Hans Dewachter

Exchange rate theory : chaotic models of foreign exchange markets

Introduction to chaos theory exchange rate theories a simple chaotic exchange rate model additional analysis of chaos in a simple exchange rate model a chaotic exchange rate model with money empirical methods for detecting and describing chaos on detecting chaos in exchange rate data evidence of non-linearities in foreign exchange rates.

Macro Factors and the Term Structure of Interest Rates

This paper presents an essentially affine model of the term structure of interest rates making use of macroeconomic factors and their long-run expectations. The model extends the approach pioneered by Kozicki and Tinsley (2001) by modeling consistently long-run inflation expectations simultaneously with the term structure. Application to the U.S. economy shows the importance of long-run inflation expectations in the modeling of long-term bond yields. The paper also provides a macroeconomic interpretation for the latent factors found in standard finance models of the yield curve: the level factor represents the long-run inflation expectation of agents; the slope factor captures business cycle conditions; and the curvature factor expresses a clear independent monetary policy factor.

An Extended Macro-Finance Model with Financial Factors

This paper extends the benchmark Macro-Finance model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return forecasting factors. Liquidity factors are obtained from a decomposition of the TED spread while the return forecasting (risk premium) factor is extracted by imposing a single factor structure on the one-period expected excess holding returns. The model is estimated on US data using MCMC techniques. Two findings stand out. First, the model outperforms significantly most structural and non-structural Macro-Finance yield curve models in terms of cross-sectional fit of the yield curve. Second, we find that financial shocks, either in the form of liquidity or risk premium shocks have a statistically and economically significant impact on the yield curve. The impact of financial shocks extends throughout the yield curve and is most pronounced at the high- and intermediate frequencies.

Endogenous risk in a DSGE model with capital-constrained financial intermediaries

This paper proposes a perturbation-based approach to implement the idea of endogenous financial risk in a standard DSGE macro-model. Recent papers, such as Mendoza (2010), Brunnermeier and Sannikov (2012) and He and Krishnamurthy (2012), that have stimulated the research field on endogenous risk in a macroeconomic context, are based on sophisticated solution methods that are not easily applicable in larger models. We propose an approximation method that allows us to capture some of the basic insights of this literature in a standard macro-model. We are able to identify an important risk-channel that derives from the risk aversion of constrained intermediaries and that contributes significantly to the overall financial and macro volatility. With this procedure, we obtain a consistent and computationally-efficient modelling device that can be used for integrating financial stability concerns within the traditional monetary policy analysis.

Imperfect information, macroeconomic dynamics and the yield curve: an encompassing macro-finance model

In this paper we estimate an encompassing Macro-Finance model allowing for time variation in the equilibrium real rate, mispricing and learning dynamics. The encompassing model specification incorporates (i) a small-scale (semi-) structural New-Keynesian model, (ii) flexible price of risk specifications, (iii) liquidity premiums in the form of (constant) deviations from (Gaussian) no-arbitrage and (iv) learning dynamics. This model is estimated on US data using MCMC techniques. We find that the encompassing model outperforms significantly standard Macro-Finance models in terms of marginal likelihood and BIC. Three findings stand out. First, unlike standard Macro-Finance models, a substantial fraction of the variation in long-term yields is attributed to changes in the perceived equilibrium real rate. Second, statistically and economically significant learning effects, especially for inflation expectations, are found. Finally, historical decompositions show that the model can replicate the US yield curve dynamics over the period 1960-2007.

Price dynamics under stochastic process switching: some extensions and an application to EMU1

Abstract In this paper we solve a particular type of stochastic process switching problem where the date of switching is fixed and known but the terminal price may depend on past prices. We derive closed-form solutions for the price dynamics of the asset before the terminal date and deduce the variance and jump components of these dynamics at the announcement. We subsequently extend the model to price dynamics prior to the announcement of the regime switch assuming that markets may have some expectations regarding the occurrence and/or the type of the regime switch. Finally, we apply the general model to discuss the implications of the chosen conversion modalities in the European Monetary Union (EMU) conversion procedure.

Setting futures margins: the extremes approach

Using a cost minimizing approach it can be shown that futures margins are set optimally when the cost rate induced by the margin equals the probability of default. Empirically this implies that extreme value analysis should be used since cost rates are, most likely, very small. Application of this approach to NYSE composite futures for the period 1982-1990 shows that actual margins are too invariable and too low, especially before the stock market crash of October 1987.

Sign predictions of exchange rate changes: Charts as proxies for Bayesian inferences

Sign Predictions of Exchange Rate Changes: Charts as Proxies for Bayesian Inferences. - One recurrent and controversial feature of high-frequency exchange rate returns is the apparent profitability of simple chartist rules. This paper attests the relevance of these rules for predicting the upward and downward tendencies in speculative prices. First, it is shown by means of a variant to the standard Markov switching model that there are swings in the mean for various weekly exchange rate returns. The paper proceeds by showing that certain chartist rules detect these regime shifts quite accurately. As such, these rules can be interpreted as workable proxies for the Bayesian filtering rule of Hamilton.ZusammenfassungVorhersage der Vorzeichen von Wechselkursänderungen: Charts als Näherungswerte für Bayes’sche Inferenzen. - Eine wiederkehrende und umstrittene Eigenschaft von häufigen Wechselkursumschwüngen ist der offensichtliche Nutzen von einfachen chartanalytischen Regelmäßigkeiten. Der Verfasser bestätigt die Bedeutung dieser Regelmäßigkeiten für die Vorhersage der aufwärts und abwärts gerichteten Tendenzen spekulativer Preise. Zuerst zeigt er mit Hilfe einer Variante des Markovschen Umkehrmodells, daß es bei verschiedenen Währungen auf Wochenbasis Schwingungen im Mittelwert der Wechselkursrenditen gibt. Dann zeigt er, daß gewisse chartanalytische Regelmäßigkeiten diese Regimewechsel ziemlich genau offenlegen. Demnach können diese Regelmäßigkeiten als brauchbare Annäherungen für die Bayes’sche Filterregel nach Hamilton interpretiert werden.

Explaining Recent European Exchange-Rate Stability

In this paper we analyse the behaviour of the bilateral exchange rates that were converted into euros on 1 January 1999. Using a model of stochastic regime switching we study the effects of future conversion on current exchange-rate dynamics. We find that exchange rates are to a large extent determined by the discounted (expected) conversion value. The theoretical model is subsequently applied to the currencies that participate in the first wave of the European Monetary Union (EMU). Using a Kalman approach, we find that for most currencies the weight attached to the future conversion value was well over 95%. This pricing characteristic successfully insulated intra-European exchange rates from the turmoil generated by the ongoing crises in Asia, Russia and Latin America. Copyright 1999 by Blackwell Publishers Ltd.

The intra-day impact of communication on euro-dollar volatility and jumps

In this paper, we examine the intra-day effects of verbal statements and comments on the FX market uncertainty using two measures: continuous volatility and discontinuous jumps. Focusing on the euro-dollar exchange rate, we provide empirical evidence of how these two sources of uncertainty matter in measuring the short-term reaction of exchange rates to communication events. Talks significantly trigger large jumps or extreme events for approximately an hour after the news release. Continuous volatility starts reacting prior to the news, intensifies around the release time and stays at high levels for several hours. Our results suggest that monetary authorities generally tend to communicate with markets on days when uncertainty is relatively severe, and higher than normal. Disentangling the US and Euro area statements, we also find that abnormal levels of volatility are mostly driven by the communication of the Euro area officials rather than US authorities.