Non-linearities in exchange rate pass-through: Evidence from smooth transition models

This paper examines the presence of non-linear mechanism in the exchange rate pass-through (ERPT) to CPI inflation for 12 euro area (EA) countries. Using smooth transition regression (STR) model, we explore the existence of non-linearities with respect to the inflation environment. We find strong evidence that pass-through respond non-linearly to inflation level for 8 out of 12 EA countries, that is, the transmission of exchange rate is higher when inflation rate surpass some threshold. Our results provide a broad support to the hypothesis suggested by Taylor (2000) that ERPT is decreasing in a lower and more stable inflation environment

A subordinated CIR intensity model with application to Wrong-Way risk CVA

Credit Valuation Adjustment (CVA) pricing models need to be both flexible and tractable. The survival probability has to be known in closed form (for calibration purposes), the model should be able to fit any valid Credit Default Swap (CDS) curve, should lead to large volatilities (in line with CDS options) and finally should be able to feature significant Wrong-Way Risk (WWR) impact. The Cox-Ingersoll-Ross model (CIR) combined with independent positive jumps and deterministic shift (JCIR++) is a very good candidate : the variance (and thus covariance with exposure, i.e. WWR) can be increased with the jumps, whereas the calibration constraint is achieved via the shift. In practice however, there is a strong limit on the model parameters that can be chosen, and thus on the resulting WWR impact. This is because only non-negative shifts are allowed for consistency reasons, whereas the upwards jumps of the JCIR++ need to be compensated by a downward shift. To limit this problem, we consider the two-side jump model recently introduced by Mendoza-Arriaga \& Linetsky, built by time-changing CIR intensities. In a multivariate setup like CVA, time-changing the intensity partly kills the potential correlation with the exposure process and destroys WWR impact. Moreover, it can introduce a forward looking effect that can lead to arbitrage opportunities. In this paper, we use the time-changed CIR process in a way that the above issues are avoided. We show that the resulting process allows to introduce a large WWR effect compared to the JCIR++ model. The computation cost of the resulting Monte Carlo framework is reduced by using an adaptive control variate procedure

Who would vote for inflation in Brazil? : an integrated framework approach to inflation and income distribution

Most studies of how inflation affects income distribution focus only on wages or the inflation tax. The authors argue that this approach can be misleading as it ignores important channels through which inflation affects income distribution. The authors present an integrated framework that combines interest bearing assets with labor income and cash holdings. This allows them to describe clearly the conditions under which inflation will create gainers and losers. They apply the model to Brazil, which is a prime candidate for this exercise because its economy combines skewed income distribution and high inflation. They show that in Brazil inflation helped worsen income distribution in the 1980s. Their major findings follow. In 1980-1989, the inflation induced income loss for the lowest quintile in Brazil was an estimated 19 percent a year, of which 16 percent is attributable to the erosion of real wages and the rest to the inflation tax. During the same period, Brazil's middle class which lost close to 30 percent of its annual income, was devastated because of its limited access to indexed assets. But the richest quintile managed to insulate itself from inflation by taking advantage of high real interest on demand deposits - without losing from reduced labor income. Had real assets and subsidized credits been considered in the analysis, the regressive effects on inflation would probably have been worse, say the authors. This raises aquestion: Do these findings about the distributional effects of inflation help explain Brazil's delays in adopting a stabilization program?Economic Theory&Research,Environmental Economics&Policies,Economic Conditions and Volatility,Inequality,Banks&Banking Reform