FREE ELECTRONIC LIBRARY - Online materials, documents

Pages:     | 1 |   ...   | 3 | 4 || 6 |

«ABSTRACT Over the period 1972-1986, the correlations of GDP, employment and investment between the United States and an aggregate of Europe, Canada ...»

-- [ Page 5 ] --

A. Shock correlation and diversification In table 11 we report the equilibrium levels of international diversification in the models with restricted and unrestricted stock trade, and compare both with international diversification in the data.

Table 11. International Diversification

–  –  –

To understand the equilibrium determination of λ, it is helpful to consider figure 7. The curves plot equilibrium levels of diversification given particular tax rates τ on foreign dividends.

Recall that the tax rate in the restricted stock trade economy is set so that the model reproduces the average level of diversification observed in the first sub-sample of data. The picture shows that in the second period (characterized by less correlated shocks) more international diversification is observed in equilibrium; the amount of foreign assets held by domestic consumers increases from Diversification in the data is measured as the average across asset and liabilities of the ratio of FDI plus equity to the capital stock for the U.S. v/s Europe plus Canada and Japan (see table 7).

5.5 percent to 15 percent of total asset holdings. Since the tax rate τ is held constant across the two periods, this suggests that the correlation of shocks is a quantitatively important factor in determining the extent of international diversification.

Alternatively, if trade in foreign stocks is assumed to be costless (τ = 0) then figure 7 confirms the results of proposition 1. In this case, the equilibrium share of foreign assets does not depend on the correlation of the shocks and thus it is the same in both periods. The share of foreign assets is approximately 20%, which is the value obtained by plugging the parameters of the model into equation 25.

Thus our first conclusion from figure 7 and table 11 is that the model with restricted stock trade can be used to relate the observed increase in diversification to the change in the correlation of shocks, while the model with unrestricted stock trade has nothing to say about the trend towards financial globalization.

Figure 7 also shows that for certain tax rates the model has two equilibria corresponding to two different levels of diversification. We conjecture that this feature is due to a diversification externality. The specification of the firms’ objective implies that the value to households of diversifying their asset holdings depends on the aggregate level of diversification, since when aggregate diversification is higher, firms place a higher weight on the preferences of foreign shareholders. If this effect is sufficiently strong, it is possible to have a low diversification equilibrium in which agents do not diversify because foreign firms do not consider them when deciding dividends, and a high diversification equilibrium in which agents do diversify because foreign firms now pay sufficient attention to their preferences when making investment, employment and dividend decisions. The picture suggests that for the calibrations corresponding to both sub-periods there is a (small) range of taxes for which this phenomenon arises. To verify the conjecture regarding the source of multiplicity, we consider an alternative specification in which we eliminate the diversification externality by assuming that domestic firms care only about domestic consumers (regardless of the level of diversification).

In this case, we find only one equilibrium for each level of the tax (see figure 8). Notice also that when firms only care about domestic consumers the value of international diversification is reduced, and for any given tax rate less diversification is observed in equilibrium. Naturally, the two varieties of the model coincide when there is perfect home bias (λ = 1) and when there is perfect risk sharing (λ is given by eq. 25).

B. Shock correlation and the international business cycle In table 12 we report selected empirical business cycle statistics along with the predictions of the calibrated model economies with restricted and unrestricted stock trade. Statistics for the models are averages across 200 simulations, each of which is 58 periods long. The equilibrium levels of diversification for each period are those reported in table 11.

Table 13 reports the changes in the empirical and model simulation statistics across the two time periods (for example, the output correlation for period two minus the output correlation for period one). The last two lines of this table report results from two additional experiments that we conduct in the restricted stock trade economy. In the first experiment (labeled constant diversification) we change the correlation of the real shocks (as in the the other models) but we do not let agents reoptimize their portfolios. In the second experiment (labeled constant shock correlation) we keep the correlation of the shocks fixed (at the value ρ estimated over the whole sample) but we change the tax on foreign dividends across the two periods to obtain the same increase in international diversification as in the benchmark model.

–  –  –

The model with restricted stock trade predicts international correlations that are quite close to those observed empirically. This is the case in both sub-periods, and applies to all variables (though the model slightly over-predicts the consumption correlation). On the negative side, in the All numbers in the table are differences between the statistic in the first period (72.1-86.2) and the statistic in the second period (86.3-00.4). For example, the data number for the output correlation is 0.26 − 0.76 = −0.50.

data output is more strongly correlated across countries than consumption, while the model predicts the reverse. Moreover, the real exchange rate is too smooth, and there is too little intertemporal trade. These are common shortcomings in this class of models, and have been noted by many authors beginning with Backus, Kehoe and Kydland 1994.

The model with unrestricted stock trade generally underpredicts international correlations in the first period. This is due to the fact that the market structure enables large capital flows from the less to the more productive country. These flows tend to lower the international correlation of investment and thus of employment and output. The real exchange rate volatility is even lower than in the restricted stock trade economy. On the positive side the model does predict that output should be more strongly correlated across countries than consumption, as is the case empirically.26 The difference between the two economies that we want to emphasize is how the predicted business cycle statistics change when the correlation of the shocks is reduced (see table 13). The restricted stock trade economy predicts an increase in intertemporal trade and a reduction in exchange rate volatility, as we observe in the data. In addition, the predicted declines in international correlations are very similar in magnitude to those observed empirically. In the unrestricted stock trade economy, by contrast, the size of the decline in co-movement predicted by the model is too small. Another failing of the unrestricted stock trade economy is that it counterfactually predicts an increase in the volatility of the real exchange rate.

To better understand why the model with restricted trade is better able to account for the observed decline in international business cycle correlations, consider the experiments reported in the last two lines of table 13. When diversification is held constant and the shock correlation is reduced, the model-implied correlations fall but not by as much as in the data.27 The same thing happens This feature of models with complete risk sharing has been noted by Arvanitis and Mikkola (1996). It does not survive for higher values of the elasticity of substitution between domestic and foreign goods.

One could imagine that at the same time that the shock correlation falls, the tax rate on foreign dividends rises by an amount such that the optimal level of diversification remains unchanged.

when the correlation of the shocks is held constant and diversification is increased. Thus these experiments indicate that both less correlated shocks and increased diversification are required to match the magnitude of observed declines in business cycle correlations. The model with restricted stock trade provides a simple mechanism through which less correlated shocks endogenously induce an increase in international diversification.

Why does increasing portfolio diversification reduce international co-movement in investment and employment? For simplicity, consider a situation of no international diversification and imagine that domestic productivity rises while foreign productivity is constant. Domestic firms would like to reduce dividends to increase investment, but they recognize that the lower are dividends, the lower will be the income and consumption of domestic shareholders. This effectively limits the size of the domestic investment boom. If agents are diversified, however, domestic (and foreign) owners of the domestic firm receive dividend income from abroad. Thus each additional dollar of domestic investment has a smaller negative effect on domestic income and consumption than in the no diversification economy, and the increase in domestic investment is consequently larger.

In addition, with positive diversification the value of foreign agents’ holdings of domestic stocks increases following a positive domestic shock. Thus the wealth of foreign agents increases, which tends to reduce labor supply and consequently investment abroad.28

8. Conclusion Financial markets are becoming increasingly integrated internationally. A trend towards portfolio diversification has left asset holders less exposed to country-specific risk, and the flow of capital to its most productive location is increasingly unhindered by restrictions on international Note that this diversification effect is also apparent in table 12. In particular, the second and third lines of the table indicate that increasing diversification in the restricted stock trade economy from the equilibrium level for period 1 to the level that supports perfect risk sharing (the level defined by eq. 25) implies large declines in business cycle correlations borrowing and lending.

This paper explores the implications of the ongoing growth in international asset trade for the real economy. We find that empirically the trend towards financial globalization has been accompanied by a trend towards real regionalization. In particular, while output, employment and investment in the United States were strongly correlated with their foreign counterparts in the immediate post Bretton-Woods period, these correlations have since fallen dramatically.

We then develop a model in which stocks are traded internationally subject to certain frictions which limit risk-sharing. Within this model we are able to simultaneously account for both the trend towards financial globalization and the trend towards real regionalization. When stocks may be traded freely, we cannot account for either trend.

Our conclusions are threefold. First, there is evidence of increasing country-specific risk, which is consistent with observed growth in international asset trade. Second, in models which quantitatively capture this growth in asset trade, financial integration has large implications for the real side of the international business cycle. Third, observed changes in the international business cycle are difficult to account for when the extent to which countries are linked via international financial markets is assumed constant, but are readily reconciled in a model in which international financial integration increases endogenously in response to increased country-specific risk.

References [1] Arvanitis, A.V. and A. Mikkola, 1996, Asset market structure and international trade dynamics, AEA Papers and Proceedings 86, 67-70.

[2] Backus, D.K. and P.J. Kehoe, 1992, International evidence on the historical properties of business cycles, American Economic Review 82, 864-888.

[3] Backus, D.K., P.J. Kehoe, and F.E. Kydland, 1992, International real business cycles, Journal of Political Economy 101, 745-775.

[4] Backus, D.K., P.J. Kehoe, and F.E. Kydland, 1994, Dynamics of the trade balance and the terms of trade: the J-curve?, American Economic Review 84, 84-103.

[5] Baxter, M. and M.J. Crucini, 1995, Business cycles and the asset structure of foreign trade, International Economic Review 36, 821-854.

[6] Baxter, M. and U. Jermann, 1997, The international diversification puzzle is worse than you think, American Economic Review 87, 170-180.

[7] Cantor, R. and N.C. Mark, 1988, The international transmission of real business cycles, International Economic Review 29(3), 493-507.

[8] Cole, H.L. and M. Obstfeld, 1991, Commodity trade and international risk sharing, Journal of Monetary Economics 28, 3-24.

[9] Cooley, T. and E. Prescott, 1995, Economic growth and business cycles, in T. Cooley ed., Frontiers of Business Cycle Research, Princeton University Press, Princeton, 1-38.

[10] Diamond, P.A., 1967, The role of a stock market in a general equilibrium model with technological constraints, American Economic Review 57, 759-776.

[11] Drèze, J., 1985, (Uncertainty and) the firm in general equilibrium theory, in J. Drèze ed., Essays on economic decisions under uncertainty, Wiley.

[12] Engle, R., 2000, Dynamic conditional correlation - a simple class of multivariate Garch models, Mimeo, Stern School of Business, NYU.

[13] Forbes, K. and R. Rigobon, 2002, No contagion, only interdependence: Measuring stock market co-movements, Journal of Finance, 57, 2223-2261.

[14] Grossman, S.J. and O. Hart, 1979, A theory of competitive equilibrium in stock market economies, Econometrica 47, 293-330.

[15] Heathcote, J. and F. Perri, 2002, Financial autarky and international business cycles, Journal of Monetary Economics 49 (3), 601-627.

[16] Kehoe, P. and F. Perri, 2002, International business cycles with endogenous incomplete markets, Econometrica 70 (3), 907-928.

[17] Kollmann, R., 2001, Macroeconomic effects of nominal exchange rate regimes: new insights into the roles of price dynamics, Mimeo, University of Bonn.

Pages:     | 1 |   ...   | 3 | 4 || 6 |

Similar works:

«Confidence Risk and Asset Prices Ravi Bansal Ivan Shaliastovich ∗ Current Version: January 2010 Comments Welcome Bansal (email: ravi.bansal@duke.edu) is affiliated with the Fuqua School of Business, Duke ∗ University, and NBER, and Shaliastovich (email: ishal@wharton.upenn.edu) is at The Wharton School, University of Pennsylvania. We would like to thank Alexander David, Cade Massey, Adriano Rampini, Robert Stambaugh, Pietro Veronesi, Amir Yaron and seminar participants at Duke, MIT...»

«BEFORE THE OFFICE OF CAMPAIGN FINANCE DISTRICT OF COLUMBIA BOARD OF ELECTIONS AND ETHICS FRANK D. REEVES MUNICIPAL BUILDING 2000 FOURTEENTH STREET, N.W., SUITE 433 WASHINGTON, D.C. 20009 (202) 671-0550 IN THE MATTER OF: Date: August 2, 2011 The Honorable Yvette M. Alexander Docket No.: FI-2011-106 Councilmember Ward 7 The Council of the District of Columbia ORDER I. Introduction This matter arises from a complaint filed by Geraldine Washington, resident of Ward 7, alleging that Councilmember...»

«Crossing boundaries to make better planning, management, and policy decisions External economic pressures and park planning: a 57 case study from Dominica BARRY ALLEN, Department of Environmental Studies, Rollins College, Campus Box 2753, Winter Park, Florida 32789; ballen@rollins.edu LEE LINES, Department of Environmental Studies, Rollins College, Campus Box 2753, Winter Park, Florida 32789 Established in 1975, Morne Trois Pitons National Park protects one of the most spectacularly rugged...»

«DISCUSSION PAPER PI-0010 Pension Funds, Financial Intermediation and the New Financial Landscape E Philip Davis July 2000 ISSN 1367-580X The Pensions Institute Cass Business School City University 106 Bunhill Row London EC1Y 8TZ UNITED KINGDOM http://www.pensions-institute.org/ PENSION FUNDS, FINANCIAL INTERMEDIATION AND THE NEW FINANCIAL LANDSCAPE E Philip Davis Abstract Pension funds are analysed as financial intermediaries using a functional approach to finance which encompasses traditional...»

«Waldo County Emergency Management Agency Volunteer Staff Positions Guide April 2012 Version Waldo County Emergency Management Agency Volunteer Staff Positions Guide 4 Public Safety Way., Belfast, ME 04915 (207) 338-3870 Fax 338-1890 Email: emadirector@waldocountyme.gov Introduction Welcome to the Waldo County Emergency Management Agency (EMA) Volunteer Staffing Positions program! We are seeking interested and qualified volunteers to serve their communities through the County Emergency...»

«Thailand AJDF Category B (Krung Thai Bank Limited, The Industrial Finance Corporation of Thailand) Report Date: March 2001 Field Survey: August 2000 1. Project Profile and Japan’s ODA Loan Myanmar Loas Thailand Bangkok Cambodia Site Map: The whole of the Kingdom of Thailand Valve Factory (Paton Thani area) (1) Background 1) The Thai economy has shown a high aptitude for change, sifting from an agriculture-centered monoculture economy through a period of import-substitution industrialization,...»

«RISK MANAGEMENT LESSONS LEARNED: COUNTRYWIDE REPORT Gordon Yale Yale & Company, Denver CO Hugh Grove Professor of Accounting University of Denver Maclyn Clouse Professor of Finance University of Denver Please address all correspondence to: Maclyn Clouse Professor of Finance Daniels College of Business University of Denver 2101 S. University of Blvd Denver, CO 80208 USA Phone: 303-871-3320 Email: mclouse@du.edu RISK MANAGEMENT LESSONS LEARNED: COUNTRYWIDE REPORT ABSTRACT International and U.S....»

«IOSR Journal of Business and Management (IOSR-JBM) e-ISSN: 2278-487X, p-ISSN: 2319-7668. Volume 16, Issue 1. Ver. III (Jan. 2014), PP 30-36 www.iosrjournals.org The Influence of Age and Gender on the Leadership Styles Bhargava R. Kotur1, S. Anbazhagan2 Department of Life Long Learning, Bharathidasan University, Khajamalai Campus, Trichy, TN, India. Abstract: The aim of this study is to investigate the different leadership styles of the workers and the influence of age and gender on the...»

«Applying virtue ethics to business: The agent-based approach By: John Dobson It ca be argued that the presence of what are in a slightly old-fashioned terminology called virtues in fact plays a significant role in the operation of the economic system.Kenneth Arrow Introduction There are two basic approaches to integrating ethics in business: the action-based approach, and the agent-based approach. The traditional approach is action-based in that it focusses on developing rules or guidelines to...»

«The Business & Management Review, Volume 5 Number 3 November 2014 Globalisation: Impact on Indian Small and Medium Enterprises Aarti Deveshwar DCR University of Science and Technology, Haryana, India. Key Words Indian Small and Medium Enterprises, globalization, contribution MSMEs, prospects and problems, World Trade Organisation. Abstract Micro, Small and Medium Enterprises (MSME) sector has emerged as a highly vibrant and dynamic sector of the Indian economy over the last five decades. MSMEs...»

«Working Paper Structured Discretion in the Doctrine of Illegality: The Solution or Yet Another Attempt? TAN Hong Chia Adjunct Researcher, Centre for Banking & Finance Law, Faculty of Law, National University of Singapore hongchia@u.nus.edu 20 October 2014 The views expressed in this paper are those of the author(s). They do not necessarily represent or reflect the views of the Centre for Banking & Finance Law (CBFL), or of the National University of Singapore. © Copyright is held by the...»

«Investing FOR DUMmIES ‰ 5TH EDITION by Eric Tyson, MBA Financial counselor, syndicated columnist, and author of six national bestsellers, including Personal Finance For Dummies®, Real Estate Investing For Dummies®, and Mutual Funds For Dummies® Praise for Eric Tyson’s Bestselling For Dummies Titles “Eric Tyson For President!!! Thanks for such a wonderful guide. With a clear, no-nonsense approach to... investing for the long haul, Tyson’s book says it all without being the least...»

<<  HOME   |    CONTACTS
2017 www.thesis.dislib.info - Online materials, documents

Materials of this site are available for review, all rights belong to their respective owners.
If you do not agree with the fact that your material is placed on this site, please, email us, we will within 1-2 business days delete him.