How Important Is Liquidity Risk for Sovereign Bond Risk Premia? Evidence from the London Stock Exchange

This paper uses the framework of arbitrage-pricing theory to study the relationship between liquidity risk and sovereign bond risk premia. The London Stock Exchange in the late 19th century is an ideal laboratory in which to test the proposition that liquidity risk affects the price of sovereign debt. This period was the last time that the debt of a heterogeneous set of countries was traded in a centralized location and that a sufficiently long time series of observable bond prices are available to conduct asset-pricing tests. Empirical analysis of these data establishes three new results. First, sovereign bonds with wide bid-ask spreads earn 3-4% more per year than bonds with narrow bid-ask spreads, and the difference is reflected in greater sensitivity to innovations in market liquidity. Second, small sovereign bonds, as measured by market value, earn 1.8-3.5% more per year than large sovereign bonds, and the difference is also reflected in their exposure to innovations in market liquidity. Third, market liquidity is a state variable important for pricing the cross-section of sovereign bonds. This paper thus provides estimates of the quantitative importance of liquidity risk as a determinant of the sovereign risk premium and underscores the significance of market liquidity as a nondiversifiable risk.Financial markets; International topics

Productivity and the Euro-Dollar Exchange Rate Puzzle

This paper documents the evidence for a productivity based model of the dollar/euro real exchange rate over the 1985-2001 period. We estimate cointegrating relationships between the real exchange rate, productivity, and the real price of oil using the Johansen (1988) and Stock-Watson (1993) procedures. We find that each percentage point in the US-Euro area productivity differential results in a five percentage point real appreciation of the dollar. This finding is robust to the estimation methodology, the variables included in the regression, and the sample period. We conjecture that productivity-based models cannot explain the observed patterns with the standard set of assumptions, and describe a case in which the model can be reconciled with the observed data.

Conventional and Unconventional Approaches to Exchange Rate Modeling and Assessment

We examine the relative predictive power of the sticky price monetary model, uncovered interest parity, and a transformation of net exports and net foreign assets. In addition to bringing Gourinchas and Rey’s new approach and more recent data to bear, we implement the Clark and West (forthcoming) procedure for testing the significance of out-of-sample forecasts. The interest rate parity relation holds better at long horizons and the net exports variable does well in predicting exchange rates at short horizons in-sample. In out-of-sample forecasts, we find evidence that our proxy for Gourinchas and Rey’s measure of external imbalances outperforms a random walk at short horizons as do some of other models, although no single model uniformly outperforms the random walk forecast.

Did adhering to the gold standard reduce the cost of capital?

A commonly cited benefit of the pre-World War One gold standard is that it reduced the cost of international borrowing by signaling a country’s commitment to financial probity. Using a newly constructed data set that consists of more than 55,000 monthly sovereign bond returns, we test if gold-standard adherence was negatively correlated with the cost of capital. Conditional on UK risk factors, we find no evidence that the bonds issued by countries off gold earned systematically higher excess returns than the bonds issued by countries on gold. Our results are robust to allowing betas to differ across bonds issued by countries off- and on-gold; to including proxies that capture the effect of fiscal, monetary, and trade shocks on the commitment to gold; and to controlling for the effect of membership in the British Empire.Gold standard ; Bonds

The Role of Financial Speculation in Driving the Price of Crude Oil

Over the past 10 years, financial firms have increased the size of their positions in the oil futures market. At the same time, oil prices have increased dramatically. The conjunction of these developments has led some observers to argue that financial speculation caused the run-up in oil prices. Yet several arguments cast doubt on the validity of this claim. First, although the stock of open futures contracts is many times larger than the flow of oil consumption in the United States, comparing these two statistics is misleading. Stocks are not measured with respect to a specific unit of time but flows are, so the two are not directly comparable. Second, empirical analysis shows that changes in financial firms’ positions do not predict oil-price changes, but that oil-price changes predict changes in positions. Third, the evidence indicates that financial firms’ positions did not cause the market to expect persistent price increases during 2007/08. Other explanations for the increase in oil prices include macroeconomic fundamentals, such as interest rates and increased demand from emerging Asia. Of these two explanations, the one that seems most consistent with the facts explains oil-price fluctuations in terms of large and persistent demand shocks related to growth in global real activity in the presence of supply constraints.International topics

Forecasting the Price of Oil

We address some of the key questions that arise in forecasting the price of crude oil. What do applied forecasters need to know about the choice of sample period and about the tradeoffs between alternative oil price series and model specifications? Are real or nominal oil prices predictable based on macroeconomic aggregates? Does this predictability translate into gains in out-of-sample forecast accuracy compared with conventional no-change forecasts? How useful are oil futures markets in forecasting the price of oil? How useful are survey forecasts? How does one evaluate the sensitivity of a baseline oil price forecast to alternative assumptions about future demand and supply conditions? How does one quantify risks associated with oil price forecasts? Can joint forecasts of the price of oil and of U.S. real GDP growth be improved upon by allowing for asymmetries?Econometric and statistical methods; International topics

Commodity price co-movement and global economic activity

Guided by a macroeconomic model in which non-energy commodity prices are endogenously determined, we apply a new factor-based identification strategy to decompose the historical sources of changes in commodity prices and global economic activity. The model yields a factor structure for commodity prices and identification conditions that provide the factors with an economic interpretation: one factor captures the combined contribution of shocks that affect commodity markets only through general-equilibrium forces. Applied to a cross-section of commodity prices since 1968, the theoretical restrictions are consistent with the data and yield structural interpretations of the common factors in commodity prices. Commodity-related shocks have contributed modestly to global economic fluctuations.À partir d’un modèle macroéconomique dans lequel les prix des produits de base non énergétiques sont déterminés de façon endogène, les auteurs appliquent une nouvelle stratégie d’identification factorielle pour décomposer les éléments à l’origine des variations des prix des produits de base et de l’activité économique mondiale observées par le passé. Le modèle génère une structure factorielle des prix des produits de base, ainsi que des conditions d’identification permettant de donner aux facteurs examinés une interprétation économique : un facteur unique rend compte de l’incidence combinée de chocs dont l’influence sur les marchés des produits de base s’exerce uniquement par l’entremise des effets d’équilibre général. Appliquées à un échantillon représentatif des prix des produits de base depuis 1968, les contraintes théoriques sont conformes aux données et cadrent avec une interprétation structurelle des facteurs communs influant sur les prix de ces produits. Les auteurs constatent que les chocs liés aux produits de base ont pesé modestement sur les fluctuations de l’économie mondiale

Liquidity-driven FDI

We develop a model of foreign direct investment (FDI) in which financially liquid foreign firms acquire liquidity-constrained target firms. Using a large dataset of emerging-market acquisitions, we find evidence supporting three central predictions of the model: (i) firms in external finance dependent and intangible sectors are more likely to be targets of foreign acquisitions; (ii) these targets have ownership structures with larger foreign stakes; (iii) these effects are most prominent in countries with low levels of financial development. The regression evidence indicates that liquidity is at least as economically important as technology- or trade-related motives for FDI in emerging-market economies

What does the convenience yield curve tell us about the crude oil market?

Using the prices of crude oil futures contracts, we construct the term structure of crude oil convenience yields out to one-year maturity. The crude oil convenience yield can be interpreted as the interest rate, denominated in barrels of oil, for borrowing a single barrel of oil, and it measures the value of storing crude oil over the borrowing period. We show that the convenience yield curve is well explained by a level and a slope factor. Consistent with the theory of storage, convenience yields have predictive power over future crude oil inventories, production, global real economic activity and the price of oil

What do we learn from the price of crude oil futures?

Despite their widespread use as predictors of the spot price of oil, oil futures prices tend to be less accurate in the mean-squared prediction error sense than no-change forecasts. This result is driven by the variability of the futures price about the spot price, as captured by the oil futures spread. This variability can be explained by the marginal convenience yield of oil inventories. Using a two-country, multi-period general equilibrium model of the spot and futures markets for crude oil we show that increased uncertainty about future oil supply shortfalls under plausible assumptions causes the spread to decline. Increased uncertainty also causes precautionary demand for oil to increase, resulting in an immediate increase in the real spot price. Thus the negative of the oil futures spread may be viewed as an indicator of fluctuations in the price of crude oil driven by precautionary demand. An empirical analysis of this indicator provides evidence of how shifts in the uncertainty about future oil supply shortfalls affect the real spot price of crude oil. Copyright © 2010 John Wiley & Sons, Ltd.Peer Reviewedhttp://deepblue.lib.umich.edu/bitstream/2027.42/75776/1/1159_ftp.pd