Peter Spencer

Official Intervention in the Foreign Exchange Market

In an article in this Journal, Dean Taylor (1982) proposes a simple statistical test of the significance of central bank losses in the exchange market: Would random intervention be likely to result in as large a loss? This comment shows that, as it stands, his test statistic does not allow properly for the effect of the mean level of intervention. There is in fact an element of ambiguity in the question Taylor poses, and this is illustrated with examples taken from his empirical work. The connection between the Taylor test and regression analysis is noted and explored.

Monetary integration and currency substitution in the EMS: The case for a European monetary aggregate

Abstract This paper examines the phenomenon of cross-currency substitution and the validity of monetary aggregation within the European Monetary System using non-parametric methods which exploit the relationship between intergroup substitution and separability. The separability property is tested using the methodology developed by Varian (‘The Nonparametric Approach to Demand Analysis’, Econometrica 50, 945–974, 1982; ‘Nonparametric Tests of Consumer Behaviour’, Review of Economic Studies 51, 99–110, 1983) and is violated in the case of most European countries, suggesting that the hypothesis of zero currency substitution which forms the basis of national monetary aggregation should be rejected. The results do however validate the use of monetary aggregates for the EMS as a whole, and I use a standard parametric demand for money approach to compare the performance of an EMS divisia index with that of simple sum aggregates during the 1980s and 1990s.

The Effect of Oil Discoveries on the British Economy-Theoretical Ambiguities and the Consistent Expectations Simulation Approach

The finding of oil in the North Sea has stimulated the interest of U.K. economists in the effect of resource discoveries on an open economy. This has spawned a large number of theoretical papers including those by Neary (1983), Eastwood and Venables (1982), Buiter and Miller (1981) and Neary and Purvis (1981). These papers are primarily concerned with the various dynamic effects which are likely and have typically assumed perfect capital mobility and perfect foresight in order to keep the analysis tractable. However it turns out that these models can say nothing about the dynamic response to an oil discovery unless some unrealistic assumptions are made about the associated monetary effects. This is demonstrated in the first part of the paper. This point has been made independently by Neary and Wijnbergen (1982). The second part of the paper describes some results obtained by simulating the Treasury macroeconomic model under similar assumptions to those used in the theoretical literature in an attempt to throw some empirical light on these ambiguities.

How to Make the Central Bank Look Good: A Reply

In his original (1982) paper, Dean Taylor proposes a simple test of the significance of central bank losses in the exchange market: Would random intervention be likely to result in as large a loss? My comment (Spencer 1985) took his model at face value but showed that his test statistic was misspecified and that the question he posed was ambiguous, yielding two alternative criteria. In his comment (this issue) Taylor has shown that if in fact central banks lean into the wind, then one of these criteria is biased. But this analysis raises a general question about the use of profitability indicators. It shows that the conditional nature of these calculations makes them unstable and prone to manipulation when central banks lean into the wind.

Financial Innovation, Efficiency and Disequilibrium: Problems of Monetary Management in the United Kingdom 1971-1981.

Monetary control has assumed increasing importance in Great Britain as inflationary pressures have intensified and other counter-inflation policies have collapsed. This book is the first complete exposition of the basic Treasury econometric model that was developed for financial cial forecasting and policy analysis. In it, the co-author of the model reviews Britains experience and analyzes some of the problems that confronted the authorities in their attempts to restrain monetary grown between 1971 and 1981.

UK Macroeconomic Volatility and the Term Structure of Interest Rates

This study uses a macro-finance model to examine the ability of the gilt market to predict fluctuations in macroeconomic volatility. The econometric model is a development of the standard ‘square root’ volatility model, but unlike the conventional term structure specification it allows for separate volatility and inflation trends. It finds that although volatility and inflation trends move independently in the short run, they are cointegrated. Bond yields provide useful information about macroeconomic volatility, but a better indicator can be developed by combining this with macroeconomic information.

Financial Innovation and Divisia Monetary Aggregates: Comment on Ford, Peng, Mullineux (1992)

This note shows that there is an error in the mathematical argument deployed by J. L. Ford, W. S. Peng, and A. W. Mullineux (1992). Once this is corrected, the author sees that, remarkably, the standard opportunity cost based weighting system remains appropriate even in the face of nonneutral technical change. Copyright 1998 by Blackwell Publishing Ltd

US Bank Credit Spreads During the Financial Crisis

This paper argues that first passage time models are likely to better than affine hazard rate models in modelling stressed credit markets and confirms their superior performance in explaining the behavior of Credit Default Swap rates for the major US banking groups over the period of the financial crisis. Affine models find it hard to deal with periods of exceptionally high or low default risk given their assumption of a constant rate of mean reversion in the hazard rate. In contrast, first passage time models are specified in terms of the distance to default rather than the hazard rate. The persistence of shocks varies with the distance to default, allowing the default curve to invert sharply (compress) when the distance to default is low (high). I use an empirical version of the Collin-Dufresne et al. (2003) model, which contains a smoothing parameter that allows it to control the relative effect of these shocks on the short spreads and can be interpreted as an information lag.

Estimating the Term Structure with Linear Regressions: Getting to the Roots of the Problem

Linear estimators of the affine term structure model are inconsistent since they cannot reproduce the factors used in estimation. This is a serious handicap empirically,giving a worse fit than the conventional ML estimator that ensures consistency. We show that a simple self-consistent estimator can be constructed using the eigenvalue decomposition of a regression estimator. The remaining parameters of the model follow analytically. The fit of this model is virtually indistinguishable from that of the ML estimator. We apply the method to estimate various models of U.S. Treasury yields and a joint model of the U.S. and German yield curves.

Overseas Unspanned Factors and Domestic Bond Returns

Using data on government bond yields in Germany and the United States, we show that overseas unspanned factors — constructed from the components of overseas yields that are uncorrelated with domestic yields — have significant explanatory power for subsequent domestic bond returns. This result is remarkably robust, holding for different sample periods, as well as out of sample. Shocks to overseas unspanned factors have large and persistent effects on domestic yield curves. Dynamic term structure models that omit information about foreign bond yields are therefore likely to be misspecified.