Common Shocks Research Articles

Inflation Interdependence in Advanced Economies

Although there is a vast literature on GDP comovement across countries, there is scant evidence on inflation interdependence. We analyze inflation comovements across a wide set of advanced economies and across the subset of euro area countries. Some of our findings are expected, such as the fact that inflation interdependence among advanced economies is quite relevant, but is higher among euro area countries, which show strong trade links and a share common monetary policy, or the fact that inflation synchronization among countries is highest for energy prices, reflecting common oil shocks. We also find a robust puzzle: core inflation interdependence is fairly low and this result holds for both core goods and services. Inflation synchronization seems to be particularly linked to comovements in driving variables of open economy new Keynesian Phillips curve and mark-up pricing models.

Carry Trades and Commodity Risk Factors

This paper investigates the importance of commodity prices for the returns of currency carry trade portfolios. We adopt a recently developed empirical factor model to capture commodity commonalities and heterogeneity. Agricultural material and metal price risk factors are found to have explanatory power on the cross-section of currency returns, while commodity common and oil factors do not. Although stock market risk is strongly linked to currencies in developed countries, the agricultural material factor is more important for emerging currencies compared to the stock market factor. This suggests that emerging currencies are somewhat segmented from a common financial market shock.

An Investigation of the Exchange Rate Pass-Through in the Baltic States

In this paper, we investigate the Exchange Rate Pass-Through (ERPT) to import and consumer prices in the three Baltic states. We apply reduced form equations first. Then, to look at measures of shock-dependent ERPT, we use Bayesian VARs with zero and sign restrictions and a local projection exercise, using common euro area shocks. We find that results from reduced form equations are in line with the ERPT literature. As for shock-dependent ERPTs, the magnitudes are overall bigger than in the literature in the case of import prices. They get smaller for consumer prices and even smaller if we remove energy and food prices.

Time-Varying General Dynamic Factor Models and the Measurement of Financial Connectedness

We propose a new time-varying Generalized Dynamic Factor Model for high-dimensional, locally stationary time series. Estimation is based on dynamic principal component analysis jointly with singular VAR estimation, and extends to the locally stationary case the one-sided estimation method proposed by Forni et al. (2017) for stationary data. We prove consistency of our estimators of time-varying impulse response functions as both the sample size T and the dimension n of the time series grow to infinity. This approach is used in an empirical application in order to construct a time-varying measure of financial connectedness for a large panel of adjusted intra-day log ranges of stocks. We show that large increases in long-run connectedness are associated with the main financial turmoils. Moreover, we provide evidence of a significant heterogeneity in the dynamic responses to common shocks in time and over different scales, as well as across industrial sectors.

The Interaction between Profitability and Macroeconomic Factors for Future Examinations of European Banks Soundness – Theoretical Study

Any weakness in the financial institution is subject to the contagion mechanism. As result, the whole financial system will experience unpredictable financial risks and possible crisis, such as to a systemically relevant institution (e.g. Lehman Brothers’ default, 2008’s financial crises and Asian financial crises). The contagion mechanism (Quagliariello, M., 2009 [1] (Trapanese, M.) is a crucial element in the assessment of the cross-border dimension. The direct cross-border contagion risks (idiosyncratic risks) are: risks related to cross-border interbank links; money markets and cross-border ownership links; common shocks of foreign economies and global financial markets that can affect banks’ exposures due to changes in credit quality, market valuations and funding costs. Secondly, the indirect cross-border contagion risks (Indirect contagion) are caused by systematics risks that exclusively related to cross-border credit exposures (e.g. lending to non- financial institutions, credit risk transfer exposures as well as international syndicated lending), market risk exposures (by holdings of securities and off-balance sheet positions), common cross-border funding (by financing through market instruments and operational risk). From a theoretical point of view, said institutions are defined as risky banks, have unpredictable impacts on the smoothness of whole financial system. Moreover, these credit, market and liquidity risks represent the main triggers of crises. This paper is the second part of my theoretical study focused on the profitability and the soundness of European banks with an emphasis on the role of the Macro profile. In this paper, I also thoroughly investigated the macroeconomic determinants used to predict the Banking crises. Moreover, this paper analyzed the history and behavior of European banks during financial crises, and the corrective measures taken by authorities, governments and supervisory institutes to bail out the troubled banks, or to support the banking system as a whole. An extensive assessment of collected data resulted in detailed analysis of quantitative methodologies as well as the examination of the effectiveness of selected macroeconomic determinants to avoid the financial instability. This study shows that the macroeconomic adjustments were called upon during the crises. Keywords: bank profitability; soundness of banks, inflation, GDP, interest rates, macroeconomic determinants, Moody’s rating, exchange rates.

A Multivariate Evolutionary Generalised Linear Model Framework with Adaptive Estimation for Claims Reserving

In this paper, we develop a multivariate evolutionary generalised linear model (GLM) framework for claims reserving, which allows for dynamic features of claims activity in conjunction with dependency across business lines to accurately assess claims reserves. We extend the traditional GLM reserving framework on two fronts: GLM fixed factors are allowed to evolve in a recursive manner, and dependence is incorporated in the specification of these factors using a common shock approach. We consider factors that evolve across accident years in conjunction with factors that evolve across calendar years. This two-dimensional evolution of factors is unconventional as a traditional evolutionary model typically considers the evolution in one single time dimension. This creates challenges for the estimation process, which we tackle in this paper. We develop the formulation of a particle filtering algorithm with parameter learning procedure. This is an adaptive estimation approach which updates evolving factors of the framework recursively over time. We implement and illustrate our model with a simulated data set, as well as a set of real data from a Canadian insurer.

Forecasting Conditional Covariance Matrices in High-Dimensional Time Series: A General Dynamic Factor Approach

Based on a General Dynamic Factor Model with infinite-dimensional factor space and MGARCH common shocks, we develop new estimation and forecasting procedures for conditional covariance matrices in high-dimensional time series. The finite-sample performance of our approach is evaluated via Monte Carlo experiments, outperforming most alternative methods. The new procedure is used to construct one-step-ahead minimum variance portfolios for a high-dimensional panel of assets. The results are shown to achieve better out-of-sample portfolio performance than alternative existing procedures.

Interconnected Banks and Systemically Important Exposures

We study the interplay between two channels of interconnectedness in the banking system. The first one is a direct interconnectedness, via a network of interbank loans, banks' loans to other corporate and retail clients, and securities holdings. The second channel is an indirect interconnectedness, via exposures to common asset classes. To this end, we analyze a unique supervisory data set collected by the European Central Bank that covers 26 large banks in the euro area. To assess the impact of contagion, we apply a structural valuation model NEVA (Barucca et al., 2016a), in which common shocks to banks' external assets are reflected in a consistent way in the market value of banks' mutual liabilities through the network of obligations. We identify a strongly non-linear relationship between diversification of exposures, shock size, and losses due to interbank contagion. Moreover, the most systemically important sectors tend to be the households and the financial sectors of larger countries because of their size and position in the financial network. Finally, we provide policy insights into the potential impact of more diversified versus more domestic portfolio allocation strategies on the propagation of contagion, which are relevant to the policy discussion on the European Capital Market Union.

WAGE CONVERGENCE ON THE COUNTY-LEVEL IN POLAND: A PANEL DATA APPROACH

This study investigates nominal wage convergence on the county level in Poland from 2005 till 2017, while accounting for the structural heterogenity of the units and common time shocks. Results reveal that wage levels converge to their own steady-state with the speed of 7.6% of the imbalance per year. When time fixed effects are accounted for, this speed becomes higher and has a value of 34.5%. Common time effects, such as economic cycle considerably contribute to the convergence speed. The exclusion of time effects tends to bias downward the estimated convergence rate. With regard to σ-convergence, wage inequalities across the counties decreased over the years 2005–2010 with their levels moving toward the national average. However, as of 2010 this process, if any, is very slow.

Amsterdam house price ripple effects in the Netherlands

Purpose: This paper examines the existence of the ripple effect from Amsterdam to the housing markets of other regions in the Netherlands. It identifies which regional housing markets are influenced by house price movements in Amsterdam. Design/methodology/approach: The paper considers the ripple effect as a lead-lag effect and a long-run convergence between the Amsterdam and regional house prices. Using the real house prices for second-hand owner-occupied dwellings from 1995q1 to 2016q2, the paper adopts the Toda-Yamamoto Granger Causality approach to study the lead-lag effects. It uses the ARDL-Bounds cointegration techniques to examine the long-run convergence between the regional and the Amsterdam house prices. The paper controls for house price fundamentals to eliminate possible confounding effects of common shocks. Findings: The cumulative evidence suggests that Amsterdam house prices have influence on (or ripple to) all the Dutch regions, except one. In particular, the Granger Causality test concludes that a lead-lag effect of house prices exists from Amsterdam to all the regions, apart from Zeeland. The cointegration test shows evidence of a long-convergence between Amsterdam house prices and six regions: Friesland, Groningen, Limburg, Overijssel, Utrecht and Zuid-Holland. Research limitations/implications: The paper adopts an econometric approach to examine the Amsterdam ripple effect. More sophisticated economic models that consider the asymmetric properties of house prices and the patterns of interregional socio-economic activities into the modelling approach are recommended for further investigation. Originality/value: This paper focuses on the Netherlands for which the ripple effect has not yet been researched to our knowledge. Given the substantial wealth effects associated with house price changes that may shape economic activity through consumption, evidence for ripples may be helpful to policy makers for uncovering trends that have implications for the entire economy. Moreover, our analysis controls for common house price fundamentals which most previous papers ignored.

Multivariate lifetime distributions for the exponential dispersion family

ABSTRACTWe consider a general form of a multivariate lifetime model in which dependence is induced via a common shock component. The univariate marginal distributions come from the well-known and widely applied exponential dispersion family that includes the normal, compound-Poisson, gamma and negative binomial distributions. Any combination of truncation or censoring, either left or right, is considered, for which all moments are derived. This allows for the model to be calibrated to any affine transformation of lifetime data.

Learning About Competitors: Evidence From SME Lending

This paper estimates the effect of lenders learning about competitors’ contract terms using micro-data from an information sharing platform. Exploiting the staggered entry of lenders into the platform, we find that, upon entry, lenders adjust their terms towards what others are offering. We address two key confounders: unobserved common shocks to fundamentals and endogenous timing of entry into the platform. Lenders’ reaction appears to be driven by a strategic motive to match competitors in order to preserve market share. This strategic channel of information sharing in credit markets operates incremental to more conventional channels, such as the revelation of a borrower’s payment history and creditor runs.

Analysing the spillover of inflation in selected Euro-area countries

We examined the spillover of inflation in selected Euro-area countries using monthly consumer price index (CPI) based inflation data covering the period 1955M1 to 2017M4. To achieve our objective, we used two recently developed methods of spillover: a time-domain spillover method, Diebold–Yilmaz (hereafter referred as DY method) and a frequency-domain method, Barunik–Krehlik (hereafter referred as BK method). We analysed 1–4 months and more than 4 months spillovers. The study has importance because the co-movement in the international inflation rates, among others, may be produced by common shocks, similarities in central bank reaction functions, international trade and the operation of purchasing power parity theory. However, to assess the synchronisation of inflation fluctuations across countries or regions, it is critical to understand the inflation behaviour and formulation of correct monetary policy.

The common sources of business cycles in Trans‐Pacific countries and the US? A comparison with NAFTA

AbstractThis paper uses both a non‐structural and a structural approach to investigate the drivers of the business cycles in the US and 15 Trans‐Pacific (TP) countries. Our non‐structural analysis, based on a principal component methodology, reveals the shares of variation in macroeconomic variables that are due to factors common to both the US and the TP region, and factors that are region‐specific. We obtain similar measures by using a structural model (an estimated two‐country dynamic stochastic general equilibrium model) that allows for common and correlated shocks across the two regions. The clear and common finding from our analyses is that common shocks explain a substantial amount of macroeconomic variation. Comparison with the NAFTA region, along this dimension, reveals that the US economy is more similar to the TP region (a wider region that also includes Mexico and Canada) than its two neighbours.

Relative Performance Evaluation and the Ratchet Effect

ABSTRACTWhen targets depend on past performance, incentives are adversely affected by the ratchet effect. We provide theory and evidence that incorporating past peer performance into targets can alleviate this adverse incentive effect. In particular, we present an analytical model that characterizes optimal target revisions as a function of past own and past peer performance. We then test the predictions of our model using data on 2008–2010 performance targets from 354 units of a governmental agency responsible for reintegration of the long‐term unemployed into the labor market. As a unique feature of our data, we have information on peer group quality, defined as the extent to which peer performance is informative about common shocks. Consistent with our model, we find that higher peer group quality (a) increases sensitivity of target revisions to past peer performance, (b) reduces sensitivity of target revisions to past own performance, and (c) reduces the ratchet effect as reflected in managerial incentives to withhold end‐of‐year effort.

Avaliação empírica da semelhança de choques e simetria na flutuação econômica na Zona do Euro: uma análise utilizando um modelo FAVAR

Este artigo analisa as semelhanças das respostas dos países da Zona do Euro aos choques na política monetária e no câmbio e investiga a simetria das flutuações do nível de atividade por meio da análise da importância relativa da resposta do crescimento do PIB aos choques comum e específico identificados pelo modelo FAVAR utilizado. A importância do choque comum nos diversos países fornece uma medida do grau de integração dos membros da Zona do Euro. Os resultados encontrados apontam para a existência de uma maior integração entre as grandes economias da Zona do Euro e menor integração para as menores economias.

International Bank Flows and the Global Financial Cycle

What is the role for supply and demand forces in determining movements in international banking flows? And what role might a common factor—the global financial cycle highlighted by Rey (Dilemma not trilemma: the global financial cycle and monetary policy independence, 2018) and others—play in movements in these flows? Answering these questions is crucial for understanding the international transmission of financial shocks and formulating policy. This paper addresses them by using the method developed in Amiti and Weinstein (J Polit Econ 126(2):525–587, 2018) to exactly decompose the growth in international bank credit into common shocks, idiosyncratic supply shocks and idiosyncratic demand shocks for the period 2000–2017. A striking feature of the global banking flows data can be characterized by what we term the “Anna Karenina Principle”: all healthy credit relationships are alike, and each unhealthy credit relationship is unhealthy in its own way. During non-crisis years, bank flows are well explained by a common global factor. But during times of crisis, flows are affected by idiosyncratic demand shocks to borrower countries and by supply shocks to their creditor banks. That is, the importance of the common component seems to vary over time. This has important implications for why standard econometric models break down during crises.

Once bitten, twice shy: The power of personal experiences in risk taking

We study whether personal experiences are so powerful that they make individuals actively shy away from risk. Our research design relies on portfolio decisions relating to inheritances, which alter the active decision from one of choosing to take risk to one of choosing to reduce risk. Experience derives from investments in banks that defaulted following the 2007–2009 financial crisis. We classify experiences into first-hand experiences, resulting from personal losses; second-hand experiences, from losses of family members; and third-hand experiences, from locations where banks defaulted. Our results demonstrate that experiences gained personally, not common shocks, make individuals shy away from risk.

Product market competition and earnings exposure to productivity shocks

This study examines the relationship between product market competition (measured by product similarities) and earnings exposure to common and specific production shocks, finding that higher product similarity lowers profit sensitivity to common productivity shocks, while increasing sensitivity to specific productivity shocks.

Health shocks in Sub-Saharan Africa: are the poor and uninsured households more vulnerable?

BackgroundIn developing countries, health shock is one of the most common idiosyncratic income shock and the main reason why households fall into poverty. Empirical research has shown that in these countries, households are unable to access formal insurance markets in order to insure their consumption against health shocks. Thus, in this study, are the poor and uninsured households more vulnerable from health shocks? We investigate the factors that lead to welfare loss from health shocks, and how to break the vulnerability from health shocks in three Sub-Saharan Africa (SSA) countries, namely, Burkina Faso, Niger and Togo.MethodsThis study focusses on 1597 households in Burkina Faso, 1342 households in Niger and 930 households in Togo. A three-step Feasible Generalized Least Squares (FGLS) method was used to estimate vulnerability to poverty and to model the effects of health shocks on vulnerability to poverty.ResultsThe estimates of vulnerability show that about 39.04%, 33.69%, and 69.03% of households are vulnerable to poverty, in Burkina Faso, Niger, and Togo respectively. Both interaction variables, ‘health shocks and wealth’ and ‘health shocks and access to health insurance’ had a significant negative effect on reducing household’s vulnerability to poverty. Poverty is the leading cause of economic loss from health shocks as the poorer cannot afford the purchase of sufficient quantities of quality food, preventive and curative health care, and education. We found that lack of health insurance coverage had a significant effect by increasing the incidence of welfare loss from health shocks. Moreover, household size, type of health care used, gender, education and age of the head of the household as well as the characteristics of housing affect vulnerability to poverty.ConclusionOur findings suggest that for the poor households, reduction of user fees of health care at the point of service or expansion of health insurance could mitigate vulnerability to poverty. Other challenges—birth control policy, adequate sanitation facilities and a universal basic education program—need to be addressed in order to reduce significantly the effects of health shocks on vulnerability to poverty in SSA.