Paolo Zagaglia

Gold and the U.S. Dollar: Tales from the Turmoil

We investigate how the relation between gold prices and the U.S. Dollar has been affected by the recent turmoil in financial markets. We use spot prices of gold and spot bilateral exchange rates against the Euro and the British Pound to study the pattern of volatility spillovers. We estimate the bivariate structural GARCH models proposed by Spargoli e Zagaglia (2008) to gauge the causal relations between volatility changes in the two assets. We also apply the tests for change of co-dependence of Cappiello, Gerard and Manganelli (2005). We document the ability of gold to generate stable comovements with the Dollar exchange rate that have survived the recent phases of market disruption. Our findings also show that exogenous increases in market uncertainty have tended to produce reactions of gold prices that are more stable than those of the U.S. Dollar.

Measuring market liquidity: An introductory survey

Asset liquidity in modern financial markets is a key but elusive concept. A market is often said to be liquid when the prevailing structure of transactions provides a prompt and secure link between the demand and supply of assets, thus delivering low costs of transaction. Providing a rigorous and empirically relevant definition of market liquidity has, however, provided to be a difficult task. This paper provides a critical review of the frameworks currently available for modelling and estimating the market liquidity of assets. We consider definitions that stress the role of the bid-ask spread and the estimation of its components that arise from alternative sources of market friction. In this case, intra-daily measures of liquidity appear relevant for capturing the core features of a market, and for their ability to describe the arrival of new information to market participants.

On (Sub)Optimal Monetary Policy Rules under Untied Fiscal Hands

We examine the interplay between monetary and fiscal policies in a context where disturbances to the public deficit process are a primary source of macroeconomic instability. We perform simulations of optimal targeting rules on a sticky-price model a la Woodford (1996). Our investigation compares the dynamic adjustment path under inflation targeting with that arising from nominal income growth targeting. When fiscal shocks enter the picture, inflation targeting is a superior strategy. In opposition to Jensen (1999)s results, we show that an inflation targeter is capable of bringing about the required degree of interest rate inertia. This does not occur at the cost of additional nominal instability.

The Co-Movements Along the Forward Curve of Natural Gas Futures: A Structural View

This paper studies the co-movements between the daily returns of forwards on natural gas traded in the NYMEX with maturity of 1, 2 and 3 months. We identify a structural multivariate BEKK model using a recursive assumption whereby shocks to the volatility of the returns are transmitted from the short to the long section of the forward curve. We find strong evidence of spillover effects in the conditional first moments, for which we show that the transmission mechanism operates from the shorter to the longer maturity. In terms of reduced form conditional second moments, the shortest the maturity, the higher the volatility of the return, and the more the returns become independent from the others and follow the dynamics of the underlying commodity. The evidence from the structural second moments indicates that the longer the maturity is, the higher the uncertainty about the returns. We also show that the higher the structural variance of a maturity relative to that of another maturity, the stronger the correlation between the two.

Determinacy of interest rate rules with bond transaction services in a cashless economy

Canzoneri and Diba (2004) show that the Taylor principle is not a panacea for equilibrium determinacy in a model where bonds and money provide liquidity services to households. We consider a cashless New Keynesian model with two types of government bonds. One bond provides transaction services, whereas the other is used only as a store of value. We show that the Taylor principle is still sacrosanct, and that the results of Leeper (1991) are confirmed.

Fractional integration of inflation rates: a note

This note studies the persistence of CPI inflation for 12 OECD countries. The fraction order of integration is estimated through the wavelet-OLS estimator of Jensen (1999). The results show that CPI inflation is characterized by mean reversion in the long run with finite variance.

Forecasting Value-at-Risk with Time-Varying Variance, Skewness and Kurtosis in an Exponential Weighted Moving Average Framework

This paper provides an insight to the time-varying dynamics of the shape of the distribution of financial return series by proposing an exponential weighted moving average (EWMA) model that jointly estimates volatility, skewness and kurtosis over time using a modified form of the Gram–Charlier density in which skewness and kurtosis appear directly in the functional form of this density. In this setting, Value-at-Risk (VaR) can be described as a function of the time-varying higher moments by applying the Cornish-Fisher expansion series of the first four moments. An evaluation of the predictive performance of the proposed model in the estimation of 1-day and 10-day VaR forecasts is performed in comparison with the historical simulation, filtered historical simulation and generalized autoregressive conditional heteroscedasticity (GARCH) model. The adequacy of the VaR forecasts is evaluated under the unconditional, independence and conditional likelihood ratio tests as well as Basel II regulatory tests. The results presented have significant implications for risk management, trading and hedging activities as well as in the pricing of equity derivatives.

A Continuous-Time Model of the Term Structure of Interest Rates with Fiscal-Monetary Policy Interactions

We study the term structure implications of the fiscal theory of price level determination. We introduce the intertemporal budget constraint of the government in a general equilibrium model in continuous time. Fiscal policy is set according to a simple rule whereby taxes react proportionally to real debt. We show how to solve for the prices of real and nominal zero coupon bonds.

Money-Market Segmentation in the Euro Area: What Has Changed During the Turmoil?

In this paper we study how the pattern of segmentation in the euro area money market has been affected by the recent turmoil in financial markets. We use nonparametric estimates of realized volatility to test for volatility spillovers between rates at different maturities. For the pre-turmoil period, exogeneity tests from VAR models suggest the presence of a transmission channel from longer maturities to the overnight. This disappears in the subsample starting in August 9 2007. The results of the semiparametric tests of Cappiello, Gerard and Manganelli (2005) report evidence of an increase in volatility contagion within the longer end of the money market curve. However this takes place in the lower tail of the empirical distributions. Keywords: money market, high-frequency data, time-series methods JEL classification numbers: C22, E58

Structural distortions in the Euro interbank market: The role of ‘key players’ during the recent market turmoil

We study the frictions in the patterns of trades in the Euro money market. We characterize the structure of lending relations during the period of recent financial turmoil. We use network-topology method on data from overnight transactions in the Electronic Market for Interbank Deposits (e-Mid) to investigate on two main issues. First, we characterize the division of roles between borrowers and lenders in long-run relations by providing evidence on network formation at a yearly frequency. Second, we identify the ‘key players’ in the marketplace and study their behaviour. Key players are ‘locally-central banks’ within a network that lend (or borrow) large volumes to (from) several counterparties, while borrowing (or lending) small volumes from (to) a small number of institutions. Our results are twofold. We show that the aggregate trading patterns in e-Mid are characterized by largely asymmetric relations. This implies a clear division of roles between lenders and borrowers. Second, the key players do not exploit their position of network leaders by imposing opportunistic pricing policies. We find that only a fraction of the networks composed by big players are characterized by interest rates that are statistically different from the average market rate throughout the turmoil period.