Depreciation bias, financial-sector fragility and currency risk

Do expected future exchange rate fluctuations affect current social welfare? In the third-generation approach to currency crises, financial fragility can trigger devaluation and default. Expected future depreciation is costly if it raises ex ante real interest rates. Given the strong violation of uncovered interest parity, expected future outcomes' current cost/benefit depends on the currency risk premium. I extend the static one-period Barro-Gordon welfare loss function to include expected future depreciation and show that, when foreign investors are risk-averse, depreciation bias is higher than the static case if aggregate demand is a function of ex ante real rates. If demand depends on the ex post real interest rate, average depreciation can be zero if current welfare is sufficiently sensitive to the state of the financial sector. In this stylised framework, depreciation bias can be mitigated even in the presence of time-inconsistency, and expected welfare may be higher

Can Feedback Traders Rock the Markets? A Logistic Tale of Persistence and Chaos

This paper introduces a nonlinear feedback trading model at high frequency. All price adjustment is endogenous, driven by asset return and volatility in the previous trading period. There is no stochastic uncertainty or asymmetric information. The dynamics of expected returns display stable or unstable behavior–including the possibility of turbulence and chaos–as a function of market liquidity (inverse price impact) and the concentration of investor beliefs, which is proportional to the intensity of positive feedback. The results highlight the complementary role of investor diversity and market liquidity in maintaining financial stability

Endogenous Market Turbulence

In this paper I study a nonlinear feedback trading model which can generate stable, unstable, turbulent or chaotic asset returns depending on market conditions. The dynamics are driven by the stochastic price impact of net order flow (inverse market liquidity). If price impact grows beyond exogenous threshold values, liquidity dries up and asset returns become turbulent. In the absence of fundamental factors, the occurrence of turbulence and chaos is entirely endogenous. The results highlight the critical role of maintaining stable market-making conditions for averting “liquidity black holes”

Fear of Floating and Social Welfare

This paper studies the welfare implications of financial stability and inflation stabilization as distinct monetary policy objectives. Introducing asymmetric aversion to exchange rate depreciation in the Barro-Gordon model mitigates inflation bias due to credibility problems. The net welfare impact of fear of floating depends on the economy’s recent track record, the credibility of monetary policy, and the central bank’s discount factor. It is shown that fear of floating is more appropriate for financially fragile developing countries with imperfectly credible monetary policy than for advanced economies

On strategic default and liquidity risk

How does the uncertain provision of external finance affect investment projects' default probability and liquidity risk? In this paper, I study the strategic interaction between many creditors and a single borrower in the context of a two-period investment project requiring external credit. Loans mature in one period but the project requires two periods to complete. The key working assumptions are that creditors are risk-averse and that any uncertainty is common knowledge: information about the fundamentals can be incomplete but not asymmetric. Mixed and perfect Bayesian strategies are used to compute the equilibrium probabilities of default and early liquidation. The impact of the maturity structure on default and liquidity risk is a function of the underlying structural and stochastic parameters and investors' beliefs about the state of fundamentals. The implications for banking regulation are assessed under fixed and variable loan rates. An open range of fundamentals is derived outside of which default and liquidity risk are either zero or one. The cyclical properties of default and liquidity risk are shown to depend sensitively on the relative cost of early liquidation to the borrower and the creditors, hence also on the regulatory policy stance

International financial contagion: what do we know?

This paper attempts a synthesis of theoretical and empirical work on international financial contagion. Although a professional consensus on the appropriate definitions of contagion has yet to emerge, we document substantial research progress towards this goal. On the empirical front, determining when returns are ‘excessive’ is a pre-condition for designing effective policy response to crises. At the theoretical level, tracing the observed herding behavior to market participants’ uncertain beliefs and information asymmetries is a key element for understanding how contagious effects arise. It is argued that the recent focus on better understanding of high-frequency financial returns data and decision making at the market microstructure level are promising avenues for understanding the transmission of shocks across markets and countries

What is the scope to test a smoking cessation intervention aimed at young people admitted to hospital?

Background: Young adults are reluctant to use evidence-based smoking cessation interventions. Subsequently, they are less successful at giving up smoking compared to older adults. This highlights the need for innovative strategies to engage young people in smoking cessation. A novel intervention using photoageing technology has been shown to be an effective trigger for smoking cessation. Aims: To conduct a pilot study deploying photoageing care technology to trigger smoking cessation attempts in young adults admitted to hospital. Method: A randomised controlled trial was designed. Thirty participants were recruited from a regional hospital in Melbourne, Australia. Participants were allocated to the intervention and control groups on alternate weeks. All participants received brief smoking cessation advice. The intervention group was digitally aged using the APRIL Face Aging Software. The primary outcomes were measured at six weeks’ post-intervention and included number of quit attempts, nicotine dependence, and progression through the stages of change model. Results: At six weeks’ post-intervention, there was no difference in quit attempts between the two groups (Mann-Whitney U=111 and p=0.484). There was also no difference in nicotine dependence (Mann-Whitney U=106 and p=0.403) or stage of change (2=1.71 and p=0.634) between the groups. Conclusion: Hospitalisation is associated with a number of barriers, which prevent the implementation of photoageing technology in this setting. Of these barriers, participant recruitment and retention pose the greatest challenge. Due to these considerations, it was not possible to demonstrate an effect size with any confidence

Determinate liquidity traps

I study the long run determinacy tradeoff - recurrent episodes of passive monetary policy are (in)determinate if their expected duration is long (brief ) - when passive pol- icy is at the zero bound. On-going regime change implies qualitatively different shock transmission from the standard New Keynesian model. For U.S. baseline parameter values, I find temporary fiscal stimulus is effective, while adverse supply shocks can be expansionary if the central bank's active policy stance is weak and/or if the liquidity trap's average duration exceeds 3 quarters