Arbitrage normally ensures that covered interest parity (CIP) holds. Until recently, excess profits, if any, were documented to last merely seconds and reach a few pips. Instead, this paper finds that following the Lehman bankruptcy, these were large, persisted for months and involved strategies short in dollars. Profits are estimated by specifying the arbitrage strategy as a speculator would actually implement it, considering both unsecured and secured funding. Either way, it seems that dollar funding constraints kept traders from arbitraging away excess profits. The claim finds support in an empirical analysis drawing on several novel high frequency datasets of synchronous quotes across securities, including transaction costs.
While it is well established that across-country taste differences are associated with "home market effects", there is very limited analysis of how such preference heterogeneity impacts the aggregate volume of trade and the welfare gains from liberalization. I develop a structural model of aggregate demand featuring products with heterogeneous attributes, consumers with heterogeneous tastes for attributes, and across-country differences in the distribution of tastes. The impact of across-country taste differences depends on whether the domestic industry can adjust to the mismatch between the attribute composition of imports and the domestic distribution of tastes. For the case of a large degree of across-country taste differences, countries specialize completely and the model supports notions along the lines of Linder (1961) that taste diversity impedes the volume of trade and leads to group-specific gains from trade. In contrast, if specialization is incomplete, free firm entry implies that the relative toughness of competition across different market segments must be invariant to liberalization. It is shown that therefore, both trade volume and welfare gains are entirely unaffected by the distribution of foreign tastes and coincide with those in a representative agent framework.
During the financial crisis of 2007/08 the level and volatility of interest rate spreads increased dramatically. This paper examines how the choice of the target interest rate for monetary policy affects the volatility of inflation, the output gap and the yield curve. We consider three monetary policy operating procedures with different target interest rates: two market rates with maturities of one and three months, respectively, and an essentially riskless one-month repo rate. The implementation tool is the one-month repo rate for all three operating procedures. In a highly stylised model, we find that using a money market rate as a target rate generally yields lower variability of the macroeconomic variables. This holds under discretion as well as under commitment both in times of financial calm or turmoil. Whether the one month or three month rate procedure performs best depends on the maturity of the specific rate that enters the IS curve.
Momentum in foreign stock market returns is exploitable as signal of currency excess returns. Past stock market winner currencies offer higher returns than past stock market loser currencies. This finding is unrelated to interest rate differentials. Funding liquidity risk explains the time series variation in foreign stock market momentum sorted currency portfolio returns. Their cross-sectional dispersion is hardly rationalized by systematic risk factors in contrast to forward discount and currency momentum sorted currency portfolios. This latter finding reflects that fundamentals driving stock market momentum based currency portfolio returns are not related to recently proposed currency risk factors in the cross-section.
We develop a reciprocity-based model of wage determination and incorporate it into a modern dynamic general equilibrium framework. We estimate the model and find that, among potential determinants of wages, rent-sharing (between workers and firms) and wage entitlement (based on wages earned in the past) are important to fit the dynamic responses of output, wages and inflation to various exogenous shocks. Aggregate employment conditions (measuring workers' outside option), on the other hand, are found to play only a negligible role for wage setting. These results are broadly consistent with micro-studies on reciprocity in labor relations but contrast with traditional efficiency wage models which emphasize aggregate labor market variables as the main determinant of wage setting.
Based on survey data covering 8,387 firms in 20 countries we compare credit demand and credit supply for firms in Eastern Europe to those for firms in selected Western European countries. We find that, while 30% of firms do not need credit in Eastern Europe, their need for credit is higher than in Western Europe. The firm-level determinants of credit needs in Eastern Europe are quite similar to that in Western Europe: Firms with alternative financings sources, i.e. government-owned, foreign-owned and internally financed firms, are less likely to need credit. Small firms are also less likely to demand credit than larger firms, suggesting that they may have limited investment opportunities. We find that a higher share of firms is discouraged from applying for a loan in Eastern Europe than in Western Europe. Firms in Eastern Europe seem particularly discouraged by high interest rates compared to firms in Western Europe, with collateral conditions and loan application procedures also more discouraging. The higher rate of discouraged firms in Eastern Europe is related to a stronger reluctance of small and financially opaque firms to apply for a loan compared to Western Europe. While many discouraged firms correctly anticipate that their loan applications would be rejected, a large majority of discouraged firms seem to be creditworthy. At the country-level we find that the higher rate of discouraged firms in Eastern Europe is driven more by the presence of foreign banks than by the macroeconomic environment or the lack of creditor protection. We find no evidence that foreign bank presence leads to stricter loan approval decisions. Our findings suggest to policy makers that the low incidence of bank credit among firms in Eastern Europe, compared to Western Europe, is not driven by less need for credit or banks' reluctance to extend loans. The main driver seems to be that many (creditworthy) firms are discouraged from applying for a loan, due to high interest rates, collateral conditions and cumbersome lending procedures. As discouragement is particularly high among small and opaque firms, as well as in countries with a strong presence of foreign banks, it seems that firms perceive lending standards to have become more reliant on "hard information" with the entry of foreign banks. However, as loan rejection rates are not related to foreign bank presence, it seems that firms' perceptions of the likely lending conditions may be too pessimistic. Thus more transparency about credit eligibility and conditions may improve credit access, particularly in countries with a high presence of foreign banks.
This paper analyses the development of housing market imbalances, housing prices and residential investment in Switzerland within a stock-flow framework. In the long run, the desired level of residential capital stock and the existing residential capital stock revert. Empirical results indicate, however, that housing demand can diverge from the existing supply for several years due to the slow adjustment of the residential capital stock to shocks. In the short run, the market therefore has to be cleared by price adjustments. And indeed, it can be shown empirically that changes in prices are significantly and strongly dependent on the level of stock imbalances. Furthermore, housing prices prove to be an important determinant of residential investment, which in turn drives the adjustment process of the residential capital stock towards its desired level.
An increasing number of oil market experts argue that OPEC members substantially overstate their oil reserves. While the economic implications could be dire, the incentives for overreporting remain unclear. This paper analyzes these incentives, showing that oil exporters may overreport to raise expected future supply, thereby discouraging oil-substituting R&D and improving their own future market conditions. In general, however, overreporting is not costless: it must be backed by observable actions and therefore induces losses through supply distortions. Surprisingly, these distortions offset others that arise when suppliers internalize the buyers' motives for R&D. In this case, overreporting is rational, credible, and cheap.
Based on real-time trade data from the Swiss franc overnight interbank repo market and SIX Interbank Clearing (SIC) - the Swiss real-time gross settlement (RTGS) system - we are able to gain valuable insights on the daytime value of money and its determinants: First, an implicit hourly interbank interest rate can be derived from the intraday term structure of the overnight rate. We thereby provide evidence that an implicit intraday money market exists. Second, we show that after the introduction of the foreign exchange settlement system CLS the value of intraday liquidity has increased during the hours of the CLS settlement cycle. Third, the turnover as well as the liquidity in SIC influence the intraday rate correspondingly. These facts provide evidence for the cost of immediacy. Features like RTGS, delivery-versus-payment and payment-versus-payment substitute credit risk with liquidity risk which in turn increases the value of intraday liquidity. The analysis is central bank policy relevant insofar as different designs of intraday liquidity facilities and different collateral policies result in different intraday term structures for the overnight money market.
This article studies the relationship between the degree of banking sector stability and the subsequent evolution of real output growth and inflation. Adopting a panel VAR methodology for a sample of 18 OECD countries, we find a positive link between banking sector stability and real output growth. This finding is predominantly driven by periods of instability rather than by very stable periods. In addition, we show that an unstable banking sector increases uncertainty about future output growth. No clear link between banking sector stability and inflation seems to exist. We then argue that the link between banking stability and real output growth can be used to improve output growth forecasts. Using Fed forecast errors, we show that banking sector stability (instability) results in a significant underestimation (overestimation) of GDP growth in the subsequent quarters.
