Sylvia Gottschalk

The Volatility of the Output Gap in the G7

We investigate declining output volatility in the G7 since 1970 in a panel context, seeking to explain the causes of the decline. We show that there is a significant role for both net financial wealth and trade openness as well as inflation volatility, even though previous studies have ignored the fact that it may be endogenous and its role therefore spurious. However, its importance clearly varies over time and across countries, and it appears less important as an explanation of declining volatility in the US than it does in the UK. Changes in openness appear to be at least as important in explaining the decline in US output volatility.

Capital Adequacy Requirements in Emerging Markets

In 1988, the Basel Committee on Banking Supervision introduced an international standard of banking regulation, founded on a single measure of regulatory capital provisions for credit risk and straightforward credit risk categories. Its main objectives were to encourage international banks to boost their capital positions and to reduce competitive inequalities. In the late 1990s, international regulators became increasingly concerned about the impacts Basel I would have on emerging markets. Up until then, the main focus of the Basel Committee was the banking system of its members, even though some of the risk categories of the Capital Accord concerned directly loans to non-OECD countries. Two events contributed to this change. First, the disproportionate amount of one-year and interbank loans that flowed to Asia in years preceding the 1997 Asian Crisis led the Committee to investigate whether its simple credit risk structure was to blame for the crisis. Second, since the mid-1900s, many developing countries have been adopting its regulatory framework. And after the Asian Crisis, this happened with the support of the Basel Committee.

Can market size outweigh adverse comparative advantage

This paper investigates the roles of comparative advantage and market size in the international location of manufacturing production. Building on the conventional Helpman and Krugman (1985) general equilibrium framework, our analysis extends the present literature by incorporating both effects in the same model, while allowing trade costs to vary almost continuously from autarky to free trade. The main result of our exercise is that market size effects offset comparative advantage if countries have similar factor proportions. A large country with a slight comparative disadvantage in manufacturing production may thus be a net exporter of manufactures. A small country with the same comparative disadvantage would be a net importer of manufactures. When countries are very dissimilar in their relative factor endowments, land-abundant countries specialize in the production of food, irrespective of market size, if manufactures are a labour-intensive sector. Labour-rich countries of any size are manufacture cores. However, land-abundant countries with large markets can sustain a domestic manufacturing industry until trade costs are very low, and in some cases only specialize in agriculture at free trade.

Entropy measure of credit risk in highly correlated markets

We compare the single and multi-factor structural models of corporate default by calculating the Jeffreys–Kullback–Leibler divergence between their predicted default probabilities when asset correlations are either high or low. Single-factor structural models assume that the stochastic process driving the value of a firm is independent of that of other companies. A multi-factor structural model, on the contrary, is built on the assumption that a single firm’s value follows a stochastic process correlated with that of other companies. Our main results show that the divergence between the two models increases in highly correlated, volatile, and large markets, but that it is closer to zero in small markets, when asset correlations are low and firms are highly leveraged. These findings suggest that during periods of financial instability, when asset volatility and correlations increase, one of the models misreports actual default risk.