On Sovereign Credit Migration: A Study of Alternative Estimators and Rating Dynamics

This paper investigates the finite-sample behaviour of sovereign credit migration estimators and analyzes the properties of the rating process. Through bootstrap simulations, we compare a discrete multinomial estimator and two continuous hazard rate methods which differ in that one neglects time-heterogeneity in the rating process whereas the other accounts for it. The study is based on Moody's ratings 1981-2004 for 72 industrialized and emerging economies. Hazard rate estimators yield more accurate default probabilities. The time homogeneity assumption leads to underestimating the default probability and greater migration risk is inferred upon relaxing it. There is evidence of duration dependence and downgrade momentum effects in the rating process. These findings have important implications for economic and regulatory capital allocation and for the pricing of credit sensitive instruments.Sovereign credit risk; Rating transitions, Markov chain, Time heterogeneity, Rating momentum, Duration dependence.

Numerical issues in threshold autoregressive modelling of time series

This paper analyses the contribution of various numerical approaches to making the estimation of threshold autoregressive time series more efficient. It relies on the computational advantages of QR factorizations and proposes Givens transformations to update these factors for sequential LS problems. By showing that the residual sum of squares is a continuous rational function over threshold intervals it develops a new fitting method based on rational interpolation and the standard necessary optimality condition. Taking as benchmark a simple grid search, the paper illustrates via Monte Carlo simulations the efficiency gains of the proposed tools

A Principal Components Approach to Cross-Section Dependence in Panels

The use of GLS to deal with cross-section dependence in panels is not feasible where N is large relative to T since the disturbance covariance matrix is rank deficient. Neither is it the appropriate response if the dependence results from omitted global variables or common shocks correlated with the included regressors. These can be proxied by the principal components of the residuals from a baseline regression. It is shown that the OLS estimates from a regression augmented by these principal components are unbiased and consistent using sequential limits for large T, large N. Simulations show that this leads to a substantial reduction in bias even for relatively small T and N panels. An empirical application indicates that the impact of cross section dependence seems to strengthen the case for long run PPP.Factor analysis; global shocks; omittted variable bias

Rethinking the forward premium puzzle in a non-linear framework

The forward premium puzzle needs to be reformulated since extant studies address the negative slopes associated with the long dollar swings of the 1980s. By contrast the insignificant coefficients from recent data spans can be explained by an unbalanced regression problem caused by asymmetries in spot returns. These stem from market frictions such as transaction costs and are associated with overshooting of spot rates. Monte Carlo experiments show that asymmetries and overshooting effects produce widely dispersed and statistically insignificant slope coefficients whose small sample mean is close to zero

Overnight News and Daily Equity Trading Risk Limits

This paper proposes a new bivariate modeling approach for setting daily equity-trading risk limits using high-frequency data. We construct one-day-ahead Value-at-Risk (VaR) forecasts by taking into account the different dynamics of the overnight and daytime return processes and their covariance. The covariance is motivated by market microstructure effects such as price staleness and news spillover. Among the competitors we include a simpler bivariate model where the overnight return is redefined by moving the open price further into the trading day, and a univariate model based on the close-to-close return and an overnight-adjusted realized volatility. We illustrate the different approaches using data on the S&P 500 and Russell 2000 indices. The evidence in favour of modeling the covariance is more convincing for the latter index due to the lower trading volumes and, relatedly, the less efficient price discovery at market open for small-cap stocks

ECB Policy and Eurozone Fragility: Was De Grauwe Right? CEPS Working Document No. 397, June 2014

Paul De Grauwe’s fragility hypothesis states that member countries of a monetary union such as the eurozone are highly vulnerable to a self-fulfilling mechanism by which the efforts of investors to avoid losses from default can end up triggering the very default they fear. The authors test this hypothesis by applying an eclectic methodology to a time window around Mario Draghi’s “whatever it takes” (to keep the eurozone on firm footing) pledge on 26 July 2012. This pledge was soon followed by the announcement of the Outright Monetary Transactions (OMT) programme (the prospective and conditional purchase by the European Central Bank of sovereign bonds of eurozone countries having difficulty issuing debt). The principal components of eurozone credit default swap spreads validate this choice of time frame. An event study reveals significant pre announcement contagion emanating from Spain to Italy, Belgium, France and Austria. Furthermore, time-series regression confirms frequent clusters of large shocks affecting the credit default swap spreads of the four eurozone countries but solely during the pre-announcement period. The findings of this report support the fragility hypothesis for the eurozone and endorse the Outright Monetary Transactions programme

Solución de problemas no lineales con restricciones usando DIRECT y una función Lagrangeana aumentada

Publicado em CD-ROMEn este trabajo se pretende hacer la resolución de problemas no lineales con restricciones a través de la utilización del algoritmo DIRECT y de una función Langrangeana aumentada. DIRECT es un método deterministico de optimización global. Ha sido hecha una extensión de DIRECT para resolver problemas con restricciones de tipo igualdad y desigualdad, a través de la utilización de métodos de penalización basados en la función Langrangeana aumentada, teniendo como base los métodos de los multiplicadores. La idea central es resolver el problema de optimización con restricciones a través de la resolución de una sucesión de sub-problemas más simples, esos problemas apenas con restricciones de límites simples, que serán resueltos por DIRECT. Por último, para evaluar el desempeño del método, fue aplicado el método en un conjunto de problemas bien conocidos de optimización global y comparado con otras estrategias