Alexander Ludwig

Credit risk-free sovereign bonds under Solvency II: a cointegration analysis with consistently estimated structural breaks

European insurance and reinsurance undertakings are facing the advent of a new regulatory framework. In the current proposal for its technical specifications under the pillar 1 standard formula, sovereign debt of European Union (EU) member states is treated as risk-free. This article examines the validity of this assumption for 26 EU member states. Taking into account the possibility of multiple structural breaks, we find evidence for the convergence of government bond yields of several countries with the yields of a risk-free asset. For the majority of countries, however, there is no such evidence. A detailed discussion of regime shifts in relation to European bond market integration is provided. Our findings have important implications for insurance companies, bond investors and regulators alike.

A two-step approach to examine the dynamics of market convergence

We present an improved approach to examine convergence of markets such as those for equity, bonds or commodities. The approach is motivated by Monte Carlo simulations and consists of two steps. First, we test for regime-shifts in the cointegration paths and cointegration with structural breaks. If equilibrium errors are stationary, we then obtain the degree of convergence by rolling speeds of adjustment in a vector error correction model. Our approach is illustrated by an application on stock market convergence.

The export-led growth hypothesis for India: examining causality by a new approach in the time-frequency domain

The literature on the relationship between export and growth is inconsistent in its conclusions regarding the direction of causality. Most recent contributions argue that inconclusive results among studies are likely to be related to the instability of causal relationships over time or over frequencies. To unify these two aspects in one approach, we compute a time-varying Diebold-Yilmaz (2012) spillover measure for the relationship between output and growth at different frequency scales which are obtained from discrete wavelet transforms. Our results confirm the time and scale dependence of causalities between export and output growth in India in the period 1960 to 2011. This new methodological approach can also be applied to systems of more than two variables and thus shows an avenue to modelling the time and scale dependence of causalities between many other economic variables.

On the usability of the fluctuation test statistic to identify multiple cointegration break points

ABSTRACT The fluctuation test suggested by Hansen and Johansen [Some tests for parameter constancy in cointegrated VAR models, Econometrics J. 2 (1999), pp. 306–333] intends to distinguish between the presence of zero and one break in cointegration relations. In this article, we provide evidence by Monte Carlo simulations that it also serves as a graphical device to detect even multiple break locations. It suffices to consider a simplified and easy-to-implement version of the original fluctuation test. Its break detection performance depends on the sign of change in cointegration parameters and the break height. The sign issue can be approached successfully by a backward application of the test statistic. If breaks are observable, the break locations are detected at the true location on average. We apply the graphical procedure to assess the cointegration of bond yields of Spain, Italy and Portugal with German yields for the period 1995–2013 which is surprisingly supported by the trace test. However, the recursive cointegration approach shows that a stable relationship with German yields is only present for sub-periods between the introduction of the Euro and the global financial crisis which is in line with expectations. The statistical robustness of these results is supported by a forward and backward application of the cointegration breakdown test by Andrews and Kim [Tests for cointegration breakdown over a short time period, J. Bus. Econom. Stat. 24 (2006), pp. 379–394].

Short- and long-run rolling causality techniques and optimal window-wise lag selection: an application to the export-led growth hypothesis

The literature devoted to the export-led growth (ELG) hypothesis, which is of utmost importance for policymaking in emerging countries, provides mixed evidence for the validity of the hypothesis. Recent contributions focus on the time-dependence of the relationship between export and output growth using rolling causality techniques based on vector autoregressive models. These models focus on a short-term view which captures single policy-induced developments. However, long-term structural changes cannot be covered by examinations related to the short-term. This paper hence examines the time-varying validity of the ELG hypothesis for India for the period 1960–2011 using rolling causality techniques for both the short-run and long-run horizon. For the first time, window-wise optimal lag-selection procedures are applied in connection with these techniques. We find that exports long-run caused output growth from 1997 until 2009 which can be seen as a consequence of political reforms of the 1990s that boosted economic growth by generating foreign direct investment opportunities and higher exports. For the short-run, export significantly caused output in the period 1998–2003 which followed a concentration of liberalization measures in 1997. Causality in the reversed direction, from output to exports, only seems to be relevant in the short-run.