Massimo Sbracia

A Primer on Financial Contagion

This paper presents a theoretical framework to highlight possible channels for the international transmission of financial shocks. We first review the different definitions and measures of contagion adopted by the literature. We then use a simple multi-country asset pricing model to classify the main elements of the current debate on contagion and provide a stylized account of how a crisis in one country can spread to the world economy. In particular, the model shows how crises can be transmitted across countries, without assuming ad hoc portfolio management rules or market imperfections. Finally, tracking our classification, we survey the results of the empirical literature on contagion. Copyright Blackwell Publishing Ltd, 2003.

The CAPM and the Risk Appetite Index: Theoretical Differences, Empirical Similarities, and Implementation Problems

We make a thorough analysis of the Risk Appetite Index (RAI), a measure of changes in risk aversion proposed by Kumar and Persaud (2002). Building on Misina (2003), we first argue that the theoretical assumptions granting that the RAI correctly distinguishes between changes in risk versus changes in risk aversion are very restrictive. Then, by comparing the RAI with a measure of risk aversion obtained from the CAPM, we find that estimates are surprisingly similar. We prove that, if the variance of returns is sufficiently smaller than the variance of asset riskiness, then RAI and CAPM provide essentially the same information about risk aversion. We also show, however, that the RAI and the CAPM suffer from exactly the same implementation problems - the main one being the difficulty in measuring expected returns. At high and medium frequencies, the standard method of using ex post returns generates negative risk aversions and other inconsistencies. Hence, future research is needed to address this problem.

The Role of the Banking System in the International Transmission of Shocks

The paper analyzes the role of the banking system in the international transmission of financial shocks. A channel of transmission is defined as a mechanism through which a financial crisis in one country induces a financial crisis in another country. Channels involving banks operate through changes in the capital adequacy ratios of a common lender and in the value of collateral of domestic borrowers, through bank runs and bank panics, and through moral hazard. Recent empirical evidence points to the significant effects of the common lender channel on the probability of a financial crisis, while mitigating the role of bank runs and remaining inconclusive about moral hazard. Thus, we introduce a series of indices of vulnerability to the common lender channel that improve existing measures by taking into account both the borrowers dependence on foreign loans and the lenders exposure to a single country. By comparing the degree of vulnerability to the common lender channel during the 1990s major crises, we find that vulnerability was higher in the Asia Pacific region in 1997 (and, especially, in the five countries most involved in the crisis) than in Latin America and East Europe. Vulnerability was significantly lower in 2000 for almost all the countries in our sample, due to both a more even distribution of liabilities on the part of developing countries and a higher degree of diversification of bank investments from the three main lending countries (United States, Japan, Germany).

Real Exchange Rates, Trade, and Growth: Italy 1861-2011

What is the relationship between real exchange rate misalignments and economic growth? And what effect, if any, did undervaluations or overvaluations of the lira/euro have on Italys growth? We address these questions by presenting, first, three main facts: (i) there is a positive relationship between undervaluation and growth; (ii) this relationship is strong for developing countries and weak for advanced countries; (iii) these results tend to hold for both the pre- and the post-World War II period. Building a simple analytical model, we explore channels through which undervaluation may exert a positive effect on real GDP. We assume that productivity is higher in the tradeable-goods than in the non-tradeable-goods sector, and examine the roles of market structure, scale economies and wage flexibility in channelling resources from the latter to the former sector, increasing exports and real GDP. We then turn to Italy and verify empirically that, as the theory suggests, undervaluation has positively affected its exports. Undervaluation has been helpful, in particular, to increase the exports of high-productivity sectors, such as most manufacturing industries. Finally, we describe the misalignments of the lira/euro since 1861, analyze their determinants and draw the implications for Italys economic growth.

The Secular Stagnation Hypothesis: A Review of the Debate and Some Insights

Recent studies warn that the U.S. economy may return to a phase of secular stagnation. In the next 20 to 50 years, U.S. economic growth will be negatively affected by lower contributions of hours worked and education. But some studies also add that productivity could decelerate sharply and that GDP per capita, by focusing on the average household, neglects that income has already been stagnating in the last 30 years for the households in the bottom 99% of the income distribution. After reviewing recent long-run projections, we argue that similar warnings were issued in the past after all deep recessions. Interestingly, pessimistic predictions turned out to be wrong neither because they were built on erroneous theories or data, nor because they failed to predict the discovery of new technologies, but because they underestimated the potential of the technologies that already existed. These findings suggest that today we should not make the same mistake and undervalue the effects of the information technology. Finally, we discuss a number of issues that should be tackled by future research.

A New Indicator of Competitiveness for Italy and the Main Industrial and Emerging Countries

This paper presents the new competitiveness indicators of the Bank of Italy. While the old ones were calculated with reference to 25 industrial or OECD countries, the new indicators are available for 62 countries, including the main emerging and developing economies. In order to extend the country coverage, we have used a new methodology to compute country weights, introduced by the Federal Reserve, which is entirely based on trade flows; by contrast, the previous IMF-BIS methodology adopted for the old indicators required also data on the domestic production of the manufacturing sector — figures that are rarely available for non-industrial countries. In addition, we have adjusted the trade flows of China and Hong Kong as suggested in the literature, in order to reduce the distortions due to the entrepot trade of these two countries. Results show that methodological differences have a negligible impact on competitiveness indicators; on the other hand, the effect of the country coverage may be quite remarkable. In Italy’s case, the old and new indicators show a similar dynamics in the period from January 1980 to September 2005; differences in levels, well-contained between 1980 and 1993, grow thereafter reaching a maximum of 5.5 percentage points. During the recent phase of dollar depreciation began in February 2002, Italy recorded a sharp decline in competitiveness. In addition to the United States, the countries that mostly contributed to this negative performance were Japan, China, Hong Kong and Taiwan. These losses were partly offset by the gains recorded with respect to several central and eastern European countries.

Deconstructing the Gains from Trade: Selection of Industries vs. Reallocation of Workers

In a Ricardian model with general distributions of industry efficiencies, the welfare gains from trade can be decomposed into a selection and a reallocation effect. The former is the change in average efficiency due to the selection of industries that survive international competition. The latter is the rise in the weight of exporting industries on total production owing to the reallocation of workers from non-exporting industries. Measuring the two effects is difficult in the general case, but the calculations become much simpler when using Frechet-distributed efficiencies, providing easily quantifiable model-based measures of the two effects. The selection (reallocation) effect appears to be most significant when welfare gains are small (large).

The CAPM and the Risk Appetite Index: Theoretical Differences and Empirical Similarities

This paper analyzes the Risk Appetite Index (RAI), a measure of investorsi?½ risk aversion proposed by Kumar and Persaud (2001, 2002). We show that the RAI distinguishes between risk and risk aversion only under theoretically restrictive assumptions on the distribution of returns and the shocks affecting assetsi?½ riskiness. However, by comparing the RAI with a measure of risk aversion derived from the CAPM i?½ a model that does not require those restrictive assumptions i?½ we find that estimates are surprisingly similar. We explain this result by proving that, under a certain condition, the RAI can approximate the risk aversion parameter of a CAPM. This occurs if the ratio between the variance of the returns on assets and the variance of the riskiness of assets is sufficiently smalli?½a condition that is met in our sample.

The cyclicality of the income elasticity of trade

In 2011-2015 global trade volumes have systematically surprised on the downside, to a much larger extent than real GDP. We show that two key features of real trade flows --- their high volatility and their procyclicality --- determine a cyclicality of the income elasticity of trade. This property is such that when real GDP growth is positive but lower than its long-run trend, then the income elasticity of trade is also smaller than its own long-run trend. As a consequence, when real GDP growth turns out to be weaker than expected, the forecast error on trade volumes is amplified by the fact that also the income elasticity of trade happens to be smaller than predicted. Our analysis shows, in particular, that long-run and cyclical forces have contributed to a similar extent to the recent weakness of trade volumes. As a by-product, we also explain how the high volatility and procyclicality of real trade flows, together with the size of the non-tradeable-goods sector, contribute to determine cross-country differences in the income elasticity of trade.