Willem F. C. Verschoor

On the Biasedness of Forward Foreign Exchange Rates: Irrationality or Risk Premia?

In this article, the authors reconsider the K. A. Froot and J. A. Frankel (1989) results on the sources of forward discount bias. They question the economic validity of some estimation restrictions that they impose and, thus, are led to question some of their results. The authors employ a new exchange rate survey database that includes European Monetary System currencies and use univariate and pooling estimation techniques that impose fewer restrictions than those of Froot and Frankel to test their hypotheses. They find that the bias in the forward discount is attributable to both the failure of rational expectations and the existence of time-varying risk premia. Copyright 1994 by University of Chicago Press.

European Foreign Exchange Risk Exposure

We find that about 13% of our sample of 817 European multinational firms experienced economically significant exposure effects to the Japanese yen, 14% to the US dollar and 22% to the UK pound. Our evidence differs substantially from the US experience and is robust across sub-sample periods, suggesting that a depreciating (appreciating) euro against foreign currencies has a net negative (positive) impact on European stock returns. Short-term exposure seems to be relatively well hedged, where considerable evidence of long-term exposure is found. Firms with weak liquidity positions tend to have smaller exposures. Foreign exposure is found to increase with firm size.

Stochastic Trends and Jumps In EMS Exchange Rates

In this paper we study the statistical properties of EMS exchange rate returns. Our findings show that jumps, time- varying parameters, and conditional leptokurtosis are pertinent features in the empirical distributions of EMS exchange rate returns. Allowance for fat tails, however, tends to reduce the measured frequency of jumps in the distributions to more realistic proportions. Most successful in capturing the relevant features of EMS exchange rate returns is a combined jump-GARCH model with conditionally t-distributed innovations.

Foreign exchange rate expectations : survey and synthesis

This paper reviews the empirical literature on foreign exchange rate expectations. Prominent issues are the forward premium puzzle, expectations formation in financial markets, heterogeneity of expectations, market microstructure, time-varying risk premiums and forecast performance. Although much has been learned in each field, this survey highlights the areas of research in which our understanding of the mechanism of exchange rate expectations is still incomplete. Our survey suggests that both irrational expectations and time-varying risk premiums account for the forward discount anomaly, that long-term expectations reverse towards their long-run equilibrium values and that heterogeneous behaviour of market participants has the potential of explaining some of the empirical regularities in the international finance literature. Copyright 2007 The Authors. Journal compilation

Measuring Financial Contagion Using Time-Aligned Data : The Importance of the Speed of Transmission of Shocks

This paper presents a new empirical approach to address the problem of trading time differences between markets in studies of financial contagion. In contrast to end‐of‐business‐day data common to most contagion studies, we employ price observations, which are exactly aligned in time to correct for time‐zone and end‐of‐business‐day differences between markets. Additionally, we allow for time lags between price observations in order to test the assumption that the shock is not immediately transmitted from one market to the other. Our analysis of the financial turmoil surrounding the Asian crisis reveals that such corrections have an important bearing on the evidence for contagion, independent of the methodology employed. Using a correlation‐based test, we find more contagion the faster we assume the shock to be transmitted.

Further evidence on Asian stock return behavior

Abstract This paper examines the relationship between expected stock returns and size, and market-to-book ratio in five Asian emerging markets: India, Korea, Malaysia, Taiwan and Thailand. Overall, we find a strong size effect in all markets and a significant market-to-book effect in Korea, Malaysia and Thailand. When the tests allow for both variables, the negative relationship between size and average return is less robust; the inclusion of market-to-book equity seems to absorb the role of size in Asian stock returns. Our finding for the Asian market applies to the post-1984 period, thus questioning the assertion of Black [J. Portfolio Manage. 20 (1993) 8] and MacKinlay (1995) that “the value premium is sample-specific”. Although small firms have—to a certain extent—higher average returns than large firms in Asian markets, the market-to-book variable seems to have a consistently stronger role in average returns and would suggest that value stocks have higher average returns than growth stocks. Thus, the higher average return on value stocks in the Asian emerging markets can be considered as a local manifestation of a global phenomenon.

The Asian crisis exchange risk exposure of U.S. multinationals

Purpose - This paper aims to increase understanding of the (time-varying) relationship between exchange rates and stock prices at the individual firm level. Rather than analyzing the impact of exchange rate movements on firm value by regressing multinationals’ stock returns on exchange rate changes, it is proposed to examine the impact of increased exchange rate variability on the stock return volatility of US multinationals by focusing on the 1997 Asian financial turmoil. Design/methodology/approach - In a first step, it is investigated whether the enhanced uncertainty about the future performance of US multinationals active in Asia resulted in an increased stock return variability. The second step separates the impact of increased exchange rate variability on the stock return volatility of US multinationals into systematic and diversifiable risk. Findings - It is found that the stock return variability of US multinationals increases significantly in the aftermath of the financial turmoil. In conjunction with this increase in total volatility, there is also an increase in market risk (beta) for US multinationals. Moreover, trade- and service-oriented industries appear to be particularly sensitive to these changing exchange rate conditions. Practical implications - If the additional risk imparted to exposed firms from increased exchange rate variability is systematic in nature, it will affect the required rate of (equity) return (i.e. investors demand higher returns for holding the firms shares). Consequently, this effect of exchange rate fluctuations increases the cost of (equity) capital for US multinationals with real foreign operations in the crisis countries. Originality/value - This paper demonstrates the impact of increased exchange risk on stock return volatility and market risk.

EMS exchange rate expectations and time-varying risk premia

Abstract In this paper we examine exchange risk premia employing a survey dataset of EMS exchange rates. We are able to test a risk premium model directly, i.e. without having to rely on the rational expectations assumption. Our results indicate that time-varying risk premia are present in almost all cases and that a GARCH-in-mean specification for the premium is often appropriate.

Home Bias and Dutch Pension Funds’ Investment behaviour

Using a panel data set of more than 600 Dutch pension funds (PFs) between 1992 and 2006, we investigate asset allocation behavior of Dutch PFs across multiple asset classes. We find that domestic investments, also known as home bias, in portfolio choices of Dutch institutional investors have fallen. We also find that the introduction of the euro, the dot-com crisis (1999–2001) and individual PFs characteristics are significant determinants of home bias. Overall, mature PFs’ portfolios are diversified internationally, whereas large PFs seem to prefer to only scale up their foreign, less-risky positions at the expense of domestic fixed-income positions. The effect of the dot-com crisis is more pronounced for domestic bonds, whereas the introduction of the euro was more important for domestic equities.

A heterogeneous route to the European monetary system crisis

We estimate a dynamic heterogeneous agents model for the British pound during the European monetary system crisis. We illustrate the chain of events leading to the suspension of the pound from the exchange rate mechanism in terms of switching beliefs, from fundamentalist to chartist.