Kevin James Daly

The Causes of Stock Market Volatility in Australia

The paper examines the extent to which the conditional volatility of stock market returns in a small, internationally integrated stock market are related to the conditional volatility of financial and business cycle variables. It employs a low frequency monthly dataset for Australia including stock market returns, interest rates, inflation, the money supply, industrial production and the current account deficit over the period from July 1972 to January 1994. A novel feature of the analysis is the estimation strategy employed to overcome the generated regressors problem which pervades some recent related research. Specifically, the procedure of employing a two-stage estimation process to first estimate conditional volatilities and then model their interrelationships yields inefficient estimates, introduces bias into a number of diagnostic test statistics and generates potentially invalid inferences. This problem is overcome in the current paper by jointly estimating the equation for the conditional volatility of stock market returns together with the equations determining the conditional volatilities of all variables included in the model using the generalized least squares (GLS) estimation procedure together with the Hendry general-to-specific modelling strategy. Among the most important determinants of the conditional volatility of the Australian stock market are found to be the conditional volatilities of inflation and interest rates which are directly associated with stock market volatility, and the conditional volatilities of industrial production, the current account deficit and the money supply which are indirectly associated with stock market conditional volatility. Among these variables, the strongest effect is found to be from the conditional volatility of the money supply to the conditional volatility of the stock market. By contrast, no evidence is found of volatility spillover from the foreign exchange market to the stock market in Australia.

Does exchange rate volatility impede the volume of Japan's bilateral trade?

Abstract The purpose of this paper has been to examine the extent to which exchange rate volatility impedes Japans bilateral trade flows. In addition to exchange rate volatility, other factors that were posited to affect trade flows include data on real economic activity, costs, and prices which feature in the theoretical framework. The empirical analysis differs from the majority of previous research by appropriately specifying the models in terms of the order of integration of the data and in terms of the equation dynamics. The major finding of the paper is that exchange rate volatility is at least as likely to raise trade flows as it is to impede them.

Where do Australians Invest

In this article, we analyse the geography of Australias international portfolio investment using the International Monetary Funds Co-ordinated Portfolio Investment Survey dataset. Preliminary results suggest that Australias external holdings of equity and debt as a percentage of national income almost doubled between 1997 and 2001. However, Australias international investment position as a percentage of national income is one of the lowest amongst the major OECD countries. In 2001 approximately two-thirds of Australias total investments were in the United States and the United Kingdom. By contrast Australias trade share (exports plus imports as a percentage of Australias total world trade) with these countries was approximately 20 per cent in the same year. The major determinants of Australias geographical allocation of portfolio investment indicate a broad correspondence between stock market capitalisation of destination countries and the allocation of Australian financial investments but with some deviations from that baseline, where the deviations are correlated with Australian trade patterns. Copyright 2006 The University of Melbourne, Melbourne Institute of Applied Economic and Social Research.

Determinants of international financial integration

It is generally accepted that there has been an increase in the degree of international financial integration over the last two decades. Countries are trying to remove the restrictions on cross-border capital movement, deregulate domestic financial markets and offer competitive investment environments to encourage investment. As a result, international financial integration has been a topical area for many financial economists. However, there is a limited amount of research focusing on the determinants of international financial integration theoretically and empirically. To enrich the literature on this topic, the current paper will empirically investigate the potential drivers of international financial integration including policy on capital controls and other components of financial structure which are the level of economic and educational development, economic growth, the institutional and legal environment, trade openness, financial development and tax policy.

The Impact of Bank-Specific and Macroeconomic Factors on China’s Bank Performance ok

Abstract In the last decade the Chinese government owned banks have undergone a privatization program resulting in considerable changes in ownership of Chinese banks. This paper examines the impact of bank-specific, macroeconomic, financial, and globalization variables on the performance of Chinese banking from 2004 to 2010. The results suggest that banks with lower credit risk, which are well capitalized, tend to be more profitable, while banks with higher expense preferences exert a negative impact on bank performance. The macroeconomic variables suggest that China’s financial services tend to grow along with economic growth. Our results also suggest that greater economic integration through increased trade and capital flows coincides with an increase in bank profitability. Likewise, social globalization and political globalization seem to exert positive effects on the profitability of Chinese banks.

Finding Fair Value in Global Equities: Part II—Forecasting Returns

This article is the second of a two-part series that develops a framework for comparative valuation of major equity markets around the world. In this article, the authors invert the dividend discount model (DDM) discussed in “Fair Value in Global Equities:Part I,” published in the preceding issue of this journal, in order to extract a time series of the implied equity risk premium (ERP) and the real required return (RRR).They estimate regression equations to find the macroeconomic drivers of these series. The ERP increases with the output gap at home and abroad, as well as with high past values of the ERP. This relationship allows for benchmarking the ERP and the RRR to the current economic environment and to forecasts of the future economic environment. The authors compare the use of these tools with other ways to forecast returns. At a five-year horizon, valuation alone is a good predictor of future returns, and the current value of the RRR works particularly well in this regard. At a one-year horizon, forecasts based on the benchmarking of the RRR to the future economic environment work significantly better than traditional valuation metrics, if the economic outlook is correct.

International financial integration : an empirical investigation into Asian equity markets, pre- and post- 1997 Asian financial crisis

The study investigates the interdependence of the stock markets between the following countries Hong Kong, Japan, Korea, Taiwan, Indonesia, Malaysia, Philippines, Singapore, Thailand and the advanced stock markets of Australia, Germany, United Kingdom and the United States. Using data from 1994 to 2003 the paper employs both correlation, causality and cointegration analysis to describe the behaviour of the above stock market indices over the period pre and post the 1997 Asian Financial Crises. The paper investigates both the short- and long-run relationships between the Asian markets and the markets of selected advanced industrial countries.

Fiscal financing decisions and exchange rate variability

One of the perceived benefits of a flexible exchange rate system is the insulation of the domestic economy from foreign shocks, and the potential for independent policy actions. In view of the considerable uncertainty, which pervades appropriate specification of the relevant theoretical models, the empirical analysis of this paper adopts the vector autoregressive approach. Using quarterly data over the period 1975(2)‐1995(2), models are estimated which test the effect on exchange rates of fiscal variables for seven countries (Australia, Canada, Britain, France, Germany, Italy and the USA). In testing the exchange rate response to a bond financed fiscal expansion, a tax financed fiscal expansion and to a swap of taxes for debt with no change in the level of government expenditure, the results for the seven countries over the recent float are mixed because the impulse response functions to the shocks do not have the same pattern in every country.

Monetary Volatility and Real Output Volatility: An Empirical Model of the Financial Transmission Mechanism in Australia

This paper examines how monetary volatility is transmitted to the volatility of financial asset prices, inflation and real output in an open economy. A Markowitz efficient portfolio is constructed to eliminate diversifiable financial risk, and estimation by GLS on monthly Australian data from 1972(1)-1994(1) using the general-to-specific estimation strategy overcomes the generated regressors problem in related ARCH-type models. The findings include: first, higher monetary volatility is associated with lower volatility of financial asset prices and higher real output volatility, and second, monetary volatility is transmitted to real output volatility predominantly through the share market with no foreign exchange market effect.

“Fair go” for all? Wealth and Risk Aversion of Australian Households

A mean‐variance framework is applied to Australian household financial portfolios in order to provide estimates of relative risk aversion in the economy. Controlling for various socio‐economic characteristics, we explore whether risk aversion heterogeneity is a function of wealth heterogeneity. In contrast to most studies, we find evidence of very high risk aversion amongst the majority of households of poor households but vastly lower risk aversion amongst the high percentiles in the wealth distribution. Applying a first differences model across three survey waves spanning 2002 to 2010, we find that risk tolerance increases significantly with wealth. Risk tolerance is positively associated with mortgage payments, but rental payments have no relationship. In addition, we found no evidence that holding a university education has any discernible impact on risk aversion. Lastly, we present some preliminary findings as to the impact of financial advice on observed risk aversion. Financial advice is found to accentuating risk aversion, particularly amongst the wealthiest households. The findings have potential implications for the distribution of wealth in Australia that has received renewed interest recently.