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Capital Flows and Exchange Rates: An
Empirical
Analysis (First Version: August 2002. New Version: May 2007)
Abstract: This paper investigates the empirical relationship between capital flows and nominal exchange rates for five major countries. Recent international finance theory suggests that currencies are influenced by capital flows as much as by current account balances and log-term interest rates. Using VAR’s we document the following: a) Incorporating net cross-border equity flows into linear exchange rate models can improve their in-sample performance. Using net cross-border bond flows, however, has no such e?ect; b) Positive shocks to home equity returns (relative to foreign markets) are associated with short-run home currency appreciation and equity inflow. Positive shocks to home interest rates (relative to foreign countries) cause currency movements that are consistent with the long-run interpretation of uncovered interest rate parity (UIP); c) An equity-augmented linear model supports exchange rate predictability and outperforms a random walk in several cases. Such superior forecast performance, however, depends on the exchange rate and the forecast horizon.
Optimal Currency Shares in International Reserves: The Impact of the Euro and the Prospects for the Dollar with Richard Portes (London Business School, CEPR and NBER) and Elias Papaioannou (Dartmouth College) - Journal of the Japanese and International Economies, 20 (2006), pp. 508-547.
Abstract: Foreign exchange reserve accumulation has risen dramatically over the past five years. The introduction of the euro and the increased liquidity in other major currencies has increased the pressure on central banks to diversify away from the dollar. This could have substantial implications for the international financial system. In this paper we use a mean-variance framework to estimate optimal weights among the main international currencies and assess how the euro has changed this allocation over time. We also incorporate rebalancing costs, which we proxy with (mean and extreme) currency bid-ask spreads. The results indicate that the recent drop in euro spreads fully compensated for the diversification losses associated with fewer currencies. We then perform some simple simulations for the optimal currency allocation of four large emerging market countries (Russia, Brazil, China and India) incorporating a central bank’s desire to hold a sizable portion of its portfolio in the currencies of its foreign debt and international trade. The constrained optimization suggests that the euro potentially rivals the dollar as an international reserve currency. Actual dollar allocations are far greater than the optimizer implies, consistent with the current dominant role of the dollar as a reserve currency. But the increased tendency of many developing countries to issue euro-denominated assets and trade with the euro zone may shift this equilibrium and put pressure on the dollar.
Democratization and Growth
(with Elias Papaioannou
(ECB)
- Economic
Journal, forthcoming.
Abstract: This paper challenges recent empirical findings that democratic institutions have a negligible direct effect on economic growth. We delve into numerous historical sources and democracy indicators to identify the countries and timing of recent democratization episodes. We then employ a before-after event study approach and analyze the impact of democratization on growth in countries that have managed to abandon autocracy and consolidate democratic institutions. We explore the within country effect of a permanent democratization, controlling for time-invariant country-specific effects. The dynamic panel estimates imply that democratizations, on average, are associated with a half to one percent increase in per capita growth. The analysis also reveals a J-shaped growth pattern: during the transition growth is slow and even negative; after, however, the third post-democratization year growth peaks and stabilizes at higher level. We also document that countries with relatively high level of human capital gain the most from the political reforms. From a theoretical standpoint the evidence offers direct support for "development" theories of democracy and growth that highlight the positive impact of representative institutions on economic activity. From a policy perspective the results imply that even moderate reforms can yield sizable growth gains.
This paper was
awarded
the 2005 Young Economist Award by the European Economic Association.
This paper was
selected
by the Econometric Society to be presented at the 2004 European Winter
Meeting, in the field of “Applied Political Economics”.
Economic and Social Factors Driving the Third Wave of Democratization ((Current version: October 2007) with Elias Papaioannou (ECB)
Abstract: During the last three decades the world has experienced an unprecedented wave of political liberalization. We first identify the timing and nature of recent democratization episodes and the employ various limited dependent panel models to test traditional and recent political economy theories on the prerequisites of democratization. Our methodology also enables us to distinguish between factors that influence the transition and features that affect the consolidation of democracy. We document that democratization is more likely to occur in: a) relatively affluent and more educated societies, b) open to international trade countries, c) after a recession, and d) after the end of a civil or cross-border war. In addition democratization is less likely to emerge in e) religiously heterogeneous countries and f) in countries with natural resource (oil) abundance. The results thus provide a synthesis to economic and social structure theories of institutional design.
Output and Net Foreign Assets Persistence Under Incomplete International Markets (Current Version: November 2003) with Alexis Anagnostopoulos (SUNY-Stony Brook)
Abstract: The aim of this paper is to develop an indirect test of international asset markets incompleteness. We show that when a country issues a full set of contingent claims, net foreign assets accumulation and growth rate of output are stationary, mean reverting processes. Examining a panel of 60 developed and developing countries and assessing stationarity with panel unit root tests reveals that net foreign assets accumulation is a non-stationary process whereas growth rate of output is a stationary process regardless of income or region stratum. We then show that this behavior is best accounted by a model of incomplete markets, where agents issue only one-period risk free assets.