Marcel PhD Conference 2012

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Marcel PhD Conference 2012

  1. 1. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Is financial globalization welfare decreasing? Marcel Schr¨der o Panel: Prema-chandra Athukorala, Paul Burke, Ippei Fujiwara Crawford School PhD Conference November 27, 2012
  2. 2. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Some Background • For any open economy, net foreign asset position (NFA) is a key variable: It limits present value of future current account deficits. • Net external asset position represents a country’s solvency constraint. • Traditional view: ∆N F At = CAt . • But: Foreign assets and liabilities are measured at market value. • Market value variations occur due to changes in asset prices, asset returns, or exchange rate changes → ”Valuation effects”.
  3. 3. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion • Valuation effects are an important driver of NFA (Lane and Milesi-Ferreti, 2007; Gourinchas, 2007; Obstfeld, 2004): ∆N F At = CAt + V ALt . (1) • However, capital transfers (CAP) and unrecorded capital flows/trade flows are also important: ∆N F At = CAt + V ALt + CAPt + EOMt . (2) • Can compute V ALt indirectly using Eq. 2. • Magnitude of VAL is proportional to gross asset positions. • Proliferation in asset trade (financial globalization) has led to a significant increase in the size of valuation adjustments.
  4. 4. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Increasing volatility in valuation effects over time Figure: Valuation-Effect Volatility and Financial Integration, 1980-2007 High Income .1 6 5 Valuation−Effect Volatility .08 (A+L)/GDP 4 .06 3 .04 2 .02 1 1980 1990 2000 2010 Year VAL Financial_Integration Note: Volatility measured as the rolling standard deviation over 10-year periods. Source: Compiled from Lane and Milesi-Ferretti (2007) and IMF BOP statistics.
  5. 5. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Figure: Valuation-Effect Volatility and Financial Integration, 1980-2007 Emerging .07 3 Valuation−Effect Volatility 2.5 .06 (A+L)/GDP 2 .05 1.5 .04 1 .03 1980 1990 2000 2010 Year VAL Financial_Integration Note: Volatility measured as the rolling standard deviation over 10-year periods. Source: Compiled from Lane and Milesi-Ferretti (2007) and IMF BOP statistics.
  6. 6. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Figure: Valuation-Effect Volatility and Financial Integration, 1980-2007 Developing 1.8 .1 1.6 Valuation−Effect Volatility .08 1.2 1.4 (A+L)/GDP .04 .06 1 .8 .02 1980 1990 2000 2010 Year VAL Financial_Integration Note: Volatility measured as the rolling standard deviation over 10-year periods. Source: Compiled from Lane and Milesi-Ferretti (2007) and IMF BOP statistics.
  7. 7. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Research Question • How does the rising importance of VEs affect economic performance? • Empirically, this remains an open question. • The purpose of the study is to fill this gap. • Here, focus on welfare through consumption volatility. • Currently, other channels not well understood theoretically.
  8. 8. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Theoretical considerations • Theoretical link between VEs and consumption is not clear-cut. • Interpretation 1: Higher valuation-effect volatility causes greater volatility in wealth ⇒ consumption should become more volatile as well. • For risk averse agents this means a welfare loss stemming from deviations from a smooth consumption path. • Interpretation 2: VEs reflect flow payments of international risk sharing → wealth not more volatile → no welfare costs.
  9. 9. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion What to expect? • The relationship between consumption and valuation-effect variability is conditional on: • The currency decomposition of a country’s balance sheet. • And/or its ability to share risk internationally. • Since Eichengreen & Hausmann (1999) it is well known that most developing countries face problem of ”original sin”. • Kose et al (2009): Developing economies still unable to share risk internationally despite financial globalization.
  10. 10. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Empirical model LV OLCit = β0 +β1 LV OLV ALit +β2 LV OLGit +β3 LV OLIN F Lit +u† . it • LV OLC: Volatility of real private consumption growth per capita. • LV OLV AL: Volatility of valuation effects. • LV OLG: Volatility of real GDP per capita growth. • LV OLIN F L: Volatility of inflation rate. • Volatility defined as log of rolling standard deviation using 10yr windows. • β1 insignificant: cannot reject that VEs reflect risk sharing. • β1 positive significant: VE-volatility welfare decreasing, reject risk sharing interpretation.
  11. 11. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Data • Unbalanced panel, 82 countries. Period: 1980-2007. • Data Sources: • LV OLC & LV OLG: PWT 7.1. • LV OLIN F L: WDI. • LV OLV AL: Compiled from: EWN II (Lane and Milesi-Ferretti, 2007) and IMF BOP statistics.
  12. 12. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Estimation and results Method • Step 1: Investigate unit root properties of the variables. • Step 2: Estimate long-run relationship between variables. • Step 3: Test for cointegration.
  13. 13. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Estimation: Dynamic OLS (Mark and Sul, 2003) LV OLCit = αi + θt + λi t + β xit + u† , it m u† = it δi ∆xi,t+m + uit . −m • xit = [LV OLV ALit , LV OLGit , LV OLIN F Lit ] • Assumptions: • Homogenous cointegrating vector, [1, −β ]. • u† independent across countries. it • Group-specific heterogeneity accounted for by: Fixed effects, time fixed effects, heterogeneous time trends, disparate short-run dynamics.
  14. 14. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Results Table: Baseline Regression Results (1) (2) (3) (4) Independent variable Full Sample High Income Emerging Developing Valuation-Effect Volatility 0.085 (0.025)∗∗∗ -0.045 (0.050) 0.162 (0.052)∗∗∗ 0.082 (0.029)∗∗∗ Real GDP Growth Volatility 0.677 (0.036)∗∗∗ 0.978 (0.066)∗∗∗ 0.811 (0.086)∗∗∗ 0.458 (0.037)∗∗∗ Inflation Volatility 0.103 (0.013)∗∗∗ -0.009 (0.042) 0.093 (0.02)∗∗∗ 0.129 (0.021)∗∗∗ Country Specific Effects Yes Yes Yes Yes Heterogeneous Time Trends Yes Yes Yes Yes Observations 1629 423 391 815 N 82 19 20 43 IPS (p-value) 0.00 0.00 0.00 0.00 Notes: ∗∗∗ , ∗∗ , ∗ denote the level of statistical significance at 1, 5, and 10 percent. Standard errors in parentheses. IPS refers to the Im et al. (2003) unit root test performed on the residuals under the unit root null.
  15. 15. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion • PBM predicts: Impact of VE-volatility on consumption volatility depends on currency decomposition of external debt. • I construct subsamples based on the foreign currency exposure of countries’ external debt. • I consider the following measure: • Weight of debt liabilities (portfolio debt and other debt) denominated in foreign currency. • Source: Lane and Shambaugh (2010).
  16. 16. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Table: Results for subsamples based on foreign currency exposure (1) (2) (3) Independent variable DL100 DL<100 DL100 Non High Income Emerging Valuation-Effect Volatility 0.116 (0.031)∗∗∗ 0.117(0.053)∗∗ 0.236 (0.097)∗∗ Real GDP Growth Volatility 0.536 (0.040)∗∗∗ 0.707 (0.086)∗∗∗ 1.042 (0.16)∗∗∗ Inflation Volatility 0.114 (0.015)∗∗∗ 0.103 (0.026)∗∗∗ 0.097 (0.027)∗∗∗ Country Specific Effects Yes Yes Yes Heterogeneous Time Trends Yes Yes Yes Observations 1001 205 204 N 52 11 10 IPS (p-value) 0.00 0.00 0.00 Notes: ∗∗∗ , ∗∗ , ∗ denote the level of statistical significance at 1, 5, and 10 percent. Standard errors in parentheses. IPS refers to the Im et al. (2003) unit root test performed on the residuals under the unit root null.
  17. 17. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Conclusion • The results are consistent with a priori theoretical predictions. • They suggest that valuation-effect volatility imposes welfare costs on countries with a high share of their liabilities denominated in foreign currency. • Implication of the findings is that financial globalization decreases welfare in emerging and developing economies that face the problem of original sin (partial equilibrium). • These types of countries should take a cautious approach to liberalizing their capital account transactions.
  18. 18. Background Research Question Theoretical considerations Empirical model and data Estimation and results Conclusion Thank You!

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