Extended Libor Market Models with Affine and Quadratic Volatility

The market model of interest rates specifies simple forward or Libor rates as lognormally distributed, their stochastic dynamics has a linear volatility function. In this paper, the model is extended to quadratic volatility functions which are the product of a quadratic polynomial and a level-independent covariance matrix. The extended Libor market models allow for closed form cap pricing formulae, the implied volatilities of the new formulae are smiles and frowns. We give examples for the possible shapes of implied volatilities. Furthermore, we derive a new approximative swaption pricing formula and discuss its properties. The model is calibrated to market prices, it turns out that no extended model specification outperforms the others. The criteria for model choice should thus be theoretical properties and computational efficiency.forward Libor rates, Libor market model, affine volatility, quadratic volatility, dervatives pricing, closed form solutions, LMM, BGM

On association in regression: the coefficient of determination revisited

Universal coefficients of determination are investigated which quantify the strength of the relation between a vector of dependent variables Y and a vector of independent covariates X. They are defined as measures of dependence between Y and X through theta(x), with theta(x) parameterizing the conditional distribution of Y given X=x. If theta(x) involves unknown coefficients gamma the definition is conditional on gamma, and in practice gamma, respectively the coefficient of determination has to be estimated. The estimates of quantities we propose generalize R^2 in classical linear regression and are also related to other definitions previously suggested. Our definitions apply to generalized regression models with arbitrary link functions as well as multivariate and nonparametric regression. The definition and use of the proposed coefficients of determination is illustrated for several regression problems with simulated and real data sets

Globalisation Effect on Inflation in the Great Moderation Era: New Evidence from G10 Countries

The effect of globalisation on inflation is modeled and simulated for ten countries from G10 during the Great Moderation period. The results are supportive of the globalisation hypothesis. In particular, the results show that dynamic channels and magnitudes of globalisation to domestic inflation are highly heterogeneous from country to country, that increases in trade openness could be either inflationary or deflationary, while increased imports from low-cost emerging-market economies have been mostly deflationary, and that there has been almost no direct globalisation impact as far as inflation persistence is concerned while the impact on inflation variability can be positive as well as negative. Overall, globalisation is shown to have contributed positively to the aspect of low inflation rather than that of stable inflation during the Great Moderation era

STOCK MARKET DEVELOPMENT AND ECONOMIC GROWTH: THE CAUSAL LINKAGE

This paper addresses the question: does stock market development cause growth? It examines the causal linkage between stock market development, financial development and economic growth. The argument is that any inference that financial liberalisation causes savings or investment or growth, or that financial intermediation causes growth, drawn from bivariate causality tests may be invalid, as invalid causality inferences can result from omitting an important variable. The empirical part of this study exploits techniques recently developed by Toda and Yamamoto (1995) to test for causality in VARs, and emphasises the possibility of omitted variable bias. The evidence obtained from a sample of seven countries suggests that a well-developed stock market can foster economic growth in the long run. It also provides support to theories according to which well-functioning stock markets can promote economic development by fuelling the engine of growth through faster capital accumulation, and by tuning it through better resource allocation.Financial Development, Economic Growth, Stock Market, Causality Testing, VARs, Incomplete Systems

Regime-switching Vector Error Correction Model (VECM) analysis of UK meat consumption

The asymptotic distributions of cointegration tests are approximated using the Gamma distribution. The tests considered are for the I(1), the conditional I(1), as well as the I(2) model. Formulae for the parameters of the Gamma distributions are derived from response surfaces. The resulting approximation is flexible, easy to implement and more accurate than the standard tables previously published

Regime-switching Vector Error Correction Model (VECM) analysis of UK meat consumption

The standard Vector Error Correction Model (VECM) approach to investigating the underlying dynamics of economic variables assumes a constant co-integration space. This paper relaxes this assumption by implementing a regime switching VECM that allows for shifts in both the drift and the long-run equilibrium. Applying this more flexible formulation to a study of UK meat consumption, we can clearly identify several shifts in meat consumption. These can be explained by significant shocks in consumer confidence in meat safety, such as BSE. Although it is possible to model these explicitly, since the approach adopted models the regime shift in terms of an unobserved state variable, it can be useful in identifying such shifts, thus allowing them to be modeled in subsequent steps.Markov switching, vector autoregression, error correction model

Globalisation effect on inflation in the great moderation era: new evidence from G10 countries

The effect of globalisation on inflation is modelled and simulated for ten countries from G10 during the Great Moderation period. The results are supportive of the globalisation hypothesis. In particular, the results show that dynamic channels and magnitudes of globalisation to domestic inflation are highly heterogeneous from country to country, that increases in trade openness could be either inflationary or deflationary, while increased imports from low-cost emerging-market economies have been mostly deflationary, and that there has been almost no direct globalisation impact as far as inflation persistence is concerned while the impact on inflation variability can be positive as well as negative. Overall, globalisation is shown to have contributed positively to the aspect of low inflation rather than that of stable inflation during the Great Moderation era.Inflation dynamics; globalisation