Michael Frömmel

Increasing exchange rate volatility during the recent float

The paper examines empirically whether the volatility of major floating exchange rates shows any systematic change during the period from 1973 to 1998. Four measures for unconditional and conditional volatility demonstrate increasing volatility for most currencies and for two worldwide baskets of exchange rates. Structural breaks are identified for several exchange rates, implying that the volatility increase is in some cases due to upward shifts and not due to continuous changes. This may indicate that in addition to permanent microstructural impacts, macroeconomically-caused shifts are possibly also important for the volatility increase.

Risk Reduction in the EMS? Evidence from Trends in Exchange Rate Properties

The performance of the European Monetary System is still being debated. On the subject of exchange rate characteristics it has been claimed that evidence from looking at the statistical properties of the exchange rate distribution indicates an increased risk for agents. Others argue that the apparent success of the EMS is illusory, as it has not performed better than other currencies over the same period. We analyse these propositions by searching for trends in risk of EMS exchange rates and comparing them to outside benchmarks. We find properties indicating decreasing risk and these results also hold when structural breaks are considered. Moreover, this decline seems to be faster than for world benchmarks.

Testing for a rational bubble under long memory

We analyse the time series properties of the S&P500 dividend–price ratio in the light of long-memory, structural breaks and rational bubbles. We find an increase in the long-memory parameter in the early 1990s by applying a test recently proposed by Sibbertsen and Kruse [J. Time Series Anal., 2009, 30, 263–285]. An application of the unit root test against long memory of Demetrescu et al. [Econometr. Theory, 2008, 24, 176–215] suggests that the pre-break data can be characterized by long memory, while the post-break sample contains a unit root. These results reconcile two empirical findings that are seen as contradictory: on the one hand, they confirm the existence of fractional integration in the S&P500 log-dividend–price ratio and, on the other, they are consistent with the existence of a rational bubble. The result of a changing memory parameter in the dividend–price ratio has an important implication for the literature on return predictability: the shift from a stationary dividend–price ratio to a unit root process in 1991 is likely to have caused the well-documented failure of conventional return prediction models since the 1990s.

Bank Lending and Asset Prices in the Euro Area

We examine the dynamics of bank lending to the private sector for countries of the Euro area by applying a Markov switching error correction model.We identify for Belgium, Germany, Ireland and Portugal stable, mean reverting regimes and unstable regimes with no tendency to return to the long term credit demand equation, whereas for some other countries there is only weak evidence. Furthermore, for these as well as for other countries we detect in the less stable regimes a strong co-movement with the development of the stock market. We interpret this as evidence for constraints in bank lending. In contrast, the banks? capital seems to have only marginal impact on the lending behaviour.

Interest rate convergence in the EMS prior to European Monetary Union

We analyze the convergence of interest rates in the European Monetary System (EMS) in a novel framework of changing persistence. Due to the specific historical situation in the EMS interest rate differentials were non-stationary before full convergence was achieved. After full convergence has taken place, interest rate differentials became stationary. The applied econometric approach allows us to estimate the exact dates of full convergence endogenously. Our empirical results suggest remarkable differences in the estimated convergence dates for Belgium, France, the Netherlands and Italy which are highly related to steps of European integration policies. We conclude that credibility of monetary policy is of paramount importance for establishing a monetary union successfully. This finding has significant implications for future member states of the EMU.

Crystallization: A Hidden Dimension of CTA Fees

The authors investigated the impact on fee load of variations in the frequency with which commodity trading advisers update their high-water mark. They documented crystallization frequencies used in practice, analyzed the effect on fee load, and found that the crystallization frequency set by the manager significantly affects fee load and should thus be a relevant consideration for investors. We investigated the impact on fees paid by investors of variations in the frequency with which commodity trading advisers (CTAs) or managed futures update their high-water mark (HWM). Although this aspect of hedge funds’ fee structure might be neglected in fee negotiations, the “crystallization” frequency has a material impact on the fee level that investors pay. Therefore, the issue is of high relevance for investors that are invested in or wish to allocate to CTAs or other hedge fund categories. The crystallization frequency is an important element of any performance-based fee structure that includes a high-water-mark provision. In our study, we first documented the crystallization frequency commonly used by managed futures. We found that in the majority of cases, the high-water mark is updated quarterly. This finding contrasts with the view expressed in prior academic research that hedge funds commonly charge the incentive fee annually, at the end of the year. Furthermore, using data on managed futures from BarclayHedge for 1994–2012, we studied the impact of crystallization frequency on the average annual fee load that investors pay. We first estimated CTAs’ gross returns by using the funds’ headline fee levels and assuming quarterly crystallization. We then used gross returns as inputs for a block bootstrap approach to simulate the track record of CTA funds. The final step consisted of applying a standard 2/20 fee structure but varying the crystallization frequency. In this way, we were able to quantify the average annual fee load for different crystallization frequencies under realistic conditions. The results that we report in the article provide investors with a number of useful insights. We found that the expected total fee load charged by the hedge fund manager increases with the crystallization frequency. In the case of CTAs and assuming a 2/20 fee structure, shifting from annual to quarterly crystallization leads to a 49 bp increase in the average annual fee load (as a percentage of assets under management). These results imply that funds with different (identical) headline fee levels can have remarkably similar (different) fee loads. We quantified the trade-off between crystallization frequency and performance fee level. Specifically, our results suggest that an incentive fee of 15% under monthly crystallization leads to the same total fee load as an incentive fee of 20% under annual crystallization. Our results imply that the effect of crystallization frequency on fees is important for investors evaluating and comparing different fund investments. Headline fee levels do not tell the whole story when a high-water-mark provision is used. Considering the crystallization frequency should allow a more informed choice when investing in CTAs or other investment vehicles with a high-water-mark provision.

Further Evidence on Foreign Exchange Jumps and News Announcements

ABSTRACT We apply the bipower variation technique to characterize the jump dynamics in the HUF/EUR market and examine the link between jumps and news announcements of various sources. Our findings confirm that jumps are prevalent, large, and account for approximately one-half of the total volatility during jump days. More important, we find that nearly half of the significant jumps are explained by scheduled and unscheduled news releases, confirming the dynamic announcement effect in the foreign exchange (FX) market. Finally, the postjump reversal patterns suggest that the realized jumps are mostly information based, whether they are obviously linked with news or not.

Daily Currency Interventions in Emerging Markets: Incorporating Reserve Accumulation to the Reaction Function

This study considers emerging market central bank interventions motivated by international reserve management. Emerging market central banks use currency intervention as a policy tool against exchange rate movements and accumulate international reserves as an insurance against sudden stops or reversals in capital flows. To account for both of these motivations, the model of Ito and Yabu (2007) is extended to include the international reserves-to-GDP ratio at a daily frequency. Daily values of the ratio are forecast using the Mixed Data Sampling (MIDAS) model and exchange rate returns. Compared with the benchmark model, we �?nd that the MIDAS model performs better in forecasting the reserve-to-GDP ratio. The extended model is estimated by using the floating exchange rate regime period data of Turkey. We identify breaks in the Turkish intervention policy, and the reserve-to-GDP variable in the extended model is found to have a signi�?cant role in the intervention reaction function.

Daily Currency Interventions in Emerging Markets: Incorporating Reserve Accumulation

This study considers international reserve management motivation of emerging market central banks in foreign exchange market interventions. Emerging market central banks use currency intervention as a policy tool against exchange rate movements and accumulate international reserves as an insurance against sudden-stops in capital flows. To account for both of these motivations, a model of infrequent interventions only with exchange rates is extended to include international reserves-to-gross domestic product (GDP) ratio at the daily frequency. Daily values of the ratio are forecast using the Mixed Data Sampling (MIDAS) model and exchange rate returns. The model is estimated by using the floating exchange rate regime period data of Turkey. Compared with the benchmark model, it is shown that the MIDAS model does a better job in the forecasting of the reserve-to-GDP ratio. In addition to that, there are breaks in the interventions policy in Turkey, and the extended intervention model performs better than the model only with exchange rates especially in predicting purchases of US Dollar.

Understanding the Controversy of Liquidity Beta: A Natural Experiment

The conventional, risk-based view on liquidity beta is often a dismal story for empirical data. We propose a competing, sentiment-based view on the reversed pricing pattern of liquidity beta in China: High liquidity beta stocks underperform low liquidity beta stocks by 1.17% per month. The striking pattern is robust to different weighting schemes, competing factor models, alternative liquidity measures, and other well-known determinants of cross-sectional returns. Consistent with our new perspective, liquidity beta is a negative return predictor at firm level. Moreover, the return differential between high and low liquidity beta stocks is more dramatic following high market liquidity periods.