Working Papers

Authors: Kevin Sheppard, Lily Liu, Andrew J. Patton

Feb 2013

We study the accuracy of a wide variety of estimators of asset price variation constructed from high-frequency data (so-called "realized measures"), and compare them with a simple "realized variance" (RV) estimator.  In total, we consider almost 400 different estimators, applied to 11 years of data on 31 different financial assets spanning five asset classes, including equities, equity indices, exchange rates and interest rates.  We apply data-based ranking methods to the realized measures and to forecasts based on these measures.  When 5-minute RV is taken as the benchmark realized measure, we find little evidence that it is outperformed by any of the other measures.  When using inference methods that do not require specifying a benchmark, we find some evidence that more sophisticated realized measures significantly outperform 5-minute RV.  In forecasting applications, we find that a low frequency "truncated" RV outperforms most other realized measures.  Overall, we conclude that it is difficult to significantly beat 5-minute RV.

JEL Codes: C58, C22, C53

Keywords: Realized variance, volatility forecasting, high frequency data

Reference: 645

Individual View

Authors: Mary Elisabeth Cox

Feb 2013

At the beginning of the First World War, the British imposed a blockade against Germany intending to prevent all imports from entering the country.  Germans began to call the British naval action the Hungerblockade, claiming that it seriously damaged the well-being of those on the home front, namely women and children, through lack of adequate nutrition.  These German claims that Britain used hunger as a weapon of war against civilians have sometimes been dismissed as propaganda.  However, newly discovered anthropometric measurements made of German school children during the war gives credence to German contentions that the blockade inflicted severe deprivation on children and other non-combatants.  Further, these data show that the blockade exacerbated existing nutritional inequalities between children of different social classes; working class children suffered the most profound effects of nutritional deprivation during the war.  Once the blockade ended however, working class children were the quickest to recover, regaining their pre-War standards in weight by 1921.  They surpassed their own pre-War height standards by 1923, and approximated the weight of middle class children by 1924.  This recovery of working class children is likely due to the outpouring of international aid targeted at poor German children.  These data also indicate significant gender inequalities starting at age fourteen in nutritional status, with male adolescents suffering far greater deprivation from 1914-1924.

Reference: 110

Individual View

Authors: Neil Shephard

Feb 2013

I discuss models which allow the local level model, which rationalised exponentially weighted moving averages, to have a time-varying signal/noise ratio.  I call this a martingale component model.  This makes the rate of discounting of data local.  I show how to handle such models effectively using an auxiliary particle filter which deploys M Kalman filters run in parallel competing against one another.  Here one thinks of M as being 1,000 or more.  The model is applied to inflation forecasting.  The model generalises to unobserved component models where Gaussian shocks are replaced by martingale difference sequences.

JEL Codes: C01, C14, C58, D53, D81

Keywords: Auxiliary particle filter, EM algorithm, EWMA, forecasting, Kalman filter, likelihood, martingale unobserved component model, particle filter, stochastic volatility

Reference: 644

Individual View

Authors: David Hendry, Felix Pretis

Feb 2013

We demonstrate major flaws in the statistical analysis of Beenstock, Reingewertz and Paldor (2012), discrediting their initial claims as to the different degrees integrability of CO2 and temperature.

JEL Codes: C1, Q5

Keywords: Econometric modelling, location shifts, data measurements, climate change

Reference: 643

Individual View

Authors: Elissaios Papyrakis, Ohad Raveh

Feb 2013

While there has been extensive research on the Dutch Disease (DD), very little attention, if any, has been devoted to the regional mechanisms through which it may manifest itself. This is the first empirical attempt to research a 'regional DD' by looking at the local and spatial impacts of resource windfalls across Canadian provinces and territories. We construct a new panel dataset to examine separately the key DD channels; namely, the Spending Effect (SE) and the Resource Movement Effect (RME). Our analysis reveals that the standard DD mechanisms are also relevant at the regional level; specifically, we find that: (a) Resource windfalls are associated with higher inflation and a labour (capital) shift from (to) non-primary tradable sectors. (b) Resource windfalls in neighbouring regions are associated with a capital (labour) shift from (to) non-primary tradable sectors in the source region. (c) The (spatial) DD explains (51%) 20% of the adverse effects of resource windfalls (in neighbouring regions) on region-specific non-mineral international exports (in the source region), and does not significantly affect domestic ones.

JEL Codes: F10, N92, O18

Keywords: Regional Dutch Disease, Inflation, Exports

Reference: 106

Individual View

Authors: H Peyton Young, Paul Glasserman

Feb 2013

Interconnections among financial institutions create potential channels for contagion and amplification of shocks to the financial system.  We propose precise definitions of these concepts and analyze their magnitude.  Contagion occurs when a shock to the assets of a single firm causes other firms to default through the network of obligations; amplification occurs when losses among defaulting nodes keep escalating due to their indebtedness to one another.  Contagion is weak if the probability of default through contagion is no greater than the probability of default through independent direct shocks to the defaulting nodes.  We derive a general formula which shows that, for a wide variety of shock distributions, contagion is weak unless the triggering node is large and/or highly leveraged compared to the nodes it topples through contagion.  We also estimate how much the interconnections between nodes increase total losses beyond the level that would be incurred without interconnections.  A distinguishing feature of our approach is that the results do not depend on the specific topology: they hold for any financial network with a given distribution of bank sizes and leverage levels.  We apply the framework to European Banking Authority data and show that both the probability of contagion and the expected increase in losses are small under a wide variety of shock distributions.  Our conclusion is that the direct transmission of shocks through payment obligations does not have a major effect on defaults and losses; other mechanisms such as loss of confidence and declines in credit quality are more llikely sources of contagion.

JEL Codes: D85, G21

Keywords: Systemic risk, contagion, financial network

Reference: 642

Individual View

Authors: Neil Shephard

Feb 2013

I discuss models which allow the local level model, which rationalised exponentially weighted moving averages, to have a time-varying signal/noise ratio.  I call this a martingale component model.  This makes the rate of discounting of data local.  I show how to handle such models effectively using an auxiliary particle filter which deploys M Kalman filters run in parallel competing against one another.  Here one thinks of M as being 1,000 or more.  The model applied to inflation forecasting.  The model generalises to unobserved component models where Gaussian shocks are replaced by martingale difference sequences.

Keywords: Auxiliary particle filter, EM algorithm, EWMA, forecasting, Kalman filter, likelihood, martingale unobserved component model, particle filter, stochastic volatility

Reference: 2013-W01

Individual View

Authors: David Gill, Victoria Prowse

Jan 2013

In this paper we investigate how cognitive ability influences behavior, success and the
evolution of play towards Nash equilibrium in repeated strategic interactions. We study behavior
in a p-beauty contest experiment and find striking differences according to cognitive
ability: more cognitively able subjects choose numbers closer to equilibrium, converge more
frequently to equilibrium play and earn more even as behavior approaches the equilibrium
prediction. To understand better how subjects with different cognitive abilities learn differently,
we estimate a structural model of learning based on level-k reasoning. We find a
systematic positive relationship between cognitive ability and levels; furthermore, the average
level of more cognitively able subjects responds positively to the cognitive ability of their
opponents, while the average level of less cognitively able subjects does not respond at all.
Our results suggest that, in strategic environments, higher cognitive ability translates into
better analytic reasoning and a better ‘theory of mind

JEL Codes: C92, C73, D83

Keywords: Cognitive ability, bounded rationality, level-k, convergence, learning non-equilibrium behavior, beauty contest, repeated games, structural modeling, theory of mind, intelligence, Raven test

Reference: 641

Individual View

Authors: Margaret Meyer, Florian Ederer, Richard Holden

Jan 2013

Abstract

It is often suggested that incentive schemes under moral hazard can be gamed by an agent with superior knowledge of the environment and that deliberate lack of transparency about the incentive scheme can reduce gaming. We formally investigate these arguments in a two-task moral hazard model in which the agent is privately informed about which task is less costly for him. We examine a simple class of incentive schemes that are "opaque" in that they make the agent uncertain ex ante about the incentive coefficients in the linear payment rule. Relative to transparent menus of linear contracts, these opaque schemes induce more balanced efforts, but they also impose more risk on the agent per unit of aggregate effort induced. We identify specific settings in which optimally designed opaque schemes not only strictly dominate the best transparent menu but also eliminate the efficiency losses from the agent's hidden information. Opaque schemes are more likely to be preferred to transparent ones when (i) the agent's privately known preference between the tasks is weak; (ii) the agent's risk aversion is significant; (iii) efforts on the tasks are highly complementary for the principal; or (iv) the errors in measuring performance have large correlation or small variance.

Revised April 2018

JEL Codes: D86, D21, L22

Keywords: Contracts, incentives, gaming, opacity, randomization

Reference: 640

Individual View

Authors: Anthony Venables, Torfinn Harding

Jan 2013

Foreign exchange windfalls such as those from natural resource revenues change non-resource exports, imports, and the capital account. We study the balance between these responses and show that the response to $1 of resource revenue is, for our preferred estimates, to decrease non-resource exports by 74 cents and increase imports by 23 cents, implying a negligible effect on foreign saving. The negative per $1 impact on exports is larger for manufactures than for other sectors, and particularly large for internationally mobile manufacturing sectors. While standard Dutch disease analysis points to contraction of the tradable sector as a whole, division into non-resource exports and imports is important if, as suggested by much development literature, a higher share of exports to GDP is associated with faster growth. The large negative impact of resources on these exports points to the difficulty resource rich economies face in diversifying their exports.

JEL Codes: E21, E62, F43, H63, O11, Q33

Keywords: natural resources, Dutch disease, resource curse, trade, exports, imports

Reference: 103

Individual View

Authors: David Gill,John Thanassoulis

Jan 2013

In this paper we study price competition between firms when some consumers attempt to
bargain while others buy at the public list or posted prices. Even though bargainers succeed in
negotiating discounts off the list prices, their presence dampens competitive pressure in the market
by reducing the incentive to undercut a rival

JEL Codes: C78, D43, L13

Keywords: Posted prices, list prices, collusion, bargaining, negotiation, haggling, discounts, outside option, price takers, Hotelling line

Reference: 639

Individual View

Authors: Ferdinand Rauch, Guy Michaels, Stephen J. Redding

Jan 2013

We develop a new methodology for quantifying the tasks undertaken within occupations using 3,000 verbs from around 12,000 occupational descriptions in the Dictionary of Occupational Titles (DOTs).  Using micro-data from the United States from 1880-2000, we find an increase in the employment share of interactive occupations within sectors over time that is larger in metro areas than non-metro areas.  We provide evidence that this increase in the interactiveness of employment is related to the dissemination of improvements in transport and communication technologies.  Our findings highlight a change in the nature of agglomeration over time towards an increased emphasis on human interaction.

JEL Codes: N92, O18, R12

Keywords: Economic development, human interaction, urbanization

Reference: 638

Individual View

The paper studies the long-run effects of shocks to resource rents on the economy using a structural vector error correction model for 37 developing countries. First, the long-run relations involving resource rents and the economy differ for resource importers and exporters. Second, there is an indirect effect from resource rents to output through public capital accumulation for resource exporters. Third, although resource rents have a positive long-run impact on output, good public investment management is required for resource rents to improve non-resource output.

JEL Codes: O13; O43; Q32

Keywords: Resource rents; Resource exporters; PIMI

Reference: 105

Individual View

Authors: Charles F Mason

Jan 2013

As addressing climate change becomes a high priority it seems likely that there will be a surge in interest in deploying nuclear power. Other fuel bases are too dirty (coal), too expensive (oil, natural gas) or too speculative (solar, wind) to completely supply the energy needs of the global economy. To the extent that the global society does in fact choose to expand nuclear power there will be a need for additional production.  That increase in demand for nuclear power will inevitably lead to an increase in demand for uranium. While some of the increased demand for uranium will be satisfied by expanding production from existing deposits, there will undoubtedly be pressure to find and develop new deposits, perhaps quite rapidly. Looking forward, it is important that policies be put in place that encourage an optimal allocation of future resources towards exploration. In particular, I argue there is a valid concern that privately optimal levels of industrial activity will fail to fully capture all potential social gains; these sub-optimal exploration levels are linked to an departure between the private and social values of exploration information.

Reference: 104

Individual View

Authors: Beata Javorcik, Yue Li

Jan 2013

Interconnections among financial institutions create potential channels for contagion
and amplification of shocks to the financial system. Contagion occurs when a shock to
the assets of a single firm causes other firms to default through the network of obligations.
We say that contagion is weak if the probability of default through contagion is no greater
than the probability of default through independent direct shocks to the defaulting nodes.
We derive a general formula which shows that, for a wide variety of shock distributions,
contagion is weak unless the triggering node is very large and/or highly leveraged compared
to the nodes it topples through contagion. We derive our results in the Eisenberg-Noe
(2001) framework with the addition of stochastic shocks. A distinguishing feature of our
approach is that our conditions do not depend on the topology of interconnections: they
hold for any financial network with a given distribution of bank sizes and leverage levels.
The likelihood of contagion increases when one augments the model to include bankruptcy
costs and mark-to-market losses from credit quality deterioration.

JEL Codes: F23, F14, L81, D24

Keywords: Global retail chains, productivity, services liberalization, foreign direct investment, backward linkages, reallocation, allocation efficiency

Reference: 637

Individual View

Authors: Ohad Raveh

Dec 2012

Do reduced costs of factor mobility mitigate Dutch Disease effects, to the extent that they are reversed? The case of federations provides an indication they do. We observe Resource Blessing effects at the federal-state level (within federations) yet rather

Resource Curse ones at the federal level (between federations), and argue the difference in outcomes stems from the difference in factor mobility costs. Through a two-region tax competition model we show that with sufficiently low factor mobility costs a resourceboom triggers an Alberta Effect –where resource abundant regions exploit the fiscal advantage, provided by resource rents, to compete more aggressively in the inter-regional competition over capital, and as a result attract vast amounts of capital– that mitigates, and possibly reverses, Dutch Disease symptoms, so that Resource Curse effects do not apply. Thus, this paper emphasizes the significance of the mitigating role of factor mobility in Dutch Disease theory, and presents a novel mechanism (Alberta Effect) through which this mitigation, and possible reversion, process occurs. The paper concludes with empirical evidence for the main implications of the model.

JEL Codes: O13, O18, O57, Q33

Keywords: Natural Resources, Factor Mobility, Dutch Disease, Resource Curse, Tax Competition

Reference: 100

Individual View

Authors: Roland Hodler

Dec 2012

The Arab Spring has led to very different outcomes across the Arab world. I present a highly stylized model of the Arab Spring to better understand these differences. In this model, dictators from the ethnic or religious majority group concede power if their country is oil-poor, but can stay in power by bribing the people if their country is oil-rich. Dictators from the minority group often rely on other members of their group to repress protests and to ght the majority group if necessary. These predictions are consistent with observed outcomes in Egypt, Libya, Saudi Arabia, Syria, Tunisia, and elsewhere.

JEL Codes: D72, D74

Keywords: Arab Spring, political transitions, repression, civil conflict, oil, divided societies

Reference: 101

Individual View

Authors: John Thanassoulis

Dec 2012

This paper studies the consequences of a regulatory pay cap in proportion to assets on
bank risk, bank value, and bank asset allocations. The cap is shown to lower banks' risk
and raise banks' values by acting against a competitive externality in the labour market.
The risk reduction is achieved without the possibility of reduced lending from a Tier 1
increase. The cap encourages diversi cation and reduces the need a bank has to focus on
a limited number of asset classes. The cap can be used for Macroprudential Regulation
to encourage banks to move resources away from wholesale banking to the retail banking
sector. Such an intervention would be targeted: in 2009 a 20% reduction in remuneration
would have been equivalent to more than 150 basis points of extra tier 1 for UBS, for
example.

JEL Codes: G01, G21, G28, G32

Keywords: Remuneration, compensation, bonuses, capital conservation, systemic bank risk

Reference: 636

Individual View

Authors: H Peyton Young, Thomas Noe

Dec 2012

In recent years bonuses tied to performance have become commonplace in banks and other financial institutions; indeed they now constitute a major part of employee compensation.  The practice was originally justified by academic work on principal-agent contracts, which argued that performance bonuses would better align the interests of managers and shareholders.  In this article we argue that such schemes are not well-suited to aligning these interests in the financial sector.  There are two reasons for this failure.  First, new financial products make it easy to create the appearance of superior performance over long periods of time even though the outsize returns are merely being driven by hidden tail risk.  We show that it is virtually impossible to create performance contracts that get around this problem.  Second, the complexity of new products and the size of modern financial institutions make it extremely difficult (and costly) to monitor risky activities directly.  As in the first case, compensation schemes, including deferred compensation, are inefficient substitutes because it is easy to escape detection for long periods of time.  This opens the door for outright fraud.  We argue that a greater emphasis on ethical values, e.g., a duty of care to customers and shareholders, is more likely to produce effective reforms.

JEL Codes: G20, G28, D86

Keywords: Performance bonus, incentive contract, tail risk

Reference: 635

Individual View


Loading Papers...