Aris Protopapadakis

The equilibrium pricing of exchange rates and assets when trade takes time

Abstract When trade takes time, there are systematic deviations of the exchange rate from its Law of One Price value; these depend on the real interest rate in terms of the importable good. There is no systematic tendency for the spot rate to attain its LOP value in the long run. This means that agents in different countries price the same cash flows by using different risk premia, with agents in the ‘foreign’ country pricing the asset by adding a risk premium related to foreign exchange risk.

Real and Nominal Interest Rates under Uncertainty: The Fisher Theorem and the Term Structure

This paper examines the relation between nominal and real interest rates, and the nominal and real term structure under uncertainty. We show that two separate risk terms cause the Fisher theorem to fail. One risk term is related only to the variability of money prices, while the other is related to the purchasing power riskiness of the nominal bond. Monetary policy can affect the value of both these risk terms. We also show that the pure expectations hypothesis of the term structure fails for both real and nominal bonds because of risk premia. Even if the economy is neutral with respect to monetary policy, monetary policy can alter the nominal term structure.

Leverage, time preference and the ‘equity premium puzzle’☆

Abstract We re-examine the Mehra and Prescott (1985) model. A combination of the time preference factor greater than one and reasonable leverage ratios in the equity market resolve the ‘equity premium puzzle’. Such parameter values can be consistent with finite expected utility and a positive risk-free rate of interest rate. The model performs better for the MP target values than for economically reasonable variations around those values.

Some Indirect Evidence on Effective Capital Gains Tax Rates

This paper presents estimates of effective marginal tax rates on capital gains, excluding housing, between 1960 and 1978, in the United States. Concern that the inflation of the 1970s may have worked through the tax system to reduce incentives to produce and save has focused attention on the effective marginal tax rates that apply to various sources of income. Joines (1981) sheds light on this issue by calculating the historical effective marginal tax rates on factor incomes for the United States. Part of the recent debate, however, has focused specifically on capital gains taxes and the desirability of reducing them to enhance incentives for saving and investment. The effective marginal tax rate on capital gains (henceforth EMTG) may be the most difficult rate to measure. In addition to the usual problems of how to attribute deductions, exclusions, and tax credits, further adjustment must be made because investors pay taxes only when they realize their capital gains.1 The expected EMTG This paper reports estimates of effective marginal tax rates on capital gains by comparing reported capital gains with total capital gains on an annual basis. The estimates show that the effective marginal tax rates on capital gains fluctuated between 3.4% and 6.6% between 1960 and 1978 and that capital gains are held, on average, between 24 and 31 years before they are reported.

The Book-to-Market and Size Effects in a General Asset Pricing Model: Evidence from Seven National Markets

The positive relation of returns with Book-to-Market ratio (BE/ME) and their negative relation withMarket Value(MVE) remains strong under a general stochastic discount function (SDF) that does not depend on a specific asset pricing model and avoids potentially serious simultaneity biases inherent in the Fama and French three-factor model. However, we find that SDFs that include the equivalent of the HML portfolio do not span all asset sub-spaces, even with additional conditioning information. Finally, macro and financial variables we introduce to the pricing functions do not offer an alternative explanation of the BE/ME effect. JEL Classification codes: G10, G12, G15, G30.

Are money growth and inflation related to government deficits? evidence from ten industrialized economies

Abstract We present empirical evidence on the relation between the government debt growth, money growth and inflation for ten industrialized countries over the post World War II period. Non-parametric and parametric tests reveal little evidence that government debt growth is either related to money growth or permanently related to inflation over periods of a decade or less. But the level of debt is significantly associated with subsequent inflation from 1974 to 1983. These results are consistent with the hypothesis that central banks in developed economies can conduct independent monetary policy over long periods, notwithstanding government deficits.

The Law of One Price in international commodity markets: A reformulation and some formal tests

Abstract We report formal tests of whether the Law of One Price(LOP) holds in the long and in the short run, for commodities traded in orgnized markets. We formalize the distinction between short and long run by introducing lagged price adjustments. Also, we introduce expectations explicitly. Tests support the long-run LOP but they reject the short-rn LOP. The long-run LOP holds better for future prices than for spot prices. On average, 90 per cent of the deviation from LOP is eliminated within 10 weeks, but this ranges from 1 to 120 weeks.

Financial market integration tests: an investigation using US equity markets

Abstract The literature on international financial market integration contains conflicting results, in part because there exists no economic benchmark of integration to which the statistical results can be compared. We provide such a benchmark. We subject the NYSE, AMEX and NASDAQ exchanges to a series of integration tests that use a generally accepted multifactor asset pricing (MAP) model. If we accept the premise that these three exchanges are as well integrated as any equity markets are likely to be, then our results provide a benchmark by which to adjust the significance levels used in similar international financial market integration tests. We estimate both a constant and a time-varying coefficient version of the MAP model. Both versions reject the hypothesis that the three US exchanges are integrated. Our interpretation is that these integration tests are too powerful when confronted with the practical realities of integrated markets, and the usual confidence intervals need to be substantially enlarged. The time-varying coefficient model rejects the integration hypothesis three to four times more frequently than it should. Our results can also be interpreted as a specification test of MAP models. The risk premia estimates of the fixed-coefficient model seem to be well behaved, and they do not reveal any obvious misspecification of the model. In contrast, possibly because of the low number of observations in the cross-sectional regressions, the time series of the risk premia exhibit various instabilities and undesirable properties. Finally, we find some evidence that the NASDAQ may not be as well integrated with the NYSE and the AMEX as the latter two are with each other.

General equilibrium properties of the term structure of interest rates

Abstract The paper examines the allocation of consumption and investment in a three-date binomial model in order to determine the sign of the real term structure premium in general equilibrium. When production functions are concave, markets are complete, and future production possibilities are the same irrespective of which state of the world occurs, the term structure premium will be positive. In incomplete markets, constant or increasing absolute risk aversion is sufficient to guarantee a positive term structure premium, although in the (more likely) case of decreasing absolute risk aversion a negative premium cannot be ruled out.

DO TECHNICAL TRADING PROFITS REMAIN IN THE FOREIGN EXCHANGE MARKET? EVIDENCE FROM FOURTEEN CURRENCIES

We examine the in- and out-of-sample behavior of two popular trading systems, Alexander and Double MA filters, for 14 developed-country currencies using daily data with bid-ask spreads. We find significant in-sample returns in the early periods. But out-of-sample returns are lower and only occasionally significant. We show that a currency risk factor proposed in the literature is systematically related to these returns. We find no support for the hypotheses that falling transactions costs are responsible for declining trading profits or for the Adaptive Market hypothesis. Importantly, we show that algorithms that simulate out-of-sample returns have serious instability difficulties.