Marco Tronzano

Target zone credibility and economic fundamentals

Abstract This paper investigates empirically the relationship between target zone credibility and economic fundamentals using French monthly data for the period 1991:6 to 1998:9. The econometric framework is one which allows expected devaluation (proxied by the interest rates differential) to stochastically switch between a ‘high’ and a ‘low’ phase according to the outcome of a Markov process. The transition probabilities of the Markov process are assumed to vary over time as functions of various monetary and real macroeconomic variables. Our findings suggest that expected devaluation is significantly influenced by foreign reserves and the deviations of the exchange rate from the EMS central parity, whereas the effects of real variables are weak at best.

Fiscal policy, debt management and exchange rate credibility: Lessons from the recent Italian experience

Abstract This paper explores some potential determinants of exchange rate credibility with reference to the Italian experience of the 1990s. The analysis relies on a nonlinear framework emphasizing shifts between credible and non-credible states, and assuming a significant degree of persistence in the above regimes. Almost all fiscal and debt management indicators display significant effects on devaluation expectations. The main policy implications of the paper are that a restrictive fiscal stance, a lengthening of average debt maturity and an increase in the share of foreign-denominated debt are crucial to stabilize the Lira exchange rate and to qualify Italy in the former group of countries which will join EMU.

Macroeconomic Fundamentals and Exchange Rate Credibility. Further Evidence on the Italian Experience from a Regime-switching Approach

This paper explores the links between exchange rate credibility and macroeconomic fundamentals with reference to the Italian experience during the first half of the 90s. The analysis relies on a nonlinear framework emphasizing shifts between credible and not credible states, and assuming a significant degree of persistence in the above regimes. We detect a significant influence of a cumulative loss in external competitiveness and of real output dynamics on devaluation expectations. While supporting the cautious monetary policy stance taken by monetary authorities during the transition phase following Italys re-entry in the EMS, our evidence suggests that structural supply-side policies will become crucial, in the years ahead, to ensure a credible and lasting permanence of Italy inside the EMU. Copyright 2001 by Scottish Economic Society.

Assessing the Credibility of a Target Zone: Evidence from EMS Countries

This paper proposes a Bayesian extension of Svenssons (1991) test of target zone credibility. The credibility measures considered allow us to quantify the target zones overall credibility at each point in time as well as a measure of long-run credibility. In an application of the new methodology to three European Monetary System (EMS) countries (France, Italy and the UK), using data up to 1993, we find significant anticipatory signals of the September 1992 currency crisis. We also find a strong correlation between various macroeconomic variables and the proposed credibility measure. Copyright @ 2000 by John Wiley & Sons, Ltd. All rights reserved.

A Bayesian Markov-Switching Correlation Model for Contagion Analysis on Exchange Rate Markets

This article develops a new Markov-switching vector autoregressive (VAR) model with stochastic correlation for contagion analysis on financial markets. The correlation and the log-volatility dynamics are driven by two independent Markov chains, thus allowing for different effects such as volatility spill-overs and correlation shifts with various degrees of intensity. We outline a suitable Bayesian inference procedure based on Markov chain Monte Carlo algorithms. We then apply the model to some major and Asian-Pacific cross rates against the U.S. dollar and find strong evidence supporting the existence of contagion effects and correlation drops during crises, closely in line with the stylized facts outlined in the contagion literature. A comparison of this model with its closest competitors, such as a time-varying parameter VAR, reveals that our model has a better predictive ability. Supplementary materials for this article are available online

Bayesian Markov Switching Stochastic Correlation Models

This paper builds on Asai and McAleer (2009) and develops a new multivariate Dynamic Conditional Correlation (DCC) model where the parameters of the correlation dynamics and those of the log-volatility process are driven by two latent Markov chains. We outline a suitable Bayesian inference procedure, based on sequential MCMC estimation algorithms, and discuss some preliminary results on simulated data. We then apply the model to three major cross rates against the US Dollar (Euro, Yen, Pound), using high-frequency data since the beginning of the European Monetary Union. Estimated volatility paths reveal significant increases since mid-2007, documenting the destabilizing effects of the US sub-prime crisis and of the European sovereign debt crisis. Moreover, we find strong evidence supporting the existence of a time-varying correlation structure. Correlation paths display frequent shifts along the whole sample, both in low and in high volatility phases, pointing out the existence of contagion effects closely in line with the mechanisms outlined in the recent contagion literature (Forbes and Rigobon (2002) and Corsetti at al. (2005)).

ASSESSING EUROPEAN CENTRAL BANK'S CREDIBILITY DURING THE FIRST YEARS OF THE EUROSYSTEM: A BAYESIAN EMPIRICAL INVESTIGATION

In this paper we extend Svenssons (CEPR Discussion Paper 940, April 1994) ‘simplest test’ of inflation target credibility inside a Bayesian econometric framework and obtain various estimates of the European Central Banks monetary policy credibility. Overall, our empirical evidence suggests that the strategy followed by the European Central Bank was successful in building a satisfactory degree of reputation. However, we find some significant credibility reversals concerning both anti-inflationary and anti-deflationary credibility. These reversals, in turn, are closely related to the evolution of the cyclical macroeconomic conditions in the euro area.

Sovereign Risk and Contagion Effects in the Eurozone: A Bayesian Stochastic Correlation Model

This research proposes a Bayesian multivariate stochastic volatility (MSV) model to analyze the dynamics of sovereign risk in eurozone CDS markets during the recent financial crisis. We follow an MCMC approach to parameters and latent variable estimation and provide evidence of significant volatility shifts in asset returns, strong simultaneous increases in cross-market correlations, as well as sharp declines in correlations patterns. Overall, these findings are highly consistent with various empirical characterizations of contagion put forward in the literature, allowing us to conclude that the recent financial crisis generated severe contagion effects in sovereign debt markets of eurozone countries.