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Using Copulas to Construct Bivariate Foreign Exchange Distributions with an Application to the Sterling Exchange Rate
"... Abstract: We model the joint risk neutral distribution of the euro-sterling and the dollar-sterling ex-change rates using option-implied marginal distributions that are connected via a copula function that satisfies the triangular no-arbitrage condition. We then derive a univariate distribution for ..."
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Cited by 19 (2 self)
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Abstract: We model the joint risk neutral distribution of the euro-sterling and the dollar-sterling ex-change rates using option-implied marginal distributions that are connected via a copula function that satisfies the triangular no-arbitrage condition. We then derive a univariate distribution for a simplified sterling effective exchange rate index (ERI). Our results indicate that standard parametric copula func-tions, such as the commonly used Normal and Frank copulas, fail to capture the degree of asymmetry observed in the data. We overcome this problem by using a non-parametric dependence function in the form of a Bernstein copula which is shown to produce a very close fit. We further give an example of how our approach can be used to price currency index options accounting for strike-dependent implied volatilities. We would like to thank Michael Bennett, Andrew Patton and Alessio Sancetta, participants at the CEF 2005 in Washington and the GFC 2005 in Dublin, as well as seminar participants at the Bank of England for useful comments and discussion. Any remaining mistakes are our own. This paper represents the views of the authors and should not be thought to represent those of the Bank of England and members of the Monetary Policy Committee. 2
Estimation of a microfounded herding model of German survey expectations
, 2007
"... The paper considers the dynamic adjustments of an average opinion index that can be derived from a microfounded framework where the individual agents switch between two kinds of sentiment with certain transition probabilities. The index can thus represent a general business climate, i.e., expectatio ..."
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Cited by 14 (6 self)
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The paper considers the dynamic adjustments of an average opinion index that can be derived from a microfounded framework where the individual agents switch between two kinds of sentiment with certain transition probabilities. The index can thus represent a general business climate, i.e., expectations about the future course of the economy. This approach is empirically tested with the survey expectations published by the ZEW and ifo institute. The estimated coefficients make economic sense and are highly significant. In particular, besides effects from fundamental data like the output gap in the recent past, one can identify a strong herding mechanism within both panels, such that metaphorically speaking the agents do not just join the crowd but follow each single motion of it. In addition, the transition probabilities of the ZEW agents are found to be influenced by the ifo climate but not the other way round.
A Simple Asymmetric Herding Model to Distinguish Between Stock and Foreign Exchange Markets
"... Drawing on previous work of one of the authors, the paper takes an asymmetric variant of Kirman’s ant model and combines it with an elementary asset pricing mechanism. The closed-form solution of the equilibrium probability distribution allows the specification of a tractable likelihood function for ..."
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Cited by 12 (3 self)
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Drawing on previous work of one of the authors, the paper takes an asymmetric variant of Kirman’s ant model and combines it with an elementary asset pricing mechanism. The closed-form solution of the equilibrium probability distribution allows the specification of a tractable likelihood function for daily returns, which is then employed to estimate the model’s behavioural parameters for a large pool of Japanese stocks. By way of Monte Carlo simulations it is found that most of these markets belong to the same class, which is characterized by a dominance of the stylized noise traders. In contrast, the model assigns a number of major foreign exchange markets to a different class, where on average the majority of agents follows the fundamentalist trading rule. Implications for the tail index are also worked out.
Transaction Taxes, Traders’ Behavior and Exchange Rate Risks
"... Abstract: We propose a new model of chartist-fundamentalist-interaction in which both groups of traders are allowed to select endogenously between different forecasting models and different investment horizons. Stochastic interest rates in both countries and different behavioral assumptions for tren ..."
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Cited by 9 (1 self)
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Abstract: We propose a new model of chartist-fundamentalist-interaction in which both groups of traders are allowed to select endogenously between different forecasting models and different investment horizons. Stochastic interest rates in both countries and different behavioral assumptions for trend-extrapolating and fundamental based forecasts determine the agents’ market orders which drive the exchange rate. A numerical analysis of the model shows that it is able to replicate stylized facts of observed financial return time series like excess kurtosis and volatility clustering. Within this framework we study the effects of transaction taxes on exchange rate volatil-ity and traders ’ behavior measured by their population fractions. Simula-tions yield the result that on the macroscopic level these taxes reduce the variance of exchange rate returns, but also increase their kurtosis. Moreover, on the microscopic level the tax harms short-term speculation in favor of long-term investment, while it also harms trading rules based on economic
Price and Wealth Dynamics in a Speculative Market with Generic Procedurally Rational Traders
, 2006
"... An agent-based model of a simple financial market with arbitrary number of traders having relatively general behavioral specifications is analyzed. In a pure exchange econ-omy with two assets, riskless and risky, trading takes place in discrete time under en-dogenous price formation setting. Traders ..."
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Cited by 8 (2 self)
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An agent-based model of a simple financial market with arbitrary number of traders having relatively general behavioral specifications is analyzed. In a pure exchange econ-omy with two assets, riskless and risky, trading takes place in discrete time under en-dogenous price formation setting. Traders ’ demands for the risky asset are expressed as fractions of their individual wealths, so that the dynamical system in terms of wealth and return is obtained. Agents ’ choices, i.e. investment fractions, are described by means of the generic smooth functions of an infinite information set. The choices can be consistent with (but not limited to) the solutions of the expected utility maximization problems. A complete characterization of equilibria is given. It is shown that irrespectively of the number of agents and of their behavior, all possible equilibria belong to a one-dimensional “Equilibrium Market Line”. This geometric tool helps to illustrate possibility of different phenomena, like multiple equilibria, and also can be used for comparative static analysis. The stability conditions of equilibria are derived for general model specification and allow to discuss the relative performances of different strategies and the selection principle
Out-of-Sample Predictions of Bond Excess Returns and Forward Rates: an Asset Allocation Perspective”. Review of Financial Studies (forthcoming).
, 2012
"... Abstract This paper investigates the out-of-sample predictability of bond excess returns. We assess the economic value of the forecasting ability of empirical models based on long-term forward interest rates in a dynamic asset allocation strategy. The results show that the information content of fo ..."
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Cited by 8 (2 self)
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Abstract This paper investigates the out-of-sample predictability of bond excess returns. We assess the economic value of the forecasting ability of empirical models based on long-term forward interest rates in a dynamic asset allocation strategy. The results show that the information content of forward rates does not generate systematic economic value to investors. Indeed, these models do not outperform the no-predictability benchmark. Furthermore, their relative performance deteriorates over time. JEL classi…cation: G0; G1; E0; E4.
A Prototype Model of Speculative Dynamics With Position-Based Trading
"... To avoid the indeterminate and generally unbounded positions of the agents in financial market models with order-based trading, the paper considers the al-ternative of position-based strategies. To this end it extracts a prototype model from the literature, with fundamentalists, chartists, and a ris ..."
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Cited by 7 (4 self)
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To avoid the indeterminate and generally unbounded positions of the agents in financial market models with order-based trading, the paper considers the al-ternative of position-based strategies. To this end it extracts a prototype model from the literature, with fundamentalists, chartists, and a risk-averse market maker. The deterministic formulation of the model leads to a neutral delay-differential equation of the price, whose mathematical analysis is non-standard. The stability conditions are nevertheless quite analogous to the order-based Beja–Goldman model. The effects of parameter variations are also studied in a stochastic setting, where special emphasis is put on the misalignment between price and the time-varying fundamental value, and on the differential profits of fundamentalists and chartists. JEL classification: C15, D 84, G 12.
Wealth Selection in a Financial Market with Heterogeneous Agents∗
, 2007
"... We study the co-evolution of asset prices and agents ’ wealth in a financial market populated by an arbitrary number of heterogeneous, boundedly rational investors. We model assets ’ demand to be proportional to agents ’ wealth, so that wealth dynamics can be used as a selection device. For a genera ..."
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Cited by 3 (3 self)
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We study the co-evolution of asset prices and agents ’ wealth in a financial market populated by an arbitrary number of heterogeneous, boundedly rational investors. We model assets ’ demand to be proportional to agents ’ wealth, so that wealth dynamics can be used as a selection device. For a general class of investment behaviors, we are able to characterize the long run market outcome, i.e. the steady-state equilibrium values of asset return, and agents ’ survival. Our investigation illustrates that market forces pose certain limits on the outcome of agents ’ interactions even within the “wilderness of bounded rationality”. As an application we show that our analysis provides a rigorous explanation for the results of the simulation model introduced in Levy, Levy, and Solomon (1994).
How Did We Get to Inflation Targeting and Where Do We Need to Go to Now? A Perspective from the U.S. Experience
"... The Federal Reserve is not formally inflation targeting. Nevertheless, it is commonly believed to be an implicit inflation targeter. The evolution to inflation targeting occurred because central banks, most importantly the Federal Reserve, demonstrated that monetary policy could control inflation. A ..."
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Cited by 2 (1 self)
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The Federal Reserve is not formally inflation targeting. Nevertheless, it is commonly believed to be an implicit inflation targeter. The evolution to inflation targeting occurred because central banks, most importantly the Federal Reserve, demonstrated that monetary policy could control inflation. As central banks ’ credibility for keeping inflation low increased, policy actions became increasingly focused on affecting the growth rate of employment or the unemployment rate. The author argues that this change in emphasis is unlikely to generate positive benefits; more importantly, it endangers the continued effectiveness, and perhaps even the viability, of inflation targeting. (JEL E31, E52, E58) Federal Reserve Bank of St. Louis Review, January/February 2012, 94(1), pp. 65-81.
The Expectations Hypothesis of the Term Structure: Some Empirical Evidence for Portugal
- Munich Personal RePEc Archieve
, 2007
"... The purpose of this paper is to test the (rational) expectations hypothesis of the term structure of interest rates using Portuguese data for the interbank money market. The results obtained support only a very weak, long-run or “asymptotic ” version of the hypothesis, and broadly agree with previou ..."
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Cited by 1 (0 self)
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The purpose of this paper is to test the (rational) expectations hypothesis of the term structure of interest rates using Portuguese data for the interbank money market. The results obtained support only a very weak, long-run or “asymptotic ” version of the hypothesis, and broadly agree with previous evidence for other countries. The empirical evidence supports the cointegration of Portuguese rates and the “puzzle ” well known in the literature: although its forecasts of future short-term rates are in the correct direction, the spread between longer and shorter rates fails to forecast future longer rates. In the single equation framework, the implications of the hypothesis in terms of the predictive ability of the spread are also clearly rejected.
