Delroy M. Hunter

Emerging Market Liberalization and the Impact on Uncovered Interest Rate Parity

A shock absorbing tow bar for connection between the accumulating trolley and load carriage of a power and free conveyor system is disclosed. The tow bar includes one component that is connectable to the accumulating trolley and another that is connectable to the intermediate trolley of the load carriage. Limited relative shifting is permitted between the components of the tow bar. Moreover, the components are threadably intercoupled so that such relative shifting requires a screwing or unscrewing action that serves to cushion movement between the accumulating trolley and load carriage.

A Conditional Assessment of the Relationships Between the Major World Bond Markets

This paper uses a bivariate GARCH framework to examine the lead-lag relations and the conditional correlations between 10-year US government bond returns and their counterparts from the UK, Germany, and Japan. We find that while mean and volatility spillovers exist between the major international bond markets, they are much weaker than those between equity markets. The results also indicate that the correlations between the US and other major bond market returns are time varying and are driven by changing macroeconomic and market conditions. However, in contrast to the finding that the benefits of international diversification in equity markets evaporate during high-stress periods, we find that the benefits of diversification across major government bond markets do not decrease during periods of extremely high bond market volatility or following extremely negative US and foreign bond returns.

Dynamic Relations between International Equity and Currency Markets: The Role of Currency Order Flow

Previous research on the dynamic linkages between international financial markets focused on bivariate interequity or intercurrency relationships and do not allow a specific role for the currency or equity market, respectively. In this paper, we hypothesize that there are important, yet not well understood, dynamic relationships between international equity and currency markets and these are driven by information spillover via the mechanism of currency order flow. Using a trivariate asymmetric GARCH framework, we find that the relationships between equity and currency markets are significant, bidirectional, and pervasive. These relationships, which coexist with the relationships between U.S. and foreign equity markets, are much stronger in the volatilities than in the means. Importantly, we find strong support for our information spillover hypothesis where currency order flow is the economic mechanism by which information is transmitted.

Benefits of International Bond Diversification

Despite suggestions that diversification benefits have fallen in the recent decade, currency-hedged bonds provided U.S. investors significant diversification benefits over January 1992-September 2002. U.S. bond returns have become increasingly correlated with U.K. and German bond returns, but correlations have declined with Japanese bonds. The changing correlations are consistent with more synchronized business cycles, but correlations have not become high enough to threaten the gains from diversification. Nor are gains on a currency-hedged basis diminished during periods of weakness or increased volatility in U.S. or foreign bond markets. Risk-reward trade-offs for each bond market vary in a predictable manner, which underscores the potential benefits of international bond investing.

Linear and Nonlinear Dynamic Linkages between Emerging Market ADRs and their Underlying Stocks

I examine the causal linkages between the returns on emerging market ADRs, their underlying stocks, and changes in the relevant exchange rate. Using a linear VAR model with a cointegration constraint and a nonlinear causality test on daily data, I provide evidence of significant linear and nonlinear causal transmissions from the underlying stocks to the ADRs. Contrary to results from the industrialized markets, there are also significant causal transmissions from the ADRs to the underlying stocks for several days. In fact, the ADRs have greater predictive ability for their underlying stocks than vice versa. Price transmissions from the currency market are generally less persistent, except in the case of Mexico where there are significant bi-directional linear causality between ADRs/underlying stocks and the exchange rate. A trading strategy using the predictability of the ADRs and underlying stocks provide a large excess return relative to a buy-and-hold strategy, but this is unprofitable after accounting for transaction costs.

The Role of Currency Risk in Industry Cost of Capital

In this paper we test the hypotheses that previous studies fail to find a significant role for currency risk in industry returns because of methodological shortcomings or because of hedging. Using a Fama-French three-factor model augmented with an exchange rate factor in which both the factor exposures and risk premiums are time varying, we find that 35 of 36 U.S. industries are significantly exposed to a broad currency index (containing the currencies of developed and developing economies). In sharp contrast, only 14 industries display significant time-invariant exchange rate exposure using ordinary least squares. More important, the sample means of the time-varying exposures are economically large, with 27 (75%) being greater than 0.10. This resolves the puzzle that previous research finds significant exposure at the aggregate stock market level, but fail to identify the firm or industry level as the source of this aggregate exposure. In addition, currency risk premium is an economically large component of the cost of equity, with 21 industries having a mean currency premium of over 100 basis points per year. Compared to an average cost of equity of 15% per year, the annualized (absolute) currency risk premium is 2.10% for the average industry and is substantially more for some industries. Moreover, 31 of the 36 industries have a mean absolute currency risk premium that is at least one-tenth of the industrys total risk premium. Contrary to the above, an index of the currencies of the developed countries substantially understates the economic importance of currency risk premium. Overall, we find strong support for the methodological, but not the hedging, hypothesis.

Does Deposit Insurance Retard the Development of Financial Markets

Using a panel of 87 countries, we find that the introduction of deposit insurance retards the development of nonbank financial markets, the banking sector, and, hence, the overall financial market. This effect is less severe in the short run and can be mitigated by strong law and order, but is generally not positive even with the strongest law and order. Further, design features that benefit depositors influence the negative effect on nonbank markets. Our results suggest that externalities arising from deposit insurance make concerns about its effects more pressing than those arising solely from the evidence for the banking sector.

Product Market Competition, Capital Constraints and Firm Growth

We examine the impact of rivals’ competitive activities on firms’ quantity-of-capital constraints in 60 countries. Prior work shows that competition increases the costs of debt and equity, which reduce the economic profit from investment. Capital constraints, however, may prevent firms from exploiting all positive NPV projects. Using unique survey data and several econometric techniques, we address endogeneity problems that affect both capital constraints and rivals’ competitive activities. We find that rivals’ competitive activities are positively associated with firms’ capital constraints and are more strongly correlated with capital constraints than banking sector competition. We also show that quantity-of-capital constraints are negatively related to firm growth, incremental to the cost of capital. A revised version of this article is now accepted at the Journal of Banking and Finance.

Do Foreign Investors Insulate Firms from Local Shocks? Evidence from the Response of Investable Firms to Monetary Policy

Extant theory suggests that foreign ownership of shares of emerging-market (investable) firms may insulate them from local shocks. Examining 24 emerging markets, we find that the returns of both investable and non-investable firms are sensitive to local monetary policy shocks. Surprisingly, in 46% of our country-sample, investable stock returns are more sensitive to local shocks than non-investable stock returns. Differences in leverage, stock liquidity, exposure to domestic product markets, or industry cyclicality do not drive these findings. These findings reinforce a positive association between investability and price efficiency found by prior research and have implications for the decision to further open frontier and emerging markets and the conduct of emerging-market monetary policy.

Emerging Market Liberalization and Monetary Control

Extant theory suggests that foreign ownership of shares of emerging-market (investable) firms may insulate them from local shocks. Examining 24 emerging markets, we find that the returns of both investable and non-investable firms are sensitive to local monetary policy shocks. Surprisingly, in 46% of our country-sample, investable stock returns are more sensitive to local shocks than non-investable stock returns. Differences in leverage, stock liquidity, exposure to domestic product markets, or industry cyclicality do not drive these findings. These findings reinforce a positive association between investability and price efficiency found by prior research and have implications for the decision to further open frontier and emerging markets and the conduct of emerging-market monetary policy.