple announcements spread over a long time the estimators derived from the mixed jump diffusion model are more powerful compared to the traditional cumulative abnormal return estimators the new methodology is used to study the separate effects of information surprises and strategic trading associated with blockholdings and subsequent targeted repurchases i find that for more than 93 percent of the firms in our sample the mixed jump diffusion model is statistically superior to the pure diffusion model in describing stock returns more important i find a statistically significant negative effect due to trading while the average effect around announcements is statistically insignificant in contrast the standard cumulative abnormal return is not statistically different from zero article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

predicting u s recessions financial variables as leading indicators this paper examines the out of sample performance of various financial variables as predictors of u s recessions series such as interest rates and spreads stock prices and monetary aggregates are evaluated individually and in comparison with other financial and nonfinancial indicators the analysis focuses on out of sample performance from one to eight quarters ahead results show that stock prices are useful with one to three quarter horizons as are some well known macroeconomic indicators beyond one quarter however the slope of the yield curve emerges as the clear individual choice and typically performs better by itself out of sample than in conjunction with other variables

real time forecasting regional tourism with business sentiment surveys abstract this study provides evidence that supply side soft information retrieved from business surveys is effective in real time forecasting of hotel arrivals at the regional level we assess the effect of including business sentiment indicators in commonly used naive specifications and structural time series models using residuals and predictive diagnostics we find that both the goodness of fit and the forecasting accuracy of the augmented models are superior to those of the baseline models whence the opportunity to extend to the tourism sector the surveys on the business sentiment currently realized by the provincial chambers of commerce for the manufacturing sector allowing an effective and timely managing of local tourism market where official information is likely to be either lacking or poor in quality

pricing weather derivatives this article presents a general method for pricing weather derivatives specification tests find that a temperature series for fresno ca follows a mean reverting brownian motion process with discrete jumps and autoregressive conditional heteroscedastic errors based on this process we define an equilibrium pricing model for cooling degree day weather options comparing option prices estimated with three methods a traditional burn rate approach a black scholes merton approximation and an equilibrium monte carlo simulation reveals significant differences equilibrium prices are preferred on theoretical grounds so are used to demonstrate the usefulness of weather derivatives as risk management tools for california specialty crop growers

a new look at debt rescheduling indicators and models this paper presents logit and discriminant models of debt rescheduling the models incorporated new short term debt data and variables representing economic shocks the 30 country database covered the period from 1975 to 1982 and contained the largest number of debt rescheduling observations of any previous database because of the new indicators and more recent data the models captured the effects of the changes that have occurred in the world economy since the oil price shocks and the period of rapid debt accumulation by the developing countries compared to the earlier research models the models have proven to be efficient in forecasting debt reschedulings

conditional jump dynamics in stock market returns this article develops a new conditional jump model to study jump dynamics in stock market returns we propose a simple filter to infer ex post the distribution of jumps this permits construction of the shock affecting the time t conditional jump intensity and is the main input into an autoregressive conditional jump intensity model the model allows the conditional jump intensity to be time varying and follows an approximate autoregressive moving average arma form the time series characteristics of 72 years of daily stock returns are analyzed using the jump model coupled with a generalized autoregressive conditional heteroscedasticity garch specification of volatility we find significant time variation in the conditional jump intensity and evidence of time variation in the jump size distribution the conditional jump dynamics contribute to good in sample and out of sample fits to stock market volatility and capture the rally often observed in equity markets following a significant downturn

evaluating density forecasts with applications to financial risk management density forecasting is increasingly more important and commonplace for example in financial risk management yet little attention has been given to the evaluation of density forecasts the authors develop a simple and operational framework for density forecast evaluation they illustrate the framework with a detailed application to density forecasting of asset returns in environments with time varying volatility finally the authors discuss several extensions copyright 1998 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

what happened to the oil price macroeconomy relationship abstract strong evidence is found that oil prices no longer granger cause many u s macroeconomic indicator variables in data after 1973 a number of potential explanations are explored that sample stability issues are responsible that oil prices are now endogenous and that linear and symmetric specifications misrepresent the form of the oil price interaction none of these hypotheses are supported by the data the opec price increases do appear to have had significant impacts while the effects of the price declines of the 1980s are smaller and harder to characterize these results have potentially important implications for the large body of research which utilizes oil prices as an instrumental or explanatory variable

this is what happened to the oil price macroeconomy relationship abstract many of the quarterly oil price increases observed since 1985 are corrections to even bigger oil price decreases the previous quarter when one looks at the net increase in oil prices over the year recent data are consistent with the historical correlation between oil shocks and recessions

a jump diffusion model for the european monetary system abstract we propose a general continuous time bivariate jump diffusion representation for the exchange rates of european currencies our model captures key features of the exchange rate mechanism fluctuation within bilateral limits is modeled by appropriate diffusion dynamics while discontinuous variation in the level of the fluctuation band is posited to have a jump structure under specific assumptions the probability distribution of the exchange rate process is derived analytically we also perform an empirical investigation of these exchange rates comparing the fit of alternative models we find some evidence of mean reversion inside the bands for these exchange rates jel f33 c51

debt arrears in latin america do political variables matter political instability and debt problems characterise latin america in the last two decades this article estimated a logit model of debt arrears including economic as well as political variables our results suggested that both economic and political indicators affected debt repayment in latin america during 1971 86 we also cast a shadow on the viewpoint that authoritarian and military regimes have an advantage over democratically elected governments with regard to debt related issues

the debt crisis structural explanations of country performance abstract this paper develops a cross country statistical model of debt rescheduling and the secondary market valuation of ldc debt which links these variables to key structural characteristics of developing countries such as the trade regime the degree of income inequality and the share of agriculture in gnp our most striking finding is that higher income inequality is a significant predictor of a higher probability of debt rescheduling in a cross section of middle income countries we attribute this correlation to various difficulties of political management in economies with extreme inequality we also find that outward orientation of the trade regime is a significant predictor of a reduced probability of debt rescheduling

a re examination of the predictability of economic activity using the yield spread this paper revisits the yield spread s usefulness for predicting future real gdp growth we show that the contribution of the spread can be decomposed into the effect of expected future changes in short rates and the effect of the term premium we find that both factors are relevant for predicting real gdp growth but the respective contributions differ we investigate whether the cyclical behavior of interest rate volatility could account for either or both effects we find that while volatility displays important correlations with both the term structure of interest rates and gdp it does not appear to account for the yield spread s usefulness for predicting gdp growth

early warning of debt rescheduling abstract this study addresses the early warning of debt rescheduling by developing countries the early warning capability of different statistical methods is compared by using the same data base i e 52 countries from 1974 to 1978 the results especially show that cluster analysis techniques don t do well and that multiple discriminant analysis is inferior to logit analysis the integration of qualitative and projected data is proposed in order to arrive at bank specific systems

the politics of adjustment lessons from the imf s extended fund facility the international debt crisis has forced painful economic adjustments on the developing world in the short run it has forced governments to seek to correct payments imbalances through stabilization programs usually undertaken with conditional assistance from the international monetary fund imf the crisis has also revealed deeper weaknesses in many third world economies weaknesses demanding more basic reforms in the structure of incentives prices and investment

the long run creditworthiness of developing countries theory and practice this paper analyzes the determinants of developing country long run creditworthiness focusing on the process of capital accumulation relative to external debt creditworthiness depends on the actual capital stock compared with a critical level representing the gross wealth just sufficient to ensure that interest payments to foreigners never exhaust national output given expected gross inflows and existing outstanding debt hence the probability of rescheduling is linked to debt service capital net inflows capital investment rates and income levels the empirical results based on a probit analysis of historical rescheduling incidents are quite robust and supportive of the theoretical framework

news and noise in g 7 gdp announcements revisions to gdp announcements are known to be quite large in all g 7 countries quarterly growth rate revisions are regularly more than a full percentage point at an annualized rate we examine the predictability of these revisions using standard statistical tests of whether the preliminary announcement is a rational forecast of the subsequently revised data previous work suggests that u s gdp revisions are largely unpredictable as would be the case if the revisions reflect news not available at the time that the preliminary number is produced we find that the degree of predictability varies throughout the g 7 although we find little predictability in u s revisions the data revisions for several foreign countries are highly predictable we also perform a simple real time forecasting exercise showing that for several countries the predictability of data revision could be used to generate improved preliminary data

sovereign default interest rates and political uncertainty in emerging markets abstract a large body of the empirical literature shows that high turnover rates length of tenure of policymakers and the degree of conflict within a country affects sovereign spreads debt and default rates we help to rationalize such claims by including these political features in a dynamic stochastic small open economy model of sovereign debt and default in this way we offer a complementary approach to the econometric analyses in the literature consistent with the data the quantitative analysis shows that politically unstable and more polarized economies experience higher default rates and larger level and volatility of sovereign interest rate spreads

tests for multiple forecast encompassing in the evaluation of economic forecasts it is frequently the case that comparisons are made between a number of competing predictors a natural question to ask in such contexts is whether one forecast encompasses its competitors in the sense that they contain no useful information not present in the superior forecast we develop tests for this notion of multiple forecast encompassing which are robust to properties expected in the forecast errors and apply the tests to forecasts of uk growth and inflation copyright 2000 john wiley sons ltd

caviar conditional autoregressive value at risk by regression quantiles value at risk var has become the standard measure of market risk employed by financial institutions for both internal and regulatory purposes var is defined as the value that a portfolio will lose with a given probability over a certain time horizon usually one or ten days despite its conceptual simplicity its measurement is a very challenging statistical problem and none of the methodologies developed so far give satisfactory solutions interpreting the var as the quantile of future portfolio values conditional on current information we propose a new approach to quantile estimation which does not require any of the extreme assumptions invoked by existing methodologies such as normality or i i d returns the conditional autoregressive value at risk or caviar model moves the focus of attention from the distribution of returns directly to the behavior of the quantile we specify the evolution of the quantile over time using a special type of autoregressive process and use the regression quantile framework introduced by koenker and bassett to determine the unknown parameters since the objective function is not differentiable we use a differential evolutionary genetic algorithm for the numerical optimization utilizing the criterion that each period the probability of exceeding the var must be independent of all the past information we introduce a new test of model adequacy the dynamic quantile test applications to simulated and real data provide empirical support to this methodology and illustrate the ability of these algorithms to adapt to new risk environments

oil and the macroeconomy when prices go up and down an extension of hamilton s results in an important paper hamilton 1983 demonstrated a strong correlation between oil price changes and gross national product growth in u s data however his study pertained to a period in which all the large oil price movements were upward and thus it left unanswered the question whether the correlation persists in periods of price decline moreover the price variable he used was somewhat distorted by price controls in the 1970s this note investigates whether hamilton s results continue to hold when the sample is extended to include the recent oil market collapse and the oil price variable is corrected for the effects of price controls particular attention is given to the possibility of asymmetric responses to oil price increases and decreases as suggested in the structural employment literature loungani 1986 davis 1987 hamilton 1988 like hamilton i based my investigation on the gnp equation in sims s 1 980b six variable quarterly vector autoregressive model