Financial Spreads Research Articles

Reserves, Liquidity and Money: An Assessment of Balance Sheet Policies

The financial crisis and its aftermath have stimulated a vigorous debate on the use of macroprudential instruments both for regulating the banking system and for providing additional tools for monetary policymakers. The widespread adoption of non-conventional monetary policies has provided some evidence on the efficacy of liquidity and asset purchases for offsetting the zero lower bound. Central banks have thus been put in mind of the effectiveness of extended open market operations as supplementary monetary policy tools. These are essentially fiscal instruments, in that they entail the issuance of central bank liabilities backed by fiscal transfers. Given that these tools are written into fiscal budget constraints, we can examine the consequences of the operations in the context of a microfounded macroeconomic model of banking and money, and we can simulate the responses of the Federal Reserve balance sheet to the crisis. Specifically, we examine the role that reserves for bond and capital swaps play in stabilizing the economy, as well as the impact of changes in the composition of the central bank balance sheet. We find that such policies can significantly enhance the ability of the central bank to stabilize the economy. This is because balance sheet operations supply (remove) liquidity to a financial market that is otherwise short (long) of liquidity, and hence allow other financial spreads to move less violently over the cycle to compensate.Full publication: Are Central Bank Balance Sheets in Asia Too Large?

FINANCIAL BINARY BETTING, STYLES, VALUATIONS AND DEDUCTIONS FROM DATA

A relatively new form of financial spread betting, the binary bet, has become popular. Part of the popularity of this style of bet, from the gambler’s point of view, is undoubtedly due to the simplicity and transparency of the contracts. The fact that these bets are free at the time they are taken is an added inducement. For the bet provider, as long as the correct buy and sell levels are maintained during the betting period and the betting frequency on any contract is high, it is again relatively simple to ensure a known income from the operation.Binary spread bets are examples of financial derivatives and the standard methods used in that field can be used to deduce the parameters that should apply. This gives useful information to the gamblers in telling them how much they are paying for the bet. Watching how the quotes are moving in time can also inform how the gambling community is behaving and what the average view of the outcome is.A variety of types of binary bets are valued and in many cases it is possible to derive analytic formulas. These can be applied to time series data that are acquired from quotes and used to deduce information about the bets held by a provider and the market expectations of the community.

Orthodontic education - The times they are a changin'

A resident about to graduate from one of the seventy accredited orthodontic programs in the US and Canada is facing a very different scenario than in previous years due to three factors: the current economic climate, the cost of attending a program and increased student debt. The AAO website provides an online document titled Accredited Schools which in 2003 I exported to Excel and analyzed the results. I repeated the exercise with the latest version of this document and will present some conclusions which are dependent upon the AAO document being up to date and accurate. I have also used another resource, a Bentson Clark and Copple resident survey completed recently which was emailed to 967 current residents and received a total of 461 responses. The cost of attending an orthodontic program has increased significantly for some programs. The numbers presented here represent only those costs associated with the program so living expenses such as housing, meals and transportation must be added. A very interesting fact is that there is a large financial spread among our 70 programs. Today the best financial program pays residents $160,000 over the length of the program while the most costly program charges a residents a total of $240,000 (Table 1). The five highest paying programs are hospital based so most likely the large stipends are available through GME funding assistance. ,Graduate Medical Education Reimbursement and Residency Funding. Since 2003, 20 programs have decreased resident charges (range $644 to $105,112). Two have stayed the same. On the other hand, 48 programs have raised resident charges (range $1740 to $118,153). So we currently have the equivalent of 21 two year programs, 13 two and a half year programs with the majority (36) at three years (Table 2). Changes from 2003 with the addition of new programs and adjusting the number of residents admitted have caused an increase in the number of graduates from 358 to 390, an increase of 32. The Bentson Clark and Copple resident survey has revealed some significant changes that may alter the course of future events for recent graduates. The most striking issue is the fact that in 2010, 34% of our orthodontic residents graduated with more than $300,000 of student debt. Today that percentage remains high at 36%. A recent graduate with a $300,000 debt after a six month grace period would begin paying off this debt of $300,000 over 20 years at 7% which equals $2325.90 paid with after tax earnings. This would equate to $27,910.80 annually in after tax payments which, depending on earnings would likely equate to almost $40,000 in gross income. This creates a possible scenario in which a recent graduate with little or even a negative net worth may not be able to acquire funding to either start a practice or acquire one. Since opportunities are limited to become an associate in a private practice the only remaining possibility for income for this individual may be one of the clinic chains that provides orthodontic care, doing orthodontics for a pediatric dental office or GP group or working for multiple practices doing day work. For those residents with good credit who have found a practice to purchase with good cash flow, they must think big by looking at practices with high net income to cover high expenses. Looking at a small satellite or fixer-upper won’t provide the cash flow to service educational debt and have enough left over for living expenses. Current owners selling to these residents may be required to carry some of the purchase debt in the form of a note, thus sharing the risk with an institutional lender. According to the survey, 53% o the current residents plan to purchase a practice, 25% desire to associate only while only 11% plan to undertake a startup. In July of 2010 according to the AAO’s Practice Opportunities Service there were 132 practices for sale with 674 recent graduates looking for an acquisition. Today that ratio has improved somewhat with 158 practices for sale with 443 individuals looking for an acquisition. It is

Slow-Moving Traps

This paper studies the link between productivity and technological change in both the real and financial sectors and its effect on growth. The financial system affects technological change in the real sector by providing the funds that firms in the real sector need to implement more advanced technologies. In turn, the widespread use of advanced technologies in the real sector facilitates technological innovation in the financial sector, reducing financial intermediation costs. Thus, technological change in both sectors is mutually reinforcing and may generate multiple balanced growth paths with different financial intermediation costs, interest spreads and technological gaps.

The Predictive Content of Sectoral Stock Prices: A US-Euro Area Comparison

This paper examines the out-of-sample forecast performance of sectoral stock market indicators for real GDP, private consumption and investment growth up to 4 quarters ahead in the US and the euro area. Our findings are that the predictive content of sectoral stock market indicators: i) is potentially strong, particularly for the financial sector, and is stronger than that of financial spreads; ii) varies over time, with a substantial improvement after 1999 for the euro area; iii) is stronger for investment than for private consumption; and iv) is stronger in the euro area than in the United States. JEL Classification: C53, E37, G12

Money and liquidity effects: Separating demand from supply

In the canonical monetary policy model, money is endogenous to the optimal path for interest rates and output. But when liquidity provision by banks dominates the demand for transactions money from the real economy, money is likely to contain information for future output because of its impact on financial spreads. And so we decompose broad money into primitive demand and supply shocks. We find that supply shocks have played a significant role in the time series in each of the USA, UK and Eurozone in the short to medium term. We further consider to what extent the supply of broad money is related to policy or to liquidity effects from financial intermediation.

Financial Wealth

Financial wealth over the last decades has become the clearest sign of economic advancement and well-being. The collapse of financial markets in the last 2 years has been a cataclysmic event. The loss of financial wealth has been enormous, and the consequences for the economies of the world are commensurate. The loss of capital value of financial assets worldwide may have reached US$50 trillion in 2008, the equivalent of 1 year of world gross domestic product or about one-quarter of total financial wealth before the crisis. While there has been some recovery so far in 2009, conditions under which financial markets have been operated for a few decades are unlikely to be replicated soon. The generation of wealth witnessed in recent years may come back, but in a much more sedate and controlled financial system, and subject to stricter rules. The impact of the current crisis has affected all regions of the world, showing that the decoupling theory that had been prevalent during earlier years was misplaced. There were particularly large declines in the case of Developing Asia and the European Union. This is explained by the impact of the decline in stock market values by almost one-half, and the reduction in the values of financial assets and higher spreads on debts. The decline had a direct effect on the performance of economies worldwide, with the decline in activity observed in 2009 of about 3 percent a year consistent with the loss of wealth described here. The implications of the loss of wealth, even if partially reversed, for the future are complex. It has been absolutely essential for governments to continue supporting demand, in the face of the existing collapse of private demand. However, the injection of liquidity and the rapid increase in government debt has a limit, to avoid a negative reaction by the public. Otherwise, the loss of wealth already experienced may be combined with increased inflation and a loss of confidence in public debt instruments that would aggravate rather than correct the existing level of economic distress.

When and How US Dollar Shortages Evolved into the Full Crisis? Evidence from the Cross-Currency Swap Market

This paper investigates when and how the US dollar shortage problem evolved into the full crisis during the financial turmoil that started in the summer of 2007, using cross-currency swap prices between three European currencies (EUR, GBP, and CHF) and USD. We employ the dynamic global (latent) factor model with regime-switching beta coefficients proposed by Kim (1994). The main findings are as follows. The global factor exists and there are 2 (high and low) distinctive regimes for beta coefficients of each observable price with respect to the global factor. The crisis indicators such as US and European financial credit spreads and TED spread have significant predictive power for regime-switching from and to the high-beta crisis regime. The 1-year market first entered the crisis regime soon after the onset of the subprime problem in August 2007, and has stayed in the crisis regime since early March, 2008. The 5-year market shows more gradual and delayed movements of both the global factor and the crisis regime probability, entering the crisis regime just after the collapse of Bear Sterns in mid-March, 2008.

Assessing the predictive power of financial spreads in the euro area: does parameters instability matter?

In the empirical literature there is wide consensus that financial spreads cannot constitute a broadly based assessment on future output growth and inflation because the bivariate estimated regressions are not stable over time and lead to relatively poor out-of-sample forecasting performance (e.g. J Econ Liter 41:788–829, 2003). This conclusion arised for the USA, as well as for several European countries. In this paper we check whether the marginal predictive content of some financial spreads (the slope of the yield curve, the reverse yield gap and the credit spread) for macroeconomic forecasting in the euro area can be recovered using techniques taking into account potential parameters instability. We set up a quarterly Bayesian vector autoregression model with time-varying coefficients, comprising both target variables, as well as other monetary policy indicators, to serve as a benchmark. Then, the properties of the spreads as leading indicators are assessed by augmenting this benchmark BVAR with the spreads, one at a time. We find time variation of the coefficients to be a relevant issue in our model, especially for forecasting output growth, but financial spreads continue to have no or negligible marginal predictive content for both output growth and inflation. Overall, our results confirm that there is no ready-to-use financial spread that can replace an encompassing multivariate model for the prediction of target variables in the euro area.

Financial Spread Betting

Abstract Traditional betting has two outcomes: you win or you lose. Spread betting has many more possibilities: you can win a lot or a little; you can lose or lose much, much more than you imagined. Spread betting, say its fans, brings a whole new level of uncertainty—and excitement. It has been described as the crack cocaine of gambling. Spread bets can be laid on almost any sporting or other result, but in the field of finance it is making particular inroads. David Buik, of the City spread betting company Cantor Index Ltd, explains.

Euro adoption: views from the third row

Croatia is already much more euroised than any of the first wave accession countries. The paper demonstrates that Croatia has a strong incentive to adopt euro as soon as it becomes feasible. Costs of doing so are smaller because the degrees of freedom for an independent monetary policy-making are already reduced, while the benefits are higher. A special benefit that a heavily euroised economy derives from formally adopting the euro is removal of relatively high costs of prudential regulation connected to the balance sheet risk and a possible run on the foreign exchange liabilities of the banking system. This would in turn substantially reduce costs of financial intermediation and interest rate spreads. Our analysis suggests that in a highly euroised economy, the costs of euro adoption are smaller and the benefits are larger than in a non-euroised economy.

Forecasting real estate returns using financial spreads

This paper examines the predictability of real estate asset returns using a number of time series techniques. A vector autoregressive model, which incorporates financial spreads, is able to improve upon the out of sample forecasting performance of univariate time series models at a short forecasting horizon. However, as the forecasting horizon increases, the explanatory power of such models is reduced, so that returns on real estate assets are best forecast using the long term mean of the series. In the case of indirect property returns, such short-term forecasts can be turned into a trading rule that can generate excess returns over a buy-and-hold strategy gross of transactions costs, although none of the trading rules developed could cover the associated transactions costs. It is therefore concluded that such forecastability is entirely consistent with stock market efficiency.

The Role of Financial Spreads in Macroeconomic Forecasting: Evidence for the UK

We examine the potential use of financial spreads in forecasting aggregate macroeconomic activity in the UK. We develop a quarterly Bayesian vector autoregressive macroeconomic model which is used to generate out‐of‐sample forecasts for GDP, prices, real effective exchange rate, interest rate and other macroeconomic variables at varying forecast horizons over the period 1989Q1–1995Q2. The forecasts are generated through sequential re‐estimation using the Kalman filter. Extensive experimentation is undertaken, using different priors, monetary indicators and financial spreads. The empirical results suggest that financial spreads in the UK do not contain any predictive information on future real macroeconomic activity, but they yield a significant improvement in price predictions.

Contagion and Volatility with Imperfect Credit Markets

This paper interprets contagion effects as an increase in the volatility of shocks impinging on the economy. The implications of this approach are analyzed in a model in which domestic banks borrow at a premium on world capital markets, and domestic producers borrow at a premium from domestic banks. Financial spreads depend on a markup that compensates lenders, in particular, for the expected cost of contract enforcement. Higher volatility increases financial spreads and the producers' cost of capital, resulting in lower employment and higher incidence of default. Welfare effects are nonlinearly related to the degree of international financial integration.

Are financial spreads useful indicators of future inflation and output growth in EU countries?

This paper seeks to address the policy issue of the usefulness of financial spreads as indicators of future inflation and output growth in the countries of the European Union, placing a particular focus on out-of-sample forecasting performance. Such analysis is of considerable relevance to monetary authorities, given the breakdown of the money/income relation in a number of countries and following increased emphasis of domestic monetary policy on control of inflation following the broadening of the ERM bands. The results confirm that for some countries, financial spread variables do contain some information about future output growth and inflation, with the yield curve and the reverse yield gap performing best. However, the relatively poor out-of-sample forecasting performance and/or parameter instability suggests that the need for caution in using spread variables for forecasting in EU countries. Only a small number of spreads contain information, and improve forecasting in a manner which is stable over time. © 1997 John Wiley & Sons, Ltd.

Are financial spreads useful indicators of future inflation and output growth in EU countries?

This paper seeks to address the policy issue of the usefulness of financial spreads as indicators of future inflation and output growth in the countries of the European Union, placing a particular focus on out-of-sample forecasting performance. Such analysis is of considerable relevance to monetary authorities, given the breakdown of the money/income relation in a number of countries and following increased emphasis of domestic monetary policy on control of inflation following the broadening of the ERM bands. The results confirm that for some countries, financial spread variables do contain some information about future output growth and inflation, with the yield curve and the reverse yield gap performing best. However, the relatively poor out-of-sample forecasting performance and/or parameter instability suggests that the need for caution in using spread variables for forecasting in EU countries. Only a small number of spreads contain information, and improve forecasting in a manner which is stable over time. © 1997 John Wiley & Sons, Ltd.

Contagion and Volatility with Imperfect Credit Markets

This paper interprets contagion effects as an increase in the volatility of aggregate shocks impinging on the domestic economy. The implications of this approach are analyzed in a model with two types of credit market imperfections: domestic banks borrow at a premium on world capital markets, and domestic producers (whose demand for credit results from working capital needs) borrow at a premium from domestic banks. Higher volatility of producers’ productivity shocks increases both domestic and foreign financial spreads and the producers’ cost of capital, resulting in lower employment and higher incidence of default. Welfare effects are nonlinearly related to the degree of international financial integration.

UK stock and government bond markets: predictability and the term structure

This paper explores whether conditional expected excess returns on UK shares and long-term government bonds are predictable and whether they have a common source of variation. Using monthly data for 1976–91 the results suggest that the same information helps predict expected excess returns in both the UK government bond market and the stock market. Contrary to US evidence, support is also found for the hypothesis that government bonds and shares have a single common source of risk which is unobservable but can be proxied by financial spreads.

THE ROLE OF FINANCIAL SPREADS: EMPIRICAL ANALYSIS OF SPREADS AND REAL ACTIVITY*

The issues of interpretation and estimation of VAR models of output which use financial spreads as indicators are reviewed and new empirical evidence is provided using U.K. data. The principal extensions to the existing U.S. literature are estimation of the role of spreads in the context of a cointegrating model as well as a dynamic VAR, and also use of the reverse yield gap (bond yield less equity yield) as an alternative indicator to traditional spreads such as the yield gap and credit quality spread. The evidence presented suggests financial spreads may have an important indicator function in the U.K., especially in predicting short-run movements in the real economy. Copyright 1994 by Blackwell Publishers Ltd and The Victoria University of Manchester

The Use of Financial Spreads as Indicator Variables: Evidence for the United Kingdom and Germany

There has been growing interest in the use of financial spreads as advance indicators of real activity and inflation. Empirical evidence is marshalled on a range of spreads when these are used in vector autoregressive models of the U.K. and German economies. It is found that they do provide significant information, even after allowing for the effects of other influences upon macroeconomic activity.