Periods Of High Uncertainty Research Articles

Policy Uncertainty and Short-Term Financing: The Case of Trade Credit

We examine the impact of policy uncertainty on trade credit. We document a decline (increase) in accounts payable and receivable during periods of high (low) policy uncertainty. The relation is robust and holds after controlling for endogeneity, economic and political uncertainties, and the Great Recession. Additionally, the impact of policy uncertainty on trade credit is long term, affecting short-term borrowing and lending in the following year as well. The reduction in trade credit during periods of high uncertainty is driven by a decrease in supply; firms that are most likely to lend, reduce credit to customers during these periods. There is no evidence that firms with access to alternative sources of funding reduce their borrowings during periods of high policy uncertainty. For the subset of firms that have limited access to external funds, there is an increase in accounts payable in high uncertainty periods suggesting that these firms view trade credit as a substitute source of financing during difficult times. Finally, industry competitiveness impacts the relation; suppliers (customers) in competitive industries have higher (lower) levels of accounts receivable (payable) during high uncertainty periods.

International Bank Lending Channel of Monetary Policy

How does domestic monetary policy in systemic countries spillover to the rest of the world? This paper examines the transmission channel of domestic monetary policy in the cross-border context. We use exogenous shocks to monetary policy in systemically important economies, including the U.S., and local projections to estimate the dynamic effect of monetary policy shocks on bilateral cross-border bank lending. We find robust evidence that an increase in funding costs following an exogenous monetary tightening leads to a statistically and economically significant decline in cross-border bank lending. The effect is weakened during periods of high uncertainty. In contrast, the effect is found to not vary according to the degree of borrower country riskiness, further weakening support for the international portfolio rebalancing channel.

International Bank Lending Channel of Monetary Policy

How does domestic monetary policy in systemic countries spillover to the rest of the world? This paper examines the transmission channel of domestic monetary policy in the cross-border context. We use exogenous shocks to monetary policy in systemically important economies, including the U.S., and local projections to estimate the dynamic effect of monetary policy shocks on bilateral cross-border bank lending. We find robust evidence that an increase in funding costs following an exogenous monetary tightening leads to a statistically and economically significant decline in cross-border bank lending. The effect is weakened during periods of high uncertainty. In contrast, the effect is found to not vary according to the degree of borrower country riskiness, further weakening support for the international portfolio rebalancing channel.

Investment Responses to Tax Policy Under Uncertainty

How does economic uncertainty affect the impact of tax policy? To answer this question, we exploit a unique natural experiment, in which two very similar investment subsidies were implemented in the same country, two years apart: once during a period of economic stability, and once during a period of very high uncertainty. The experiment features sharp discontinuities in firm eligibility, and we conduct our analysis using tax returns (corporate and VAT) and trade data for the universe of corporations. We find that, under low uncertainty, tax incentives have strong positive effects on investment, both on the extensive and intensive margins. This aligns with the findings in several recent empirical papers. Under high uncertainty, however, the story is very different: the effect at the intensive margin is still present, but the effect at the extensive margin disappears. Together, these results suggest that: (1) some firms wait and see during periods of high uncertainty, even in the presence of generous incentives; and (2) periods of stability offer an important policy opportunity to encourage investment.

Investigating Spillover Effects between Foreign Exchange Rate Volatility and Commodity Price Volatility in Uganda

This study investigates the impact of commodity price volatility spillovers on financial sector stability. Specifically, the study investigates the spillover effects between oil and food price volatility and the volatility of a key macroeconomic indicator of importance to financial stability: the nominal Uganda shilling per United States dollar (UGX/USD) exchange rate. Volatility spillover is examined using the Generalized Vector Autoregressive (GVAR) approach and Multivariate Generalized Autoregressive Conditional Heteroskedasticity (MGARCH) techniques, namely the dynamic conditional correlation (DCC), constant conditional correlation (CCC), and varying conditional correlation (VCC) models. Overall, the results of both the GVAR and MGARCH techniques indicate low levels of volatility spillover and market interconnectedness except during crisis periods, at which point cross-market volatility spillovers and market interconnectedness sharply and markedly increased. Specifically, the results of the MGARCH analysis show that the DCC model produces the best results. The obtained results point to an amplification of dynamic conditional correlations during and after the global financial crisis (GFC), suggesting an increase in volatility spillovers and interdependence between these markets following the global financial crisis. This is also confirmed by the results of the total spillover index based on the GVAR analysis, which shows low but time-varying volatility spillover that intensified during periods of high uncertainty and market crises, particularly during the global financial crisis and sovereign debt crisis periods.

A Picture Is Worth a Thousand Words: Market Sentiment From Photos

By applying machine learning to accurately and cost effectively classify photos based on sentiment, we introduce a daily market-level investor sentiment index (Photo Pessimism) from a large sample of news photos. Between 1926 and 2018, Photo Pessimism predicts market return reversal and increase in trading volume. The predictability pattern is concentrated among stocks with high limits to arbitrage and during high uncertainty periods. Photo Pessimism enhances pessimism embedded in text, but subsumes it during days with traumas and influential photos. Photo Pessimism from business news has over six times stronger predictive power than Photo Pessimism from general news.

Investorss Uncertainty and Stock Market Risk

We propose a novel approach to model investors' uncertainty using the conditional volatility of investors' sentiment. Working with weekly data on investor sentiment, six major U.S. stock indices, and alternative measures of uncertainty, we run various tests to validate our proposed measure. The estimates show that investors' uncertainty is greater during economic downturns, and it is linked with lower investors' sentiment. In addition, the results support the existence of a positive conditional correlation between sentiment and returns. This positive spillover between sentiment and returns is interpreted as a positive link between investors' uncertainty and market risk. We also find that investors’ uncertainty and market risk are strongly driven by their lagged values. Our measure consistently captures periods of high uncertainty as shown by a positive and highly statistically significant correlation with other existing measures of uncertainty.

Be Nice to Stakeholders: The Effect of Economic Policy Uncertainty on Corporate Social Responsibility

This study examines the reaction of firms to economic policy uncertainty (EPU) by investing in corporate social responsibility (CSR). Using a Chinese sample, we find a positive and significant relationship between EPU and the CSR engagement of firms. Moreover, we find that firms without political connection, firms in low social trust regions, firms with high profitability, and firms in policy sensitive industries, engagement more on CSR when EPU increases. Our results also suggest that CSR engagement is an efficient strategy for a firm to hedge the firm’s value from a negative shock of EPU at least for two years. The results are robust to a variety of model specifications and endogeneity problems. We contribute to the literature as firms tend to send a signal to their stakeholders to convey that they honour implicit contracts by investing in CSR activities during high uncertainty periods. The results support the risk management perspective that firms adopt CSR as an ex-ante insurance mechanism.

Knowledge that matters for the ‘survival of unfittest’: The case of the new Brussels' rail junction

The construction of a large metropolitan infrastructure, like other megaprojects, requires advanced technical expertise, capacity to manage complex procedures and planning processes as well as capacity to deal with conflicting interests. For the case of megaprojects, overestimation of benefits and underestimation of costs and risks is a common problem all over the world, leading to the ‘survival of the unfittest’ (Flyvbjerg, 2009). The main causes were identified in the optimism bias, strategic misrepresentation, path dependency leading to lock-in and poor oversight; however, the ‘survival’ of these causes is still unclear. For this purpose, the survival of the unfittest megaprojects is re-conceptualised into a proper cognitive-evolutionary framework. By introducing an innovative taxonomy of policy knowledge, this paper aims to argue that a specific policy community can ‘survive’ by strategically using a ‘cognitive monopoly’ of some of the relevant policy knowledge for megaprojects.Based on the case of the new ‘Watermael – Schuman – Josaphat’ rail junction in Brussels, findings show the critical role played by the Federal Ministry for Communications thanks to a long-standing and context-specific know-how on underground works. While missing knowledge was outsourced and instrumentally used to overcome potential lock-in, the Ministry was able to build the only new large metropolitan infrastructure of Belgium during a period of high uncertainty due to decentralisation. The paper concludes discussing the effects of preserving this policy knowledge as well as negative issues related to this ‘cognitive monopoly’.

Investor attention and currency performance: international evidence

ABSTRACTThis article investigates the relationship between investor attention measured by Google search volume index and the performance of several currencies. We find that currency performance is remarkably responsive to changes in investor attention. These impacts, generated rapidly, are present over the relatively long term, especially for emerging currencies, and are intensified during periods of high uncertainty. We also demonstrate that there is a prominent asymmetric effect for the impact of attention, as past currency performance also influences attention. Typically, past currency performance can determine the magnitude of the impact on current currency performance. Moreover, we confirm that investor attention has a predictive power for forecasting emerging currency performance in the out-of-sample analysis. Further, these forecasts generate substantial economic value in the framework of asset allocation. By contrast, statistical predictability and economic value do not exist in the currencies from developed markets. These results indicate that investor attention can alter currency performance and its predictability. More broadly, our study emphasizes the potential of employing investor attention for emerging currency performance forecasting applications.

Expected Issuance Fees and Market Liquidity

This paper studies the impact of expected issuance fees on market liquidity in the Euro-area government bond market. Investment banks have a dual role as primary dealer in the secondary market as well as competitor for lead manager in the primary market. Primary dealers have the incentive to increase liquidity due to competition for issuance fees because lead managers are selected based on their liquidity provision in the secondary market. We find that the expected issuance fee is significantly related to market liquidity. Issuance fee driven liquidity is especially strong for countries with high funding needs, in periods of high uncertainty, and for bonds with high search costs.

Economic Policy Uncertainty, U.S. Real Housing Returns and Their Volatility: A Nonparametric Approach

We analyze whether a news-based measure of economic policy uncertainty (EPU) helps predict movements in real housing returns. We find evidence of structural breaks and nonlinearity in the relation between real housing returns and EPU. We find that EPU affects both real housing returns and their volatility. This result still holds when controlling for macroeconomic and financial determinants of housing prices, suggesting that EPU has a direct impact on the housing market and not only an indirect effect through its influence on the wider economy and financial markets. Large uncertainty shocks generate disproportionate falls in housing returns, implying significant tail risks for investors in property or related securities in periods of high uncertainty. In addition, we find that taking EPU into account improves forecasts of both the level and volatility of real housing returns, in-sample as well as out-of-sample. Hence, information on EPU is useful, not only for predicting future returns on housing-related investments, but also for assessing related risks.

How are analysts’ forecasts affected by high uncertainty?

AbstractThis study examines whether key characteristics of analysts’ forecasts—timeliness, accuracy, and informativeness—change when investor demand for information is likely to be especially high, i.e., during periods of high uncertainty. Findings reveal that when uncertainty is high, analysts’ forecasts are more timely but less accurate. However, analysts’ forecasts are also more informative to the market, which is consistent with investors’ demand for timely information, even if it is less accurate. We observe these findings when market prices are increasing and decreasing, consistent with the findings resulting from uncertainty in general rather than just uncertainty associated with market declines. We also examine how timeliness, accuracy, and informativeness change in response to elevated levels of three sources of uncertainty—market, industry, and firm level. We predict and find that analysts are better able to deal with heightened industry uncertainty, as reflected by greater timeliness with no loss in forecast accuracy. In contrast, analysts have greater difficulty dealing with heightened market uncertainty, as both timeliness and forecast accuracy decline.

The Euro Crisis and the 24h Pre-ECB Announcement Return

We document economically and statistically large 24h pre-ECB announcement re- turns in European equity. For the overall market the respective annual premium (2010 – 2015) was over 6% (Sharpe ratio of 1.5). We show that the pre-ECB return is mainly driven by periods of high uncertainty during the European sovereign debt crisis which can be characterized as times of severe eurozone break-up fear. For these periods the premium for the Euro Stoxx 50 index is 2.5 times higher than in non-stressed periods; for the Euro Stoxx Banks index it reaches on average almost 3% (per announcement). Current theories and explanations that relate the positive premium to the uncertainty around an announcement or to a positively anticipated event are able to explain several of the stylized facts but cannot rationalize all characteristics of the ECB announcement returns.

Uncertainty and deviations from uncovered interest rate parity

It is well-known that uncovered interest rate parity does not hold empirically, especially at short horizons. But is it really so? We conjecture that uncovered interest rate parity is more likely to hold in low uncertainty environments, relative to high uncertainty ones, since arbitrage opportunity gains become more uncertain in a highly unpredictable environment, thus blurring the relationship between exchange rates and interest rate differentials. In this paper, we first provide a new exchange rate uncertainty index, that measures how unpredictable exchange rates are relative to their historical past. Then we use the new measure of uncertainty to provide empirical evidence that uncovered interest rate parity does hold in five industrialized countries vis-a’-vis the US dollar at times when uncertainty is not exceptionally high, and breaks down during periods of high uncertainty.

Aggregate uncertainty and sectoral productivity growth: The role of credit constraints

We show that an increase in aggregate uncertainty—measured by stock market volatility—reduces productivity growth more in industries that depend heavily on external finance. The mechanism at play is that during periods of high uncertainty, firms that are credit constrained switch the composition of investment by reducing productivity-enhancing investment—such as on ICT capital—which is more subject to liquidity risks (Aghion et al., 2010). The effect is larger during recessions, when financing constraints are more likely to be binding, than during expansions. Our statistical method—a difference-in-difference approach using productivity growth of 25 industries from 18 advanced economies over the period 1985–2010—mitigates concerns with omitted variable bias and reverse causality. The results are robust to the inclusion of other sources of interaction effects, instrumental variable approaches, and different datasets. The results also hold if economic policy uncertainty (Baker et al., 2016) is used instead of stock market volatility as a measure of aggregate uncertainty.

The Effectiveness of Unconventional Monetary Policy on Risk Aversion and Uncertainty

This paper examines the impact of unconventional monetary policy of ECB measured by its balance sheet expansion on euro area equity market uncertainty and investors risk aversion within a structural VAR framework. An expansionary balance sheet shock decreases both risk aversion and uncertainty at least in the medium-run. A negative shock on policy rates has also a negative impact on risk aversion and uncertainty. These results are generally robust to different specifications of the VAR model, estimation procedures and identification schemes. Conversely, periods of high uncertainty are followed by a looser conventional monetary policy. The effect of uncertainty on ECB’s total assets and of risk aversion on conventional or unconventional monetary policy is not always statistically significant.

Crowding, Capacity, and Valuation of Minimum Volatility Strategies

Minimum volatility (min vol) strategies are smart beta strategies that are designed to minimize risk. In the past 12 months, ending June 30, 2016, there were $7.8 billion flows into a total of 17 U.S.-equity exchange-traded fund min vol strategies. This represents just 0.04% of total equity market capitalization of the underlying securities. Capacity in these strategies is large because traditional active mutual funds tend to overweight high-volatility stocks. Were these funds to move to a neutral position in high-volatility securities, a shift of roughly $600 billion to min vol would take place. Current valuations of min vol strategies are not high relative to historical norms and are consistent with the observed outperformance of these strategies during periods of high uncertainty.

Long-term growth and productivity projections in advanced countries

In this period of high uncertainty about future economic growth, we have developed a growth projection tool for 13 advanced countries and the euro area at the 2100 horizon. This high uncertainty is reflected in the debate on the possibility of a “secular stagnation”, fueled by the short-lived Information and Communication Technology (ICT) shock and the current low productivity and GDP growth in advanced countries. Our projection tool allows for the modelling of technology shocks, for different speeds of regulation and education convergence, with endogenous capital growth and TFP convergence processes. We illustrate the benefits of this tool through four growth scenarios, crossing the cases of a new technology shock or secular stagnation with those of regulation and education convergence or of absence of reforms. Over the period 2015-2100, the secular stagnation scenario assumes yearly TFP growth of 0.6% in the US, leading to a 1.5% GDP growth trend. The technology shock scenario assumes that the third technological revolution will, in the US, provide similar TFP gains to electricity during the second industrial revolution, leading to a 1.4% TFP trend, to which we add a TFP growth wave peaking in 2040, and thus to an average GDP growth rate of 3%. In non-US countries, GDP growth will depend on the implementation of regulation reforms, the increase in education and on the distance to the country-specific convergence target, namely the US, as well. Over the period 2015-2060, for the euro area, Japan and the United Kingdom, benefits from regulation and education convergence would amount to a 0.1 to 0.4 pp yearly growth rate depending on the initial degree both of rigidity and the TFP distance to the US. JEL classification: O11, O33, O43, O47, O57 Keywords: Growth, productivity, long-term projections, structural reforms, innovation, education

Monitoring Financial Intermediaries with Subordinated Debt: A Dynamic Signal Model for Bank Risk

Dynamic Monitoring of Financial Intermediaries with Subordinated Debt by Gloria Gonzalez-Rivera University of California, Riverside Department of Economics Riverside, CA 92521 e-mail: gloria.gonzalez@ucr.edu phone: (951) 827 1470 fax: (951) 827 5685 David Nickerson Colorado State University Departments of Economics and Finance Fort Collins, CO 80523-1771 e-mail: david.nickerson@colostate.edu phone: (970) 491 5249