Mark E. Wohar

Testing the monetary model of exchange rate determination: new evidence from a century of data

Abstract We test the long-run monetary model of exchange rate determination for a collection of 14 industrialized countries using data spanning the late nineteenth or early twentieth century to the late twentieth century. Interestingly, we find support for a simple form of the long-run monetary model in over half of the countries we consider. For these countries, we estimate vector error-correction models to investigate the adjustment process to the long-run monetary equilibrium. In the spirit of Meese and Rogoff [Journal of International Economics 14 (1983) 3\24], we also compare nominal exchange rate forecasts based on monetary fundamentals to those based on a naive random walk model.

THE PREBISCH-SINGER HYPOTHESIS: FOUR CENTURIES OF EVIDENCE

We employ a unique data set and new time-series techniques to reexamine the existence of trends in relative primary commodity prices. The data set comprises 25 commodities and provides a new historical perspective, spanning the seventeenth to the twenty-first centuries. New tests for the trend function, robust to the order of integration of the series, are applied to the data. Results show that eleven price series present a significant and downward trend over all or some fraction of the sample period. In the very long run, a secular, deteriorating trend is a relevant phenomenon for a significant proportion of primary commodities.

Regime Changes in International Real Interest Rates: Are They a Monetary Phenomenon?

In this paper, we use the Bai and Perron (1998, 2001, 2003) methodology to test for multiple structural breaks in the mean real interest rate for 13 industrialized countries. We find extensive evidence of structural breaks in the mean real interest rate for all 13 countries. In an attempt to explain the breaks in international real interest rates, we also test for multiple structural breaks in the mean inflation rate for the 13 countries. Once again, we find extensive evidence of structural breaks in the mean inflation rate for all of the countries. Interestingly, the breaks in inflation rates and real interest rates often coincide, with increases (decreases) in the mean inflation rate as we move from one regime to the next typically associated with decreases (increases) in the mean real interest rate.

Nonlinear dynamics and covered interest rate parity

This paper examines the dynamics of deviations from covered interest parity using daily data on the UK/US spot, forward exchange rates and interest rates over the period January 1974 to September 1993. Like other studies we find a substantial number of instances during the sample in which the covered interest parity condition exceeds the transaction costs band, implying arbitrage profit opportunities. While most of these implied profit opportunities are relatively small, there is also evidence of some very large deviations from covered interest parity in the sample. In order to examine the persistence of these deviations, we estimated a threshold autoregression in which the dynamics behavior of deviations from covered interest parity is different outside the transaction costs band than inside them. We find that while the impulse response functions when inside the transaction costs band are nearly symmetric, those for the outside the bands are asymmetric-suggesting less persistence outside of the transaction costs band than inside the band.

Low-Frequency Movements in Stock Prices: A State-Space Decomposition

Previous analyses have concluded that expectations of future excess stock returns rather than future real dividend growth or real interest rates are responsible for most of the volatility in stock prices. In this paper, we employ a state-space model to model the dynamics of the log price-dividend ratio along with long-term and short-term interest rates, real dividend growth, and inflation. The advantage of the state-space approach is that we can parsimoniously model the low-frequency movements present in the data. We find that, if one allows permanent changes, even though very small, in real dividend growth, real interest rates, and inflation-but not excess stock returns-then expectations of real dividend growth and real interest rates become significant contributors to fluctuations in stock prices. However, we also show that stock price decompositions are very sensitive to assumptions about which unobserved market fundamentals have a permanent component. When we allow excess stock returns to have a permanent component but not real dividend growth, excess stock returns become an important contributor to stock price movements, whereas real dividend growth does not. Unfortunately, the data is not particularly informative about which of these alternative models is more likely.

Derivative activities and managerial incentives in the banking industry

Abstract Using a sample of 175 publicly traded bank holding companies (BHCs), we find that managerial incentives and external monitoring affect the decision to use derivatives in the banking industry. Managers with incentives that are more closely aligned with the interests of shareholders, as reflected in a high percentage of CEO shareholdings, are less likely to use derivatives when insider holdings exceed 10%. Similarly, when outside directors own substantial equity, the firm is less likely to use derivatives. These results suggest that managers with large equity stakes take advantage of the risk-shifting opportunities of deposit insurance by not hedging. For BHCs with insider holdings below 10%, however, monitoring by outside directors is associated with a greater likelihood of derivative usage. This suggests that monitoring by outside directors may lead to more risk-averse behavior on the part of managers with small equity stakes.

Public and private investment: Are there causal linkages?

Abstract This paper examines the causal linkage between private investment and government provision of public capital and government investment spending. The influence of the provision of public infrastructure on private investment activity is examined by including public sector investment spending and public capital stock along with the variables specified in the major theoretical private investment models. The multivariate Granger-Causality testing procedure combined with the Akaikes Final Prediction Error (FPE) criterion is employed on annual data over the period 1954–1989. The results indicate that profits, the rate of return to capital and the tax-adjusted measre of Tobins q “Granger cause” private equipment investment. Tobins q also exhibits a significant positive effect on public investment. The results indicate the existence of feedback effects between public and private investment.

Convergence in Interest Rates and Inflation Rates across Countries and over Time

We examine the relationship between interest rates and inflation rates for 10 countries during the period 1974-95. We find evidence of a unique cointegrating relationship between nominal interest rates of European Monetary System (EMS) countries, the US and Canada, and the US, Germany, and Japan. No similar relationship is obtained between inflation rates with one exception, namely that between the US and Canada. We interpret these results as convergence in inflation but not in interest rates. Hence, if interest rates represent an indicator of monetary policy, the countries considered have attempted to implement independent policies but not to an extent which produced divergent trends in inflation. Copyright 1997 by Blackwell Publishing Ltd.

Are Tax Effects Important in the Long-Run Fisher Relationship? Evidence from the Municipal Bond Market

Recent studies of the Fisher relation have yielded contradictory conclusions on the importance of taxes in determining the long-run response of nominal interest rates to changes in expected inflation. This study uses data on taxable U.S. treasury and tax exempt municipal bond interest rates to shed light on the effects of inflation on nominal interest rates.

Two puzzles in the analysis of foreign exchange market efficiency

Abstract Based on our analysis of three data sets, we explore two puzzles in the literature on foreign exchange market efficiency. First, it appears that while excess returns are stationary, the forward premium could be generated by a time series process that is integrated of order one: this is theoretically impossible. Second, regressions of the future change in the spot rate on the forward premium very often generate negative estimated slopes. The implication that the forward rate has perverse merit in the prediction of future spot rates is paradoxical. We show how the first puzzle can be resolved through the properties of a simple bivariate time series model that is compatible with our data sets. The second puzzle vanishes when forecasts are corrected for autocorrelated errors.