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Abstract:
In this paper, we study the performance of Italian listed family firms in the period 1998-2003. We measure their performance by using both accounting and market data. We first study the relative performance of family firms compared to widely held firms. Then we investigate whether performance is affected by the type of family firm (i.e., whether the CEO is a member of the family or is an outsider). We find that the data and the methodology used to measure performance strongly affect the results. When performance is measured by accounting data (ROA), using a static model, we find evidence in favor of a superior performance of family firms. Such evidence is not confirmed by the application of the same model to market measures of performance. However, we report statistical evidence that the correct econometric specification for market data is a dynamic model. The results of estimation of the dynamic model for the market measures of performance are more consistent with those based on the static model for the accounting measures of performance.

Family firms, corporate performance, management style

Abstract:
In this paper we concentrate on the consequences for the European stock market of a correction of the US Stock market. We explicitly consider the distinction between interdependence and contagion. We provide separate answers to the following questions:(i) is there long-term interdependence between US and Europe, i.e. does the equilibrium for European shares depend on the equilibrium for US shares? (ii) Is there short-term interdependence and contagion between US and European stock markets, i.e do short term fluctuations of the US share prices spill over to European share prices and is such co-movement stable in occasion of the occurrence of high volatility episodes?

Contagion, Stock Market, Interdependence, Structural Models

Abstract:
Brazil's public debt is large and interest payments weigh dangerously on the government's budget. In 2001 interest expenditure amounted to 7,3 per cent of GDP. On a mark-to-market basis (that is considering the effect of exchange rate depreciation on the value of foreign currency-denominated bonds) interest expenditure reached 9 per cent of GDP. These figures are large, though not unusual in high debt countries: they are comparable to those observed in some European countries (Italy, Greece and Belgium) prior to monetray union. Two factors contribute to this level of debt service: the size of the debt and the average cost of the debt.

Abstract:
Exogenous measures of monetary policy shocks, directly derived from financial market information, are used in close (U.S.) and open (U.S.-Germany) economy VAR models to evaluate the robustness of the dynamic effect of monetary policy obtained from traditional identified VAR. The empirical analysis confirms the main features of the monetary policy transmission mechanism in U.S. and Germany, explicitly addressing the issue of simultaneity between the German policy interest rate and the U.S. dollar-DMark exchange rate.

Abstract:
Available studies on asymmetries in the monetary transmission mechanism within Europe are invariably based on macro-economic evidence: such evidence is abundant but often contradictory. This paper takes a different route by using micro-economic data. We use the information contained in the balance sheets of individual banks (available from the BankScope database) to implement a case-study on the response of banks in France, Germany, Italy and Spain to a monetary tightening. The episode we study occurred during 1992, when monetary conditions were tightened throughout Europe. Evidence on such tightening is provided by the uniform squeeze in liquidity, which affected all banks in our sample. We study the first link in the transmission chain by analysing the response of bank loans to the monetary tightening. Our experiment provides evidence on the importance of the Europe and thus on one possibly important source of asymmetries in the monetary transmission mechanism. We do not find evidence of a significant response of bank loans to the monetary tightening, which occurred during 1992, in any of the four European countries we have considered. However we find significant differences both across countries and across banks of different dimensions in the factors that allow them to shield the supply of loans from the squeeze in liquidity.

Abstract:
Available studies on asymmetries in the monetary transmission mechanism within Europe are invariably based on macro-economic evidence: such evidence is abundant but often contradictory. This paper takes a different route by using micro-economic data. We use the information contained in the balance sheets of individual banks (available from the BankScope database) to implement a case-study on the response of banks in France, Germany, Italy and Spain to a monetary tightening. The episode we study occurred during 1992, when monetary conditions were tightened throughout Europe. Evidence on such tightening is provided by the uniform squeeze in liquidity, which affected all banks in our sample. We study the first link in the transmission chain by analysing the response of bank loans to the monetary tightening. Our experiment provides evidence on the importance of the Europe and thus on one possibly important source of asymmetries in the monetary transmission mechanism. We do not find evidence of a significant response of bank loans to the monetary tightening, which occurred during 1992, in any of the four European countries we have considered. However we find significant differences both across countries and across banks of different dimensions in the factors that allow them to shield the supply of loans from the squeeze in liquidity.

Abstract:
This paper develops a particular technique for extracting market expectations from asset prices. We use the term structure of interest rates to estimate the probability the market attaches to a country, Italy, joining the European Monetary Union at a given date. The extraction of such a probability is based on the presumption that the term structure contains valuable information regarding the markets' assessment of a country's chances of joining EMU. The case of Italy is interesting because in the survey regularly conducted by Reuters the probability that Italy joins EMU in 1999 fluctuated, in the first months of 1997, between 0.07 and 0.15 while during the same period the measures computed by financial houses--which are based on the term structure of interest rates--ranged between 0.5 and 0.8. The paper proposes a new method for computing these probabilities and shows that the discrepancies between survey and market-based measures are not the result of market inefficiencies, but of incorrect use of the term structure to compute probabilities. The technique proposed in the paper can also be used to distinguish between convergence of probabilities and convergence of fundamentals, that is to find out whether an observed reduction in interest rate spreads signals a higher probability of joining EMU at a given time or simply reflects improved fundamentals. It could also be applied, more generally, to extract information on imminent changes in an exchange rate regime from asset prices.

Abstract:
This paper evaluates VAR models designed to analyze the monetary policy transmission mechanism in the United States by considering three issues: specification, identification, and the effect of the omission of the long-term interest rate. Specification analysis suggest that only VAR models estimated on a single monetary regime feature parameters stability and do not show signs of mis-specification. The identification analysis shows that VAR-based monetary policy shocks and policy disturbances identified from alternative sources are not highly correlated but yeld similar descriptions of the monetary transmission mechanism. Lastly, the inclusion of the long-term interest rate in a benchmark VAR delivers a more precise estimation of the structural parameters capturing behaviour in the market for reserves and shows that contemporaneous fluctuations in long-term interest rates are an important determinant of the monetary authority's reaction function.

Abstract:
In this Paper, we concentrate on the hypothesis that the empirical rejections of the Expectations Theory (ET) of the term structure of interest rates can be caused by improper modeling of expectations. Our starting point is an interesting anomaly found by Campbell-Shiller (1987), when by taking a VAR approach they abandon limited information approach to test the ET, in which realized returns are taken as a proxy for expected returns. We use financial factors and macroeconomic information to construct a test of the theory based on simulating investors' effort to use the model in 'real time' to forecast future monetary policy rates. Our findings suggest that the importance of fluctuations of risk premia in explaining the deviation from the ET is reduced when some forecasting model for short-term rates is adopted and a proper evaluation of uncertainty associated to policy rates forecast is considered.

Expectations theory, macroeconomic information in finance

Abstract:
In this paper we concentrate on the hypothesis that the empirical rejections of the Expectations Theory (ET) of the term structure of interest rates can be caused by improper modelling of expectations. Our starting point is an interesting anomaly found by Campbell-Shiller (1987), when by taking a VAR approach they abandon limited information approach to test the ET, in which realized returns are taken as a proxy for expected returns. We use financial factors and macroeconomic information to construct a test of the theory based on simulating investors' effort to use the model in "real time" to forecast future monetary policy rates. Our findings suggest that the importance of fluctuations of risk premia in explaining the deviation from the ET is reduced when some forecasting model for short-term rates is adopted and a proper evaluation of uncertainty associated to policy rates forecast is considered.

Expectations Theory, Macroeconomic information in Finance

Abstract:
In this paper we propose an approach to identify indipendently the parameters describing the structure of the economy from the parameters describing central bank preferences. We first estimate the parameters describing the structure of the US economy by considering a parsimonious specification for inflation, the output-gap and the commodity price index. We then proceed to the identification of central bank preferences by estimating by GMM the Euler equations for the solution of the intertemporal optimization problem relevant to the central banker. We then compare optimal and actual interest rate behavior to select a structure of central bank's preferences. Our main results are as follows. First, persistence in interest rates could be explained by the structure of the economy. Second, "strict" inflation targeting dominates "flexible" inflation targeting. Third, the actual behavior of the policy rates cannot be described by the pure "strict" inflation targeting model, which would imply a much more aggressive monetary policy than the observed one. Fourth, when the inflation targeting model is extended to consider Brainard-type uncertainty and real interest rates smoothing, the latter is preferred hypothesis to reconcile actual and optimal interest rates behavior.

Abstract:
We explore the determinants of yield differentials between sovereign bonds in the Euro area. There is a common trend in yield differentials, which is correlated with a measure of the international risk factor. In contrast, liquidity differentials display sizeable heterogeneity and no common factor. We present a model that predicts that yield differentials should increase in both liquidity and risk, with an interaction term hose magnitude and sign depends on the size of the liquidity differential with respect to the reference country. Testing these predictions on daily data, we find that the international risk factor is consistently priced, while liquidity differentials are priced only for a subset of countries and their interaction with the risk factor is crucial to detect their effect.

Abstract:
In this paper we jointly estimate a forward-looking reaction function for the three-month rate along with a term structure relationship linking the six-month interest rates to current and expected future three-month rates. In our empirical model the response of the six-month interest rates to current and future three-month interest rates is allowed to depend on uncertainty on monetary policy. The expectations theory cannot be rejected in periods of low uncertainty on monetary policy.

forward-looking reaction functions, term structure of interest rates, expectations model

Abstract:
The paper explores the determinants of yield differentials between sovereign bonds, using Euro area data. There is a common trend in yield differentials, which is correlated with a measure of aggregate risk. In contrast, liquidity differentials display sizeable heterogeneity and no common factor. We propose a simple model with endogenous liquidity demand, where a bond's liquidity premium depends both on its transaction cost and on investment opportunities. The model predicts that yield differentials should increase in both liquidity and risk, with an interaction term of the opposite sign. Testing these predictions on daily data, we find that the aggregate risk factor is consistently priced, liquidity differentials are priced for a subset of countries, and their interaction with the risk factor is in line with the model's prediction and crucial to detect their effect.

bond markets, liquidity, risk

Abstract:
The paper explores the determinants of yield differentials between sovereign bonds, using Euro area data. There is a common trend in yield differentials, which is correlated with a measure of aggregate risk. In contrast, liquidity differentials display sizeable heterogeneity and no common factor. We propose a simple model with endogenous liquidity demand, where a bond's liquidity premium depends both on its transaction cost and on investment opportunities. The model predicts that yield differentials should increase in both liquidity and risk, with an interaction term of the opposite sign. Testing these predictions on daily data, we find that the aggregate risk factor is consistently priced, liquidity differentials are priced for a subset of countries, and their interaction with the risk factor is in line with the model's prediction and crucial to detect their effect.

Liquidity, yield differentials, bond markets

Abstract:
A fiscal shock due to a shift in taxes or in government spending will, at some point in time, constrain the future path of taxes and spending, since the government's intertemporal budget constraint will eventually have to be met. This simple fact is surprisingly overlooked in analyses of the effects of fiscal policy based on vector autoregressive models. We study the effects of fiscal shocks, keeping track of the debt dynamics that arise following a fiscal shock and allowing for the possibility that taxes, spending, and interest rates might respond to the level of the debt as it evolves over time. We show that the absence of a debt feedback effect can result in incorrect estimates of the dynamic effects of fiscal shocks. In particular, omitting an effect of fiscal shocks on long-term interest rates — a frequent finding in studies that omit a debt feedback — can be explained by the misspecification of these fiscal shocks. Using data for the U.S. economy and two alternative identification assumptions, we reconsider the effects of fiscal policy shocks, correcting for these shortcomings. We close the paper by observing that the methodology described by taking into account the stock-flow relationship between debt and fiscal variables to analyze the impact of fiscal shocks could also be applied to other dynamic models that include similar identities. The inclusion of capital as a slow-moving variable in the study of the relationship between productivity shocks and hours worked is one example.

fiscal policy, VAR models

Abstract:
Empirical investigations of the effects of fiscal policy shocks share a common weakness: taxes, government spending and interest rates are assumed to respond to various macroeconomic variables but not to the level of the public debt; moreover the impact of fiscal shocks on the dynamics of the debt-to-GDP ratio are not tracked. We analyze the effects of fiscal shocks allowing for a direct response of taxes, government spending and the cost of debt service to the level of the public debt. We show that omitting such a feedback can result in incorrect estimates of the dynamic effects of fiscal shocks. In particular the absence of an effect of fiscal shocks on long-term interest rates - a frequent finding in research based on VAR`s that omit a debt feedback - can be explained by their mis-specification, especially over samples in which the debt dynamics appears to be unstable. Using data for the U.S. economy and the identification assumption proposed by Blanchard and Perotti (2002) we reconsider the effects of fiscal policy shocks correcting for these shortcomings.

Abstract:
We employ Markov-switching regression methods to estimate fiscal policy feedback rules in the U.S. for the period 1960-2002. Our approach allows to capture policy regime changes endogenously. We reach three main conclusions. First, fiscal policy may be characterized, according to Leeper (1991) terminology, as active from the 1960s throughout the 1980s, switching gradually to passive in the early 1990s and switching back to active in early 2001. Second, regime-switching fiscal rules are capable of tracking the time-series behaviour of the U.S. primary deficit better than rules based on a constant parameter specification. Third, regime-switches in monetary and fiscal policy rules do not exhibit any degree of synchronization. Our results are at odds with the view that the post-war U.S. fiscal policy regime may be classified as passive at all times, and seem to pose a challenge for the specification of the correct monetary-fiscal mix within recent optimizing macroeconomic models considered suitable for policy analysis.

Active and passive fiscal policy rule, Markov-switching estimation, monetary policy rule

Abstract:
The rate of inflation in the US has declined from an average of 4.5% in the period 1960-79 to an average of 3.6% in 1980-98. Between those two periods, the standard deviations of inflation and the output gap have also declined. These facts can be attributed to a shift in central bank preferences, a reduction in the variability of aggregate supply shocks and a more efficient conduct of monetary policy. In this paper we propose a framework to identify the relative roles of these factors. Our framework is based on the estimation of a small structural macro model for the US economy jointly with the first order conditions, which solve the intertemporal optimization problem faced by the Fed. Overall, our results indicate that the policy preferences of the Fed, and in particular the (implicit) inflation target, have changed drastically with the advent of the Volcker-Greespan era. In addition, we find that the variance of supply shocks has been lower and also monetary policy has been conducted more efficiently during this period.

Interest rate rules, central bank preferences, US monetary policy

Abstract:
This paper brings together two strands of the empirical macro literature: the reduced-form evidence that the yield spread helps in forecasting output and the structural evidence on the difficulties of estimating the effect of monetary policy on output in an intertemporal Euler equation. We show that including a short-term interest rate and inflation in the forecasting equation improves the forecasting performance of the spread for future output but the coefficients on the short rate and inflation are difficult to interpret using a standard macroeconomic framework. A decomposition of the yield spread into an expectations-related component and a term premium allows a better understanding of the forecasting model. In fact, the best forecasting model for output is obtained by considering the term premium, the short-term interest rate and inflation as predictors. We provide a possible structural interpretation of these results by allowing for time-varying risk aversion, linearly related to our estimate of the term premium, in an intertemporal Euler equation for output.

Yield curve, term structure of interest rates, predictability, forecasting, GDP growth, estimated Euler equation

Abstract:
This paper brings together two strands of the empirical macro literature: the reduced-form evidence that the yield spread helps in forecasting output and the structural evidence on the difficulties of estimating the effect of monetary policy on output in an intertemporal Euler equation. We show that including a short-term interest rate and inflation in the forecasting equation improves the forecasting performance of the spread for future output but the coefficients on the short rate and inflation are difficult to interpret using a standard macroeconomic framework. A decomposition of the yield spread into an expectations-related component and a term premium allows a better understanding of the forecasting model. In fact, the best forecasting model for output is obtained by considering the term premium, the short-term interest rate and inflation as predictors. We provide a possible structural interpretation of these results by allowing for time-varying risk aversion, linearly related to our estimate of the term premium, in an intertemporal Euler equation for output.

Yield curve, term structure of interest rates, predictability, forecasting, GDP growth, estimated Euler equation

Abstract:
The dynamic dividend growth model linking the log dividend yield to future expected dividend growth and stock market returns has been extensively used in the literature for forecasting stock returns. The empirical evidence on the performance of the model is mixed as its strength varies with the sample choice. This model is derived on the assumption of stationary log dividend-price ratio. The empirical validity of such hypothesis has been challenged in the recent literature (Lettau&Van Nieuwerburgh, 2008) with strong evidence on a time varying mean, due to breaks, in this financial ratio. In this paper, we show that the slowly evolving mean toward which the dividend price ratio is reverting is driven by a demographic factor and a technological trend. We also show that an empirical model using information in long-run factors overperforms virtually all alternative models proposed in the literature within the framework of the dynamic dividend growth model. Finally, we exploit the exogeneity and predictability of the demographic factor to simulate the equity risk premium up to 2050.

error correction, long run predictability, equity premium, demographics

Abstract:
There has been a lot of interest recently in developing small scale rule-based empirical macro models for the analysis of monetary policy. These models, based on the conventional view that inflation stabilization should be a concern of monetary policy only, have typically neglected the role of fiscal policy. We start with the evidence that a baseline VAR-augmented Taylor rule can deliver recurrent mispredictions of inflation in the U.S. before 1987. We then show that a fiscal feed-back rule, in which the primary deficit reacts to both the output gap and the government debt, can well characterize the behavior of fiscal policy throughout the sample. However, by employing Markov-switching methods, we find evidence of substantial instability across fiscal regimes. Yet this precisely happens before 1987. We then augment the monetary VAR with a fiscal policy rule and control for the endogenous regime switches for both rules. We find that only over time windows belonging to the pre-1987 period the model based on the two rules can predict the behavior of inflation better than the one based just on the monetary policy rule. After 1987, when fiscal policy is estimated to switch to a regime of fiscal discipline, the monetary-fiscal mix can be appropriately described as a regime of monetary dominance. Over this period a monetary policy rule based model is always a better predictor of the inflation behavior than the one comprising both a monetary and a fiscal rule.

Monetary and Fiscal Policy Rules, Markov Switching, Inflation

Abstract:
Consumption is striking back. Some recent evidence indicates that the well-known asset pricing puzzles generated by the difficulties of matching fluctuations in asset prices with high frequency fluctuations in consumption might be solved by considering consumption in the long-run. A first strand of the literature concentrates on multiperiod differences in log consumption, a second concentrates on the cointegrating relation for consumption. Interestingly, only the (multiperiod) Euler Equation for the consumer optimization problem is considered by the first strand of the literature, while the cointegration-based literature concentrates exclusively on the (linearized) intertemporal budget constraint. In this paper, we show that using the first order condition in the linearized budget constraint to derive an explicit long-run consumption function delivers an even more striking strike back.

Cointegrating consumption function, long-run stock market returns, elasticity of intertemporal substitution

Abstract:
Consumption is striking back. Some recent evidence indicates that the well-known asset pricing puzzles generated by the difficulties of matching fluctuations in asset prices with high frequency fluctuations in consumption might be solved found by considering consumption in the long-run. A first strand of the literature concentrates on multiperiod differences in log consumption, a second concentrates on the cointegrating relation for consumption. Interestingly, only the (multiperiod) Euler Equation for the consumer optimization problem is considered by the first strand of the literature, while the cointegration-based literature concentrates exclusively on the (linearized) intertemporal budget constraint. In this paper, we show that using the first order condition in the linearized budget constraint to derive an explicit long-run consumption function delivers an even more striking strike back.

Cointegrating consumption function, long-run stock market returns, elasticity of intertemporal substitution

Abstract:
In this paper we assess the possibility of producing unbiased forecasts for fiscal variables in the euro area by comparing a set of procedures that rely on different information sets and econometric techniques. In particular, we consider ARMA models, VARs, small scale semi-structural models at the national and euro area level, institutional forecasts (OECD), and pooling. Our small scale models are characterized by the joint modelling of fiscal and monetary policy using simple rules, combined with equations for the evolution of all the relevant fundamentals for the Maastricht Treaty and the Stability and Growth Pact. We rank models on the basis of their forecasting performance using the mean square and mean absolute error criteria at different horizons. Overall, simple time series methods and pooling work well and are able to deliver unbiased forecasts, or slightly upward biased forecast for the debt-GDP dynamics. This result is mostly due to the short sample available, the robustness of simple methods to structural breaks, and to the difficulty of modelling the joint behaviour of several variables in a period of substantial institutional and economic changes. A bootstrap experiment highlights that, even when the data are generated using the estimated small scale multi country model, simple time series models can produce more accurate forecasts, due to their parsimonious specification.

Fiscal forecasting, forecast comparison, fiscal rules, euro area

Abstract:
In this paper, we assess the possibility of producing unbiased forecasts for fiscal variables in the Euro area by comparing a set of procedures that rely on different information sets and econometric techniques. In particular, we consider autoregressive moving average models, Vector autoregressions, small-scale semistructural models at the national and Euro area level, institutional forecasts (Organization for Economic Co-operation and Development), and pooling. Our small-scale models are characterized by the joint modelling of fiscal and monetary policy using simple rules, combined with equations for the evolution of all the relevant fundamentals for the Maastricht Treaty and the Stability and Growth Pact. We rank models on the basis of their forecasting performance using the mean square and mean absolute error criteria at different horizons. Overall, simple time-series methods and pooling work well and are able to deliver unbiased forecasts, or slightly upward-biased forecast for the debt-GDP dynamics. This result is mostly due to the short sample available, the robustness of simple methods to structural breaks, and to the difficulty of modelling the joint behaviour of several variables in a period of substantial institutional and economic changes. A bootstrap experiment highlights that, even when the data are generated using the estimated small-scale multi-country model, simple time-series models can produce more accurate forecasts, because of their parsimonious specification.

Abstract:
In this paper we assess the possibility of producing unbiased forecasts for fiscal variables in the euro area by comparing a set of procedures that rely on different information sets and econometric techniques. In particular, we consider ARMA models, VARs, small scale semi-structural models at the national and euro area level, institutional forecasts (OECD), and pooling. Our small scale models are characterized by the joint modelling of fiscal and monetary policy using simple rules, combined with equations for the evolution of all the relevant fundamentals for the Maastricht Treaty and the Stability and Growth Pact. We rank models on the basis of their forecasting performance using the mean square and mean absolute error criteria at different horizons. Overall, simple time series methods and pooling work well and are able to deliver unbiased forecasts, or slightly upward biased forecast for the debt-GDP dynamics. This result is mostly due to the short sample available, the robustness of simple methods to structural breaks, and to the difficulty of modelling the joint behaviour of several variables in a period of substantial institutional and economic changes. A bootstrap experiment highlights that, even when the data are generated using the estimated small scale multi country model, simple time series models can produce more accurate forecasts, due to their parsimonious specification.

Fiscal forecasting, forecast comparison, fiscal rules, euro area

Abstract:
The aim of this paper is to propose a new method for forecasting Italian inflation. We expand on a standard factor model framework (see Stock and Watson (1998)) along several dimensions. To start with we pay special attention to the modeling of the autoregressive component of the inflation. Second, we apply forecast combination (Granger (2000) and Pesaran and Timmermann (2001)) and generate our forecast by averaging the predictions of a large number of models. Third, we allow for time variation in parameters by applying rolling regression techniques, with a window of three-years of monthly data. Backtesting shows that our strategy outperforms both the benchmark model (i.e. a factor model with does not allow for model uncertainty) and additional univariate (ARMA) and multivariate (VAR) models. Our strategy proves to improve on alternative models also when applied to turning point prediction.

Abstract:
This paper addresses the issue of forecasting the term structure. We provide a unified state-space modelling framework that encompasses different existing discrete-time yield curve models. Within such framework we analyze the impact of two modelling choices, namely the imposition of no-arbitrage restrictions and the size of the information set used to extract factors, on the forecasting performance. Using US yield curve data, we find that both no-arbitrage and large info help in forecasting but no model uniformly dominates the other. No-arbitrage models are more useful at shorter horizon for shorter maturities. Large information sets are more useful at longer horizons and longer maturities. We also find evidence for a significant feedback from yield curve models to macroeconomic variables that could be exploited for macroeconomic forecasting.

Yield curve, term structure of interest rates, forecasting

Abstract:
A single variable describes, day-by-day, what investors think about the state of Brazil's economy: the Brazilian component of the Emerging Market Bond Index, the Embi spread. This spread is the difference between the yield on a dollar-denominated bond issued by the Brazilian government and a corresponding one issued by the US Treasury; it is thus a measure of the markets' assessment of the probability that Brazil might default on its debt obligations. This is mainly because the cost of servicing the public debt fluctuates very closely with the Embi spread. Understanding what determines this spread, how it responds to domestic monetary and fiscal policies and to international factors, how it interacts with the exchange rate and domestic interest rates, is thus the necessary first step in order to understand macroeconomic developments in Brazil. The Paper proceeds in three steps. We first document the non-linearity in the response of the Embi spread to international financial shocks. We then study how the Embi spread affects the cost of debt service and thus the dynamics of the public debt: we estimate risk premia on various financial instruments and on the exchange rate, and we show that they all move in parallel with the Embi spread. Finally we analyse a small short-run model of the Brazilian economy to show how the effectiveness of monetary policy depends on the fiscal policy regime.

EMBI spreads, risk premium, inflation targeting, fiscal policy, Brazil

Abstract:
Studying the recent experience of Brazil the paper explains how default risk is at the centre of the mechanism through which an emerging market central bank that targets inflation might lose control of inflation--in other words of the mechanism through which the economy might move from a regime of 'monetary dominance' to one of 'fiscal dominance'. The literature, from Sargent and Wallace (1981) to the modern fiscal theory of the price level has discussed how an unsustainable fiscal policy may hinder the effectiveness of monetary policy, to the point that an increase in interest rates can have a perverse effect on inflation. We show that the presence of default risk reinforces the possibility that a vicious circle might arise, making the fiscal constraint on monetary policy more stringent.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper is a first attempt at evaluating the determinants of the total interest rate differentials on government bonds between high yielders, namely Spain, Italy, Sweden, and Germany. In particular, we address the question of the relative importance of local and global factors in the determination of such spreads. We identify and measure two components of total yield differentials: one due to expectations of exchange rate depreciation, which we call the exchange rate factor; and another which reflects the market assessment of default risk. We propose and discuss a measure of the exchange rate factors and of the default risk premium based on interest rates swaps. Overall our investigation provides strong evidence in favour of the existence of a common trend for the Spanish and Italian spreads on Bunds, which is not shared by the Swedish spread. Such trend is driven by international factors and is independent from country-specific shocks. Country-specific shocks are only relevant in explaining short-term cycles around the common stochastic trend.

Yield differentials, high yielders

Abstract:
This paper is a first attempt at evaluating the determinants of the total interest rate differentials on government bonds between high yielders, namely Italy, Spain, Sweden and Germany. In particular we address the question of the relative importance of local and global factors in the determination of such spreads. We identify and measure two components of total yield differentials: one due to expectations of exchange rate depreciation -- which we call the exchange rate factor -- another which reflects the market assessment of default risk. We propose and discuss a measure of the exchange rate factors and of the default risk premium based on interest rate swaps. Overall our investigation provides strong evidence in favor of the existence of a common trend for the Italian and Spanish spreads on Bunds, which is not shared by the Swedish spread. Such a trend is driven by international factors and is independent from country- specific shocks. Country-specific shocks are only relevant in explaining short term cycles around the common stochastic trend.

Abstract:
This paper is a first attempt at evaluating the determinants of the interest rate differentials on government bonds between high yielders, namely Italy, Spain and Sweden, and Germany. In particular we concentrate on daily frequencies, where the relevance of economic fundamentals is rather limited, and address the question of the relative importance of local and global factors in the determination of such spreads. We identify and measure three components of total yield differentials: one due to expectations of exchange rate depreciation, which we call the exchange rate factor; another which reflects the market assessment of default risk; and a last one due to the different taxation treatment of long-term yields. We propose and discuss alternative measures of the exchange rate factor and of the default risk premium and favor those based on interest rates swaps. Overall our investigation provides strong evidence in favor of the existence of a common trend for the Italian and Spanish spreads on Bunds, which is not shared by the Swedish spread. Such a trend is driven by international factors and is independent from country-specific shocks. Country-specific shocks are only relevant in explaining short-term cycles around the common stochastic trend.

Abstract:
We examine monetary policy in the euro area from both theoretical and empirical perspectives. We discuss what theory tells us the strategy of Central banks should be and contrasts it with the one employed by the ECB. We review accomplishments (and failures) of monetary policy in the euro area and suggest changes that would increase the correlation between words and actions; streamline the understanding that markets have of the policy process; and anchor expectation formation more strongly. We examine the transmission of monetary policy shocks in the euro area and in some potential member countries and try to infer the likely effects occurring when Turkey joins the EU first and the euro area later. Much of the analysis here warns against having too high expectations of the economic gains that membership to the EU and euro club will produce.

Pillars, communication, transmission, EU newcomers

Abstract:
Recent financial research has provided evidence on the predictability of asset returns. In this Paper we consider the results contained in Pesaran-Timmerman (1995), which provided evidence on predictability of excess returns in the US stock market over the sample 1959-92. We show that the extension of the sample to the nineties weakens considerably the statistical and economic significance of the predictability of stock returns based on earlier data. We propose an extension of their framework, based on the explicit consideration of model uncertainty under rich parameterizations for the predictive models. We propose a novel methodology to deal with model uncertainty based on 'thick' modelling, i.e. considering a multiplicity of predictive models rather than a single predictive model. We show that portfolio allocations based on a thick modeling strategy systematically outperform thin modelling.

Abstract:
The long-run relationship between money and prices in the euro area embedded in traditional money demand models with income and interest rates broke down after 2001. We develop a money demand model where investors hold a diversified portfolio with money, domestic and foreign stocks and long-term bonds in which, in addition to the classical wealth effect, also a size and an international portfolio allocation effects arise. The estimated model identifies three cointegrating vectors stable over the sample 1980-2007: a long-run money demand, which depends on income and all risky assets' returns, and two equilibria for the euro area and the US financial markets. Steady state equilibrium of nominal M3 growth is estimated to be about 7% in 2007 with large standard errors mainly due to uncertainty in asset prices. The gap between actual euro area M3 growth and model-based fitted or predicted values helps forecast euro area inflation.

Euro area money demand, inflation forecasts, monetary policy, portfolio allocation

Abstract:
This paper discusses a number of issues that the newly constituted Board of the ECB will face early on. We show how conducting a European monetary policy is very different from living under the protective umbrella of the Bundesbank. We discuss voting on the ECB Board and argue that the ability to communicate to the public will be a critical factor for the success of the new institution. We also ask how a single monetary policy -- a common change in the interest rate controlled by the ECB -- is transmitted to the economy of the member countries. We show that the monetary process differs significantly inside EMU: initially disinflation episode could thus fall very unequally on a few member countries because they have a combination of financial structure that spreads a monetary contraction widely structure that is relatively inflexible. This process, moreover, is sure to evolve of the financial industry restructuring that is already underway and will be accentuated by the common money. Furthermore, as the Lucas principle suggests, the wage-price process itself will adapt to the changing focus of European monetary policy.

Abstract:
In this paper, we study the performance of Italian listed family firms in the period 1998-2003. We measure their performance by using both accounting and market data. We first study the relative performance of family firms compared to widely held firms. Then we investigate whether performance is affected by the type of family firm (i.e., whether the CEO is a member of the family or is an outsider). We find that the data and the methodology used to measure performance strongly affect the results. When performance is measured by accounting data (ROA), using a static model, we find evidence in favour of a superior performance of family firms. Such evidence is not confirmed by the application of the same model to market measures of performance. However, we report statistical evidence that the correct econometric specification for market data is a dynamic model. The results of estimation of the dynamic model for the market measures of performance are more consistent with those based on the static model for the accounting measures of performance.

Family firms, corporate performance, management style

Abstract:
The expectations model of the term structure states that the yields to maturity of long-term bonds are equal to the average of expected future short-term bond yields. This venerable model has been subjected to numerous empirical tests and almost invariably rejected. The empirical failure is generally attributed either to systematic expectations errors, or to shifts in the risk premia. In fact, the empirical tests, based on the estimation of single-equation models, are not able to discriminate between these two hypotheses. A recent strand of the macro-economic literature has analysed monetary policy by including the central bank reaction function is small empirical macro models. By simulating these models forward it is possible to derive the full forward path of short-term interest rates and hence to construct any long-term interest rate consistent with the expectations model. A direct test of the theory, based on full information, can then be immediately constructed by comparing observed long-term rates with the simulated ones and the associated 95% confidence interval. This is what we do in this Paper. Our results shed new light on the empirical validity of the expectations model.

Small macro-models, term structure of interest rates, expectations model

Abstract:
We study the relationship between the term structure of interest rates and fiscal policy by considering the Italian case. Empirical analysis has been so far rather inconclusive on this important topic. We abscribe such evidence to three problems: identification, regime-switching and maturity effects. All these aspects are particularly relevant to the Italian case. We propose a parsimonious model with three factors to represent the whole yield curve, and we consider yield differentials between Italian and German Government bonds. To take into account the possibility of regime-switching, we explicitly include a hidden two-state Markov chain that represents market expectations. The model is estimated using Bayesian econometric techniques. We find that government debt and its evolution significantly influence the yield of government bonds, that such effects are maturity dependent and regime-dependent. Hence when investigating the effect of fiscal policy on the term-structure it is of crucial importance to allow for multiple regimes in the estimation.

Fiscal policy, term structure, regime-switching, Bayesian estimation

Abstract:
There has been a lot of interest recently in developing small-scale rule-based empirical macro models for the analysis of monetary policy. These models, based on the conventional view that inflation stabilization should be a concern of monetary policy only, have typically neglected the role of fiscal policy. We start with the evidence that a baseline VAR-augmented Taylor rule can deliver recurrent mispredictions of inflation in the US before 1987. We then show that a fiscal feedback rule, in which the primary deficit reacts to both the output gap and the government debt, can well characterize the behaviour of fiscal policy throughout the sample. By employing Markov-switching methods, however, we find evidence of substantial instability across fiscal regimes. Yet precisely this happens before 1987. We then augment the monetary VAR with a fiscal policy rule and control for the endogenous regime switches for both rules. We find that in the pre-1987 period the model based on the two rules predict the behaviour of inflation better than the one based just on the monetary policy rule. After 1987, when fiscal policy is estimated to switch to a regime of fiscal discipline, the monetary-fiscal mix can be appropriately described as a regime of monetary dominance. Over this period a monetary policy rule based model is always a better predictor of the inflation behaviour than the one comprising both a monetary and a fiscal rule.

Monetary and fiscal policy rules, Markov switching, inflation

Abstract:
The objective of this study is to investigate the behaviour of monetary and fiscal authorities in the Euro area. Our main contribution is joint modeling of behaviour of the two authorities. Our investigation highlights a number of facts. The systematic monetary policies adopted by the non-German authorities in the seventies were not capable of stabilizing inflation. Such results have been achieved in the eighties and the nineties by anchoring more tightly domestic monetary policy to German monetary policy. All the main episodes of expansionary fiscal policy which have occurred in the course of the eighties and the nineties in Europe cannot be explained by the systematic behaviour of fiscal authorities. Stabilization of inflation has been achieved independently from the lack of fiscal discipline. There are important interactions between the two authorities but they depend exclusively on the responses of governments expenditures and receipts to interest rate payments on the public debt.

Monetary policy, fiscal policy, euro area

Abstract:
Nowadays a considerable amount of information on the behaviour of the economy is readily available, in the form of large datasets of macroeconomic variables. Central bankers can be expected to base their decisions on this very large information set. Yet the academic profession has shown a clear preference for using small models to highlight stylized facts and to implement policy simulation exercises. Omitted information is then a potentially relevant problem. Recent time-series techniques for the analysis of large datasets have shown how vast an amount of information can be captured by few factors. In this paper we combine factors extracted from large datasets with more traditional small-scale models to analyse monetary policy in Europe. In particular, we model hundreds of macroeconomic variables with a dynamic factor model, and summarize their informational content with a few estimated factors. These factors are then used as instruments in the estimation of forward-looking Taylor rules, and as additional regressors in structural VARs. The latter are then used to evaluate the effects of unexpected and systematic monetary policy.

Monetary policy, small models, dynamic factors

Abstract:
In this paper we analyse the impact of monetary policy shocks on the term structure of interest rates in US and Germany. We estimate the term structure of spot rates and of the instantaneous forward rate following the methodology proposed by Svensson (1994). We interpret the instantaneous forward rate as the expectations for the overnight rate prevailing at each point in the future. Exploiting the fact that intervention on policy rates take place in occasion of regular meetings of the FOMC in the US and of the Bundesbank Council in Germany, we estimate the term structure of spot rates and of instantaneous forward rates the day before and the day after regular meetings. From the estimation of the term structures before meetings we derive a measure of expectations for Central Banks interventions. On this basis we can assess the predictability of monetary policy under the null of the validity of the pure expectational model. We perform this exercise both by regression analysis and by the implementation of a non-parametric test proposed by Pesaran and Timmermann (1990). We then proceed to derive a measure of policy shocks by using information on the effective intervention. Such measure of policy shocks is available both for dates in which some intervention was effectively implemented by Central Banks and for dates in which a policy of no intervention was decided. Finally, we evaluate the impact of monetary policy on the term structure of interest rates by regressing the change in the yield curve between the day before and the day after meetings on expected and unexpected modification in policy rates. We conduct such exercise for the US and Germany over the period 1991-1995 to evaluate the sign and the magnitude of the response of the term structures in the two countries to expected and unexpected modifications in monetary policy.

Expectations, institutional forces, monetary policy

Abstract:
In this Paper we estimate jointly a forward-looking reaction function for the three-month rate along with a term structure relationship linking the six-month interest rates to current and expected future three-month rates. In our empirical model the response of the six-month interest rates to current and future three-month interest rates is allowed to depend on uncertainty on monetary policy. The expectation theory cannot be rejected in periods of low uncertainty on monetary policy.

Expectations model, forward-looking reaction functions, term structure of interest rates

Abstract:
This paper applies a full-information technique to test for the presence of contagion across the money markets of ERM member countries. We show that whenever it is possible to estimate a model for interdependence, a test for contagion based on a full information technique is more powerful. We test for the presence of contagion after having identified episodes of country-specific shocks, whose effects on other European markets are significantly different from those predictable from the estimated channels of interdependence. Using data on three-months interest rate spreads on German rates for seven countries over the period 1988-1992, we are unable to reject the null of contagion. Our evidence suggest that contagion within the ERM was a general phenomenon, not limited to a subset of weaker countries, the exception in the sample being France. Our results are mute as to the question of what lies behind these episodes of contagion; they show, however, that it is not always true that one only detects contagion when one applies poor statistical techniques.

Abstract:
This paper starts from the observation that parameter instability and model uncertainty are relevant problems for the analysis of monetary policy in small macroeconomic models. We propose to deal with these two problems by implementing a novel 'thick recursive modelling' approach. At each point in time, we estimate all models generated by the combinations of a base-set of k observable regressors for aggregate demand and supply. We compute optimal monetary policies for all possible models and consider alternative ways of summarizing their distribution. Our main results show that thick recursive modelling delivers optimal policy rates that track the observed policy rates better than the optimal policy rates obtained under a constant parameter specification, with no role for model uncertainty.

Model uncertainty, parameter instability, optimal monetary policy

Abstract:
This paper considers alternative option pricing models and their estimation. The stock price dynamics is modeled by taking into account both stochastic volatility and jumps. Jumps are captured by the tempered stable process and stochastic volatility is introduced via time changing the stochastic processes. We propose a characteristic function based estimation method, which overcomes problems of discretization errors and non-tractable probability density functions of models and facilitates computation. Estimation results and option pricing performance indicate that the infinite activity stochastic volatility model in general performs better than the finite activity model. We also provide an extension to investigate the double-jump model by introducing a jump component in the variance rate process.

Tempered Stable Process, Stochastic Volatility, Change of Time, Option Pricing, Characteristic Function, Continuous GMM

Abstract:
The paper explores the determinants of yield differentials between sovereign bonds in the Euro area. There is a common trend in yield differentials, which is correlated with a measure of aggregate risk. In contrast, liquidity differentials display sizeable heterogeneity and no common factor. We propose a simple model with endogenous liquidity demand, where a bond's liquidity premium depends both on its transaction cost and on investment opportunities. The model predicts that yield differentials should increase in both liquidity and risk, with an interaction term of the opposite sign. Testing these predictions on daily data, we find that the aggregate risk factor is consistently priced, liquidity differentials are priced for a subset of countries, and their interaction with the risk factor is in line with the model's prediction and crucial to detect their effect.

Bond yields, euro area, liquidity, risk

Abstract:
We use the time series of shifts in U.S. Federal tax liabilities constructed by Romer and Romer to estimate tax multipliers. Differently from the single-equation approach adopted by Romer and Romer, our estimation strategy (a Var that includes output, government spending and revenues, inflation and the nominal interest rate) does not rely upon the assumption that tax shocks are orthogonal to each other as well as to lagged values of other macro variables. Our estimated multiplier is much smaller: One, rather than three at a three-year horizon. When we split the sample in two sub-samples (before and after 1980) we find, before 1980, a multiplier whose size is never greater than one, after 1980 a multiplier not significantly different from zero. Following the findings in Bohn (1998), we also experiment with a model that includes debt and the non-linear government budget constraint. We find that, while in general not very important, the non-linearity that arises from the budget constraint makes a difference after 1980, when the response of fiscal variables to the level of the debt becomes stronger.

fiscal policy, government budget constraint, public debt, VAR models

Abstract:
We use the time series of shifts in U.S. Federal tax liabilities constructed by Romer and Romer to estimate tax multipliers. Differently from the single-equation approach adopted by Romer and Romer, our estimation strategy (a Var that includes output, government spending and revenues, inflation and the nominal interest rate) does not rely upon the assumption that tax shocks are orthogonal to each other as well as to lagged values of other macro variables. Our estimated multiplier is much smaller: one, rather than three at a three-year horizon. When we split the sample in two sub-samples (before and after 1980) we find, before 1980, a multiplier whose size is never greater than one, after 1980 a multiplier not significantly different from zero. Following the findings in Bohn (1998), we also experiment with a model that includes debt and the non-linear government budget constraint. We find that, while in general not very important, the non-linearity that arises from the budget constraint makes a difference after 1980, when the response of fiscal variables to the level of the debt becomes stronger.

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Abstract:
A shift in taxes or in government spending (a "fiscal shock") at some point in time puts a constraint on the path of taxes and spending in the future, since the government intertemporal budget constraint will eventually have to be met. This simple fact is surprisingly overlooked in analyses of the effects of fiscal policy based on Vector AutoRegressive models. We study the effects of fiscal shocks keeping track of the debt dynamics that arises following a fiscal shock, and allowing for the possibility that taxes, spending and interest rates might respond to the level of the debt, as it evolves over time. We show that omitting a debt feedback can result in incorrect estimates of the dynamic effects of fiscal shocks. In particular, the absence of an effect of fiscal shocks on long-term interest rates - a frequent finding in studies that omit a debt feedback - can be explained by their mis-specification. Using data for the U.S. economy and two alternative identification assumptions we reconsider the effects of fiscal policy shocks correcting for these shortcomings.

Fiscal policy, government budget constraint, public debt, VAR models

Abstract:
Empirical estimates of monetary policy reaction functions feature a very high estimated degree of monetary policy inertia. This evidence is very hard to reconcile with the alternative evidence of low predictability of monetary policy rates. In this paper we examine the potential relevance of the problem of weak instruments to correctly identify the degree of monetary policy inertia in forward looking monetary policy reaction function of the type originally proposed by Taylor (1993). After appropriately diagnosing and taking care of the weak instruments problem, we find an estimated degree of policy inertia which is significantly lower than the common value in the empirical literature on monetary policy rules.

Monetary Policy Rulkes, Weak Identification

Abstract:
Dynamic Stochastic General Equilibrium (DSGE) models are now considered attractive by the profession not only from the theoretical perspective but also from an empirical standpoint. As a consequence of this development, methods for diagnosing the fit of these models are being proposed and implemented. In this article we illustrate how the concept of statistical identification, that was introduced and used by Spanos(1990) to criticize traditional evaluation methods of Cowles Commission models, could be relevant for DSGE models. We conclude that the recently proposed model evaluation method, based on the DSGE-VAR(ë), might not satisfy the condition for statistical identification. However, our application also shows that the adoption of a FAVAR as a statistically identified benchmark leaves unaltered the support of the data for the DSGE model and that a DSGE-FAVAR can be an optimal forecasting model.

Bayesian analysis, Dynamic stochastic general equilibrium model, Factor-Augmented Vector Autoregression, Model evaluation

Abstract:
This paper addresses the issue of forecasting the term structure. We provide a unified state-space modelling framework that encompasses different existing discrete-time yield curve models. Within such framework we analyze the impact on forecasting performance of two crucial modelling choices, i.e. the imposition of no-arbitrage restrictions and the size of the information set used to extract factors. Using US yield curve data, we find that: a. macro factors are very useful in forecasting at medium/long forecasting horizon; b. financial factors are useful in short run forecasting; c. no-arbitrage models are effective in shrinking the dimensionality of the parameter space and, when supplemented with additional macro information, are very effective in forecasting; d. within no-arbitrage models, assuming time-varying risk price is more favourable than assuming constant risk price for medium horizon-maturity forecast when yield factors dominate the information set, and for short horizon and long maturity forecast when macro factors dominate the information set; e. however, given the complexity and the highly non-linear parameterization of no-arbitrage models, it is very difficult to exploit within this type of models the additional information offered by large macroeconomic datasets.

Factor models, forecasting, large data set, term structure of interest rates, yield curve

Abstract:
The aim of this paper is to analyse the implications of the theory of irreversible investment under uncertainty for investment in oil fields on the United Kingdom Continental Shelf (UKCS). We consider the problem of an operator who owns a licence to develop and extract oil from a field of known capacity. An intertemporal optimization model in discrete time is developed to derive decision rules for the timing of the irreversible development investment and for the optimal rate of extraction. Model simulation is then used to describe the properties of the numerical solutions. The predictions of the theory on the determinants of the irreversible investment decision are then examined using statistical duration analysis. Data on the length of the time period between discovery and development are available for individual fields on the UKCS. We measure the duration of the irreversible investment gestation lag for each field and test the model by assessing the significance of the theoretical variables in explaining the significance of such a lag. Both our theoretical model and our empirical results suggest the importance of a nonlinear interaction of the level of oil prices and the volatility of oil prices in determining the development lag. The simulation of our theoretical model shows a nonlinear impact of oil price volatility on the trigger level of oil prices. Our empirical results suggest that the effect of price volatility is a function of the expected price level, with increased price volatility having a positive impact on the duration of investment appraisal when expected prices are low and a negative impact when they are high.

Abstract:
The European Economic and Monetary Union (EMU) has created a new economic area, larger and closer with respect to the rest of the world. Area-specific shocks are thus more important in EMU than country-specific shocks used to be in the previous states, e.g. in Germany. It is thus not surprising that the models built by the staff of the European Central Bank (ECB) to study optimal monetary policy in the Euro area (for instance Smets and Wouters, 2004a, 2004b) typically assume that this works essentially as a closed economy, hit by domestic shocks - the same assumption made in standard models of U.S. monetary policy (see e.g. Christiano et al., 1999), where all shocks are domestic with the only possible exception of energy price shocks. Two-country models exist at the ECB (e.g. de Walque, Smets, Wouters, 2005) but they overlook asset price fluctuations and their international comovements.

This paper studies monetary policy in the Euro area looking at the variable most directly related to current and expected monetary policy, the yield on long term government bonds. We explore how the behaviour of European long-term rates has been affected by EMU and whether the response of long-term rates to monetary policy has got any closer to that consistent with a closed economy.

We find that the level of long-term rates in Europe is almost entirely explained by U.S. shocks and by the systematic response of U.S. and European variables (inflation, short term rates and the output gap) to these shocks. Our results suggest in particular that U.S. variables are more important than local variables in the policy rule followed by European monetary authorities: this was true for the Bundesbank before EMU and has remained true for the ECB, at least so far. Using closed economy models to analyze monetary policy in the Euro is thus inconsistent with the empirical evidence on the determinants of Euro area long-term rates. It is also inconsistent with the way the Governing Council of the ECB appears to make actual policy decisions. We also find that Euro area long rates respond more to financial shocks, in particular shocks to term premia, than they do to monetary policy shocks - i.e. instances when the ECB deviates from its rule. This finding point to the importance of incorporating into the analysis of Euro area monetary policy of the effects of fluctuations in international asset prices.

DSGE models, ECB, monetary policy, yield curve

Abstract:
We explain co-movements between stock markets by explicitly considering the distinction between interdependence and contagion. We propose and implement a full information approach on data for US and Germany to provide answers to the following questions: (i) is there long-term interdependence between US and German stock markets? (ii) Is there short-term interdependence and contagion between US and German stock markets, i.e do short term fluctuations of the US share prices spill over to German share prices and is such co-movement unstable over high volatility episodes? Our answers are, respectively, no to the first question and yes to the second one.

Contagion, Stock Market, Interdependence, Structural Models

Abstract:
We provide evidence that the movements in yield differentials between euro zone government bonds explained by changes in international risk factors as measured by banking and corporate risk premiums in the United States are more pronounced for bonds issued by Italy and Spain. Liquidity factors play a smaller role, so policies meant to increase financial market efficiency do not appear sufficient to deliver a 'seamless' bond market in the euro area. The risk of default is a small but important component of yield differentials movements, which signal market perceptions of fiscal vulnerability, impose market discipline on national fiscal policies, and may be reduced only by further convergence in debt ratios.

Bond market integration, credit risk, government bonds, liquidity premium, yield spreads

Abstract:
The empirical VAR literature on the monetary transmission mechanism in closed economies has been successful in providing evidence with which theoretical models of the monetary transmission mechanism are now confronted. The empirical VAR literature on the monetary transmission mechanism in open economies has not enjoyed the same success and it is still marred with a number of empirical puzzles. In this paper we firstly assess the relevance of the progress made estimating VAR in closed economies for the specification of VAR in open economies. Second, we propose to solve the simultaneity between exchange rate and policy interest rates by using information extracted from financial markets independently from the VAR. Lastly, we evaluate the relative importance of macroecomnomic and monetary policy variables in explaining short-term fluctuations in the nominal exchange rates. Our main results are that a commodity price index is an important variable in any VAR analysis of the monetary transmission mechanism, that the simultaneity between German policy rates and the US dollar/D mark exchange rate is not an empirically relevant problem, and that monetary factors are dominated by macroeconomic factors for the explanation of exchange rate fluctuations.

Abstract:
This paper discusses a number of issues that the newly constituted board of the European Central Bank (ECB) will face early on. We show how conducting a European monetary policy is very different from living under the protective umbrella of the Bundesbank. We discuss voting on the ECB board, and argue that the ability to communicate to the public will be a critical factor for the success of the new institution. We also ask how a single monetary policy a common change in the interest rate controlled by the ECB is transmitted to the economy of the member countries. We show that the monetary process differs significantly inside EMU: initially, at least, the cost of a disinflation episode could thus fall very unequally on a few member countries because they have a combination of financial structure that spreads a monetary contraction widely, and a wage-price structure that is relatively inflexible. Moreover, this process is sure to evolve, in part, as a result of the financial industry restructuring that is already underway and will be accentuated by the common money. Furthermore, as the Lucas principle suggests, the wage-price process itself will adapt to the changing focus of European monetary policy.

Abstract:
In this paper we analyse the impact of monetary policy shocks on the term structure of interest rates in US and Germany. We estimate the term structure of spot rates and of the instantaneous forward rate following the methodology proposed by Svensson (1994). We interpret the instantaneous forward rate as the expectations for the overnight rate prevailing at each point in the future. Exploiting the fact that intervention on policy rates take place in occasion of regular meetings of the FOMC in the US and of the Bundesbank Council in Germany, we estimate the term structure of spot rates and of instantaneous forward rates the day before and the day after regular meetings. From the estimation of the term structures before meetings we derive a measure of expectations for Central Banks interventions. On this basis we can assess the predictability of monetary policy under the null of the validity of the pure expectational model. We perform this exercise both by regression analysis and by the implementation of a non-parametric test proposed by Pesaran and Timmermann (1990). We then proceed to derive a measure of policy shocks by using information on the effective intervention. Such measure of policy shocks is available both for dates in which some intervention was effectively implemented by Central Banks and for dates in which a policy of no intervention was decided. Finally, we evaluate the impact of monetary policy on the term structure of interest rates by regressing the change in the yield curve between the day before and the day after meetings on expected and unexpected modification in policy rates. We conduct such exercise for the US and Germany over the period 1991-1995 to evaluate the sign and the magnitude of the response of the term structures in the two countries to expected and unexpected modifications in monetary policy.