Time-varying integration, the euro and international diversification strategy

This paper investigates the impact of globalization and integration on the relative benefits of country and industry diversification. Unlike previous models, our factor model allows asset exposures to vary with both structural changes and temporary fluctuations in the economic and financial environment. First, we find that globalization and integration have lead to a gradual convergence of country to industry betas, especially in Europe. Second, not accounting for time-varying factor exposures leads to substantial biases in measures of country and industry risk. Third, even though the edge has structurally decreased, geographical diversification continues being superior to industry diversification.International portfolio diversification, Country versus Industry Effects, Financial integration, Idiosyncratic risk, Time-Varying Correlations, Regime-switching models, Baele, Inghelbrecht

Essays in International Finance

During the last two decades, Europe has gone through an extraordinary period of economic, monetary, and financial integration, culminating in the introduction of the single currency in January 1999. These changes impacted on both the structure and functioning of the financial system. Recent evidence suggests that Europe is gradually moving from an intermediated to a market-based based financial system, while the different European asset markets are gradually becoming more and more integrated. The aim of the three papers in this dissertation is to increase the understanding of the (changing) financial system

The determinants of increasing equity market comovement: economic or financial integration?

This paper investigates to what extent the substantial increase in exposures of local European equity market returns to global shocks is mainly due to a convergence in cash flows ("economic integration"), to a convergence in discount rates ("financial integration"), or to both. We find that this increased exposure is nearly entirely due to increasing discount-rate betas. This finding is robust to alternative ways of calculating discount-rate and cash-flow shocks

Macroeconomic regimes

A New-Keynesian macro-model is estimated accommodating regime-switching behavior in monetary policy and macro-shocks. A key to our estimation strategy is the use of survey-based expectations for inflation and output. Output and inflation shocks shift to the low volatility regime around 1985 and 1990, respectively. Monetary policy experiences multiple shifts with an important role in shaping macro-volatility. New estimates of the onset and demise of the Great Moderation are provided and the relative role played by macro-shocks and monetary policy is quantified. The estimated rational expectations model exhibits indeterminacy in the mean-square stability sense, mainly due to passive monetary policy

Measuring financial integration in the euro area

In this paper, we present a set of specific measures to quantify the state and evolution of financial integration in the euro area. Five key markets are considered, namely the money, corporate bond, government bond, credit and equity markets. Building upon the law of one price, we developed two types of indicators that can be broadly categorised as price-based and news-based measures. We complemented these measures by a number of quantity-based indicators, mainly related to the evolution of the home bias. Results indicate that the unsecured money market is fully integrated, while integration is reasonably high in the government and corporate bond market, as well as in the equity markets. The credit market is among the least integrated, especially in the short-term segment.financial integration, EMU, law of one price.

The Determinants of Stock and Bond Return Comovements

We study the economic sources of stock-bond return comovements and its time variation using a dynamic factor model. We identify the economic factors employing a semi-structural regime-switching model for state variables such as interest rates, inflation, the output gap, and cash flow growth. We also view risk aversion, uncertainty about inflation and output, and liquidity proxies as additional potential factors. We find that macro-economic fundamentals contribute little to explaining stock and bond return correlations, but that other factors, especially liquidity proxies, play a more important role. The macro factors are still important in fitting bond return volatility; whereas the "variance premium" is critical in explaining stock return volatility. However, the factor model primarily fails in fitting covariances.

Macroeconomic Regimes

We estimate a New-Keynesian macro model accommodating regime-switching behavior in monetary policy and in macro shocks. Key to our estimation strategy is the use of survey-based expectations for inflation and output. We identify accommodating monetary policy before 1980, with activist monetary policy prevailing most but not 100% of the time thereafter. Systematic monetary policy switched to the activist regime in the 2000-2005 period through an aggressive lowering of interest rates. Discretionary policy spells became less frequent since 1985, but the Volcker period is identified as a discretionary period. Output shocks shift to the low volatility regime around 1985 whereas inflation shocks do so only around 1990, suggesting active monetary policy may have played role in anchoring inflation expectations. Shocks and policy regimes jointly drive the volatility of the macro variables. We provide new estimates of the onset and demise of the Great Moderation and the relative role played by macro-shocks and monetary policy.

Macroeconomic Regimes

We estimate a New-Keynesian macro model accommodating regime-switching behavior in monetary policy and in macro shocks. Key to our estimation strategy is the use of survey-based expectations for inflation and output. Output and inflation shocks shift to the low volatility regime around 1985 and 1990, respectively. However, we also identify multiple shifts between accommodating and active monetary policy regimes, which play an as important role as shock volatility in driving the volatility of the macro variables. We provide new estimates of the onset and demise of the Great Moderation and quantify the relative role played by macro-shocks and monetary policy. The estimated rational expectations model exhibits indeterminacy in the mean square stability sense, mainly because monetary policy is excessively passive

Macroeconomic regimes

We estimate a New-Keynesian macro model accommodating regime-switching behavior in monetary policy and in macro shocks. Key to our estimation strategy is the use of survey-based expectations for inflation and output. We identify accommodating monetary policy before 1980, with activist monetary policy prevailing most but not 100% of the time thereafter. Systematic monetary policy switched to the activist regime in the 2000-2005 period through an aggressive lowering of interest rates. Discretionary policy spells became less frequent since 1985, but the Volcker period is identified as a discretionary period. Output shocks shift to the low volatility regime around 1985 whereas inflation shocks do so only around 1990, suggesting active monetary policy may have played role in anchoring inflation expectations. Shocks and policy regimes jointly drive the volatility of the macro variables. We provide new estimates of the onset and demise of the Great Moderation and the relative role played by macro-shocks and monetary policy