Arbitrage, Covered Interest Parity and Long-Term Dependence between the US Dollar and the Yen

Using a daily time series from 1983 to 2005 of currency prices in spot and forward USD/Yen markets and matching equivalent maturity short term US and Japanese interest rates, we investigate the sensitivity over the sample period of the difference between actual prices in forward markets to those calculated from short term interest rates. According to a fundamental theorem in financial economics termed covered interest parity (CIP) the actual and estimated prices should be identical once transaction and other costs are accommodated. The paper presents four important findings: First, we find evidence of considerable variation in CIP deviations from equilibrium that tends to be one way and favours those market participants with the ability to borrow US dollars (and subsequently lend yen). Second, these deviations have diminished significantly and by 2000 have been almost eliminated. We attribute this to the effects of electronic trading and pricing systems. Third, regression analysis reveals that interday negative changes in spot exchange rates, positive changes in US interest rates and negative changes in yen interest rates generally affect the deviation from CIP more than changes in interday volatility. Finally, the presence of long-term dependence in the CIP deviations over time is investigated to provide an insight into the equilibrium dynamics. Using a local Hurst exponent – a statistic used in fractal geometry - we find episodes of both positive and negative dependence over the various sample periods, which appear to be linked to episodes of dollar decline/yen appreciation, or vice versa. The presence of negative dependence is consistent with the actions of arbitrageurs successfully maintaining the long-term CIP equilibrium. Given the time varying nature of the deviations from equilibrium the sample period under investigation remains a critical issue when investigating the presence of longterm dependence.Hurst exponent; Efficient market hypothesis; covered interest parity, arbitrage

Developing Foreign Bond Markets: The Arirang Bond Experience in Korea

This study investigates the development of Korea’s foreign bond (Arirang) market for won-denominated foreign bonds. We provide an institutional perspective and discuss the problems, concerns and key issues related to the development of this market. We find no evidence that Arirang issuance either crowded out local debt or had exchange rate implications. Overall, the Korean experience provides valuable lessons for other emerging nations seeking to build bond markets for local and foreign issuers. Instigating market development demands an enabling infrastructure, the nurturing of local and international demand and the deregulation of capital flows. This process is demanding, as the sophistication of the local bond market does not make it appealing to foreign borrowers per se.Arirang bonds; foreign bonds; bond market development

Volatility in the Gold Futures Market

We investigate the volatility structure of gold, trading as a futures contract on the Chicago Board of Trade (CBOT) using intraday (high frequency) data from January 1999 to December 2005. Apart from investigating the now familiar GARCH properties we also utilize a rarely used measure of volatility–the Garman Klass estimator – to provide new insights in intraday and interday volatility. This nonparametric measure incorporates the open, close, high and low price within a particular time interval. Both sets of results suggest significant variation across the trading day and week consistent with microstructure theories, although volatility is only slightly positively correlated with volume when measured by tick-count.Garman Klass estimator; volatility; gold; intraday patterns; futures

Credit Spread Dynamics: Evidence from Latin America

This paper examines the behaviour of credit spreads on key sovereign issuers from the Latin American region, which accounts for more than one third of international bond issues by developing, or emerging, markets. Since the late 1990s, credit spreads on Latin American issues have declined broadly inline with those in other emerging markets. Recent empirical analysis has explained this phenomenon by identifying critical macroeconomic factors, including the reduction in systematic risk in individual markets, although the structural models from the theoretical finance literature also predict the importance of key default and interest rate variables. This contribution adds to the understanding of these issues by investigating the application of structural models to the Latin American setting, one historically characterized by excessive volatility and susceptibility to episodes of default.credit spreads, long-run dynamics, Latin America, sovereign bonds, cointegration

A Pure Test for the Elasticity of Yield Spreads

The correlation between interest rates and corporate bond yield spreads is a well-known feature of structural bond pricing models. Duffee (1998) argues that this correlation is weak once the effects of call options are removed from the data; a conclusion that contradicts the negative correlation expected by Longstaff and Schwartz (1995). However, Elton et al. (2001) point out that Duffee's analysis ignores the effects of the tax differential between U.S. Treasury and corporate bonds. Canadian bonds have no such tax differential, yet, after controlling for callability, we find that the correlation between interest rates and corporate bond spreads remains negligible. We also find a significant negative relationship for callable bonds with this relationship increasing with the moneyness of the call provision. These results are robust under alternate empirical specifications.Bond Yield Spread, Default Risk, Callable Bonds, Corporate Bonds

Dynamic equilibrium correction modelling of yen Eurobond credit spreads

Understanding the long term relationship between the yields of risky and riskless bonds is a critical task for portfolio managers and policy makers. This study specifies an equilibrium correction model of the credit spreads between Japanese Government bonds (JGBs) and Japanese yen Eurobonds with high quality credit ratings. The empirical results indicate that the corporate bond yields are cointegrated with the otherwise equivalent JGB yields, with the spread defining the cointegration relation. In addition the results indicate that the equilibrium correction term is highly statistically significant in modelling credit spread changes. Another important factor is the risk-free interest rate with the negative sign, while there is little evidence of the contribution of the asset return to the behaviour of spreads.

Balanced Truncation Model Reduction of a Nonlinear Cable-Mass PDE System with Interior Damping

We consider model order reduction of a nonlinear cable-mass system modeled by a 1D wave equation with interior damping and dynamic boundary conditions. The system is driven by a time dependent forcing input to a linear mass-spring system at one boundary. The goal of the model reduction is to produce a low order model that produces an accurate approximation to the displacement and velocity of the mass in the nonlinear mass-spring system at the opposite boundary. We first prove that the linearized and nonlinear unforced systems are well-posed and exponentially stable under certain conditions on the damping parameters, and then consider a balanced truncation method to generate the reduced order model (ROM) of the nonlinear input-output system. Little is known about model reduction of nonlinear input-output systems, and so we present detailed numerical experiments concerning the performance of the nonlinear ROM. We find that the ROM is accurate for many different combinations of model parameters

Foreign Bond Markets and Financial Market Development: International Perspectives

The domestic bond markets of the Asia and Pacific region have grown considerably since the Asian financial crisis of 1997, although they remain undeveloped relative to the region's weight in the world economy. This paper proposes that in order to encourage further development of these markets, regulators should make them more accessible to foreign borrowers. To that end we offer insights into the nature and mechanics of foreign bond issuance by investigating the key characteristics of 3,132 foreign bonds issued in 14 countries (other than the United States) between July 1928 and June 2009. We found that the foreign borrowers that tap domestic markets are overwhelmingly of high credit quality and comprise sovereigns, supranationals, and major financial institutions. There is a preference for simple fixed-rate payment structures, which can then be swapped into the currency and coupon type of choice using currency and interest rate derivatives. On the whole, the long-term viability of foreign bond markets appears linked to the presence of highly liquid foreign exchange and derivatives markets that facilitate risk management and transformation, enabling regulation that facilitates cooperation with market participants, the presence of benchmark issues, and competitive pricing between alternate market segments.bond markets; financial market development; foreign bonds

The Macroeconomic Determinants of Volatility in Precious Metals Markets

We investigate key macroeconomic factors that impact the price returns of precious metals markets. The markets investigated were gold, silver, platinum and palladium; whereas the macroeconomic factors accommodated business cycle, monetary environment and financial market sentiment factors. The key findings present limited evidence that the same macroeconomic factors jointly influence the volatility processes of the precious metal price series, although there is some evidence of volatility feedback between the precious metals. This finding lends weight to views that individual commodities are too distinct to be considered a single asset class or represented by a single index; a finding of considerable importance for portfolio managers and investors.

Compressed nested certificates provide more efficient PKI

Certificate verification in PKI is a complex and time consuming process. In the classical PKI methodology, in order to obtain a public key and to accept a certificate as valid, a verifier needs to extract a certificate path from the PKI and to verify the certificates on this path recursively. Levi proposed a nested certificate model vvith the aim to simplify and speed up certificate verification. Such a nested certificate-based PKI significantly improves certificate verification, but it also requires a large increase in the number of issued certificates, which makes this model impractical for real life deployment. In order to solve this drawback of nested PKI, while retaining its speed in certificate verification, we propose in this paper the innovative concept of a compressed nested certificate, which is a significantly modified version of the nested certificate model. Compressed nested certificate PKI deploys compressed nested certificates which speed up and simplify certificate verification while keeping certificate load to a minimum, thus providing implementers the option of integrating it into the existing PKI model or building it separately as an independent model.<br /