Asset Price Volatility, Bubbles, and Process Switching

Evidence of excess volatilities of asset prices compared with those of market fundamentals is often attributed to speculative bubbles. This study examines the sense in which speculative bubbles could in theory lead to excess volatility, hut it demonstrates that some of the variance hounds evidence reported to date precludes bubbles as a reason why asset prices might violate such hounds. The findings must represent some other model misspecffication or market inefficiency. One important misspecification occurs when there searcher incorrectly specifies the time series properties of market fundamentals. A bubble-free example economy characterized by a potential switch in government policies produces paths of asset prices that would appear, to an unwary researcher, to contain bubbles.

The Role of the IFO Business Climate Indicator and Asset Prices in German Monetary Policy

We analyze the role of forward-looking indicators, like the IFO business climate indicator and asset prices, in German monetary transmission. We show that the use of both the IFO indicator and asset prices improves the performance and interpretation of a Vector AutoRegression (VAR) model of German monetary transmission. First, we show that the Bundesbank responded more intensively to changes in the IFO indicator than to changes in GDP. Secondly, we address the role of housing and equity prices. We demonstrate that especially housing prices help to give a more accurate description of the recent history of German monetary policy.monetary transmission, IFO business climate survey indicator, house prices, equity prices

Asset Prices as Indicators of Euro Area Monetary Policy: An Empirical Assessment of Their Role in a Taylor Rule

This paper estimates forward-looking and forecast-based Taylor rules for France, Germany, Italy, and the euro area. Performing extensive tests for over-identifying restrictions and instrument relevance, we find that asset prices can be highly relevant as instruments in policy rules. While asset prices improve Taylor rule estimates, different assets prove most relevant across countries and this result could be seen as complicating the tasks of the European Central Bank. Encompassing tests show that forecast-based outperform forward-looking Taylor rules. A policy implication is that central banks ought to release their own forecasts and the basis upon which they are generated.Monetary policy reaction functions, Asset prices, Instruments, European Central Bank

U.S. International Capital Flows: Perspectives From Rational Maximizing Models

This paper examines several aspects of the debate about the causes of the U.S. current account deficit in the 1980's. It surveys several popular explanations before developing two theoretical models of international capital flows. The first model is Ricardian, and it extends the analysis of Stockman and Svensson (1987): The second model is an overlapping generations framework. The major difference in predictions of these two models involves the effects of government budget deficits on the exchange rate and the current account. An update of the empirical investigation of Evans (1986) suggests that his VAR methodology is completely uninformative with additional data. Some empirical results on the importance of risk aversion in modeling international capital market equilibrium are also presented.

Evidence of Fueling of the 2000 New Economy Bubble by Foreign Capital Inflow: Implications for the Future of the US Economy and its Stock Market

Previous analyses of a large ensemble of stock markets have demonstrated that a log-periodic power law (LPPL) behavior of the prices constitutes a qualifying signature of speculative bubbles that often land with a crash. We detect such a LPPL signature in the foreign capital inflow during the bubble on the US markets culminating in March 2000. We detect a weak synchronization and lag with the NASDAQ 100 LPPL pattern. We propose to rationalize these observations by the existence of positive feedback loops between market-appreciation / increased-spending / increased-deficit-of-balance-of-payment / larger-foreign-surplus / increased-foreign-capital-inflows and so on. Our analysis suggests that foreign capital inflow have been following rather than causing the bubble. We then combine a macroeconomic analysis of feedback processes occurring between the economy and the stock market with a technical analysis of more than two hundred years of the DJIA to investigate possible scenarios for the future, three years after the end of the bubble and deep into a bearish regime. We also detect a LPPL accelerating bubble on the EURO against the US dollar and the Japanese Yen. In sum, our analyses is in line with our previous work on the LPPL ``anti-bubble'' representing the bearish market that started in 2000.Comment: 41 Latex pages including 14 eps figure

Asset Prices in a Flexible Inflation Targeting Framework

We argue that there are sound theoretical reasons for believing that an inflation targeting central bank might improve macroeconomic performance by reacting to asset price misalignments over and above the deviation of, say, a two-year ahead inflation forecast from target. In this paper, we first summarize the arguments for our basic proposition. We then discuss some of the counter-arguments. Specifically, we counter those who argue that reacting to asset prices does not improve macroeconomic performance by claiming that they are attacking the 'straw man' under which central bankers react in the same way to all asset price changes. We continue to emphasize that policy reactions to asset price misalignments must be qualitatively different from reactions to asset prices changes driven by fundamentals. Hence, we stand by our earlier results and conclusions. In practice, we do believe that central bankers can detect large misalignments (e.g. the Nikkei in 1989 or the NASDAQ in early 2000), and that they might be in a better position to react to long-lived bubbles than many market participants. However, we recognize that our proposal may present communication challenges, and it is critically important that policy set to react to asset price misalignments both be explained well and that it be based on a broad consensus. It is also important to emphasize that our proposal is wholly consistent with the remit of most inflation-targeting central banks, as we are recommending that while they might react to asset price misalignments, they must not target them.

Nonlinear bubbles in Chinese Stock Markets in the 1990s

A time series of the Shanghai stock index in China for the 1990s is studied for the possible existence of nonlinear speculative bubbles. Three alternative specifications of fundamentals are estimated using VAR models of domestic and international variables. These are subjected to regime switching tests and rescaled range analysis tests. Nulls of no persistence were mostly rejected, suggesting the strong possibility of bubbles. Nonlinearities beyond ARCH effects using the BDS test could not be rejected. The paper also discusses the special circumstances of the stock market in an emerging transition economy.

Allowance Price Drivers in the First Phase of the EU ETS

In the first phase of the EU Emissions Trading Scheme (EU ETS), the price per ton of CO2 rose to over €30 before decreasing to zero by mid 2007. I examine to what extent this variation can be explained by marginal abatement costs by deriving a structural model of the allowance price under the assumption of efficient markets. I then gradually relax the model by allowing for delayed adjustment of price to fundamentals, as well as by introducing lagged LHS variables. The pattern of the results suggests that prices were not initially driven by marginal abatement costs, but that this inefficiency was largely corrected by the first round of emission verifications.Emissions permit markets, air pollution, climate change, bubble, speculation, CO2, asset pricing, EU ETS

Markov-switching Unit Root Test: A study of the Property Price Bubbles in Hong Kong and Seoul

Evans (1991) demonstrates that the unit root tests recommended by Hamilton and Whiteman (1985) and Diba and Grossman (1988) will fail to detect periodically collapsing rational bubbles. Hall et al. (1999) however show that the power of this test procedure can be improved by incorporating a Markov-switching state variable. In this paper, we apply both procedures to selected data from Hong Kong and Seoul. Both point to the possible existence of a periodically-collapsing bubble in each price series investigated, with the second procedure more precise on timing the bubble. Our Markovswitching model is validated using a symmetry test and a Wald test.Markov-switching, unit root test, periodically-collapsing bubble, real-estate

Monetary Policy and Asset Prices in a Small Open Economy: A Factor-Augmented VAR Analysis for Singapore

The ongoing global financial turmoil has revived the question of whether central bankers ought to tighten monetary policy preemptively in order to head off asset price misalignments before a sudden crash triggers financial instability. This study explores the issue of the appropriate monetary policy response to asset price swings in the small open economy of Singapore. Empirical analysis of monetary policy based on standard VAR models, unfortunately, is often hindered by the use of sparse information sets. To better reflect the extensive information monitored by Singapore’s central bank, including global economic indicators, we augment a monetary VAR model with common factors extracted from a large panel dataset spanning 122 economic time series and the period 1980q1 to 2008q2. The resulting FAVAR model is used to assess the impact of monetary policy shocks on residential property and stock prices. Impulse response functions and variance decompositions suggest that monetary policy can potentially be used to lean against asset price booms in Singapore.Monetary Policy; Asset Prices; Dynamic Factors; Vector Autoregression