College of Behavioral & Social Sciences

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ESSAYS IN CROSS-COUNTRY CONSUMPTION RISK SHARING
(2010) Qiao, Zhaogang; Prucha, Ingmar; Korinek, Anton; Economics; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation concerns cross-country consumption risk sharing in a long-run perspective. Financial integration, empirically measured by cross-country holdings of assets and liabilities, has increased dramatically in the past two decades. But what can explain the lack of cross-country risk sharing documented in the literature? Chapters 2 and 3 of this dissertation address this question. In Chapter 2, we set up a model to illustrate the mechanical difference between a bond economy and an insurance economy. We show that a bond economy can intertemporally smooth consumption in face of transitory output shocks, but not for permanent output shocks; an insurance economy is essential for risk sharing on permanent shocks. We therefore show that when both transitory and permanent output shocks exist, transitory shocks only create "noise" if the focus of interest is on identifying risk sharing in the long run. In Chapter 3, we specify an empirical nonstationary panel regression model to test long-run consumption risk sharing across a sample of OECD and emerging market countries. This is in contrast to tests in the literature which are mainly about risks at business cycle frequency. We argue that these existing tests neglected the permanent elements of risks that are of interest and that their model specifications were not rich enough to accommodate heterogeneous short-run dynamics. Since our methodology focuses on identifying cointegrating relationships while allowing for arbitrary short-run dynamics, we can obtain a consistent estimate of long-run risk sharing while disregarding any short-run nuisance factors. Our results show that, for the period of 1950-2008, the level of long-run risk sharing in OECD countries is similar to that in emerging market countries. However, during the financial integration episode of the past two decades, long-run risk sharing in OECD countries increased more than in emerging market countries. Furthermore, we investigate the relationship between various measures of financial integration and cross-country risk sharing, but only find weak evidence of such linkages.
ESSAYS ON HOUSING INVESTMENTS IN EMERGING MARKETS
(2009) Qi, Zhikun; Vegh, Carlos; Economics; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
New residential construction is significantly more procyclical in emerging markets than in developed countries, although the correlation between aggregate investment and output is similar across emerging and developed countries. This paper shows that a multi-sector stochastic growth model with a housing production sector can explain this fact. The key feature of the model is that housing demand depends on the cyclical behavior of consumption of tradable goods, which is much more volatile in emerging markets. Therefore, when a positive productivity shock hits the economy, the larger response of consumption of tradable goods implies that it is more attractive for consumers in emerging markets to purchase housing than it is for consumers in developed countries. This paper considers various factors that contribute to the large variability of consumption in emerging markets, and finds that larger trend growth rate shocks in emerging markets than in developed countries are quantitatively important. The reason is that a positive productivity shock signals even higher productivity in the future with large growth rate shocks, so the current consumption response is large and the return to housing investment is high. While qualitatively the model matches the differences in the cyclicality of new residential construction across emerging markets and developed countries, quantitatively the model underestimates this comovement and the volatilities in housing investment in emerging markets. Furthermore, international interest rate shocks highly correlated with productivity shocks are very important in explaining the large swings in housing investment in emerging markets. Interest rate shocks work through three channels to affect housing investment: the direct `mortgage rate' effect, the indirect effect through increasing non-housing consumption and the supply effect due to the working capital constraint. Quantitatively, the direct `mortgage rate' effect is the most important channel. When the housing asset acts as collateral to reduce household's financing costs, it provides an empirically important mechanism to amplify and propagate interest rate shocks over the business cycle. The reason is that housing prices and interest rates reinforce with each other to generate more procyclical housing investment and more volatile consumption and output.
Civil Liberties, Mobility, and Economic Development
(2009) BenYishay, Ariel; Betancourt, Roger R.; Economics; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
To what extent do civil liberties affect economic development? This dissertation addresses this question in two essays. The first chapter (joint with Roger Betancourt) provides a new economic interpretation of civil liberties as rights over a person's most basic human asset: her own self. The importance of these rights to economic development is based on the principle that property rights-defined over a broad set of "property''-are crucial for economic growth. The empirical literature to date shows little support for such claims related to civil liberties, however, with ambiguous evidence on the role of these rights in driving long-run growth. Using newly available data from Freedom House, we find that one of the recently disaggregated categories of civil liberties explains income differences across countries more powerfully and robustly than any other measure of property rights or the rule of law considered. This component, entitled "Personal Autonomy and Individual Rights,'' evaluates the extent of personal choice over issues such as where to work, study, and live, as well as a broader set of property rights and other choices. While the first chapter finds that greater civil liberties can substantially improve long-run economic development, the second chapter identifies a key friction in this relationship. In countries that lack complementary institutions, civil liberties governing individual mobility can complicate credit transactions. By allowing individuals to move to locations where less is known about their prior defaults, mobility freedoms induce opaqueness and can result in credit rationing. I develop an instrumental variable estimation to study these effects, which would otherwise be complicated by omitted variable bias and endogeneity. Using household survey data from Guatemala, I instrument for individual migration with the interaction of violence patterns and individual sensitivities toward that violence. Using this approach, I find that the act of migration within a country actually causes individuals to have significantly less access to credit, primarily because lenders are concerned about these borrowers' opportunistic default.
Essays in International Finance
(2008-01-23) Daude, Christian; Mendoza, Enrique G.; Vegh, Carlos A.; Economics; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Access to private capital markets is the most salient difference between emerging market economies and other developing countries. However, in contrast to developed economies, emerging markets have had a troubled relationship with capital fows. In particular, balance of payments and debt crises have been a recurrent problem. The three chapters of this dissertation contribute to the literature on emerging markets and their relationship with capital markets. Chapter 1 analyzes the effects of volatility on sovereign default risk. Empirically, the paper establishes a concave relationship between spreads and volatility. While for low levels of volatility an increase in volatility is associated with an increase in the sovereign risk premium, the risk premium increases at a decreasing rate. This empirical relationship is robust to different estimation methods, sam- ples and control variables. Furthermore, the relationship between volatility and risk premia is non-monotonic: while at low levels of volatility an increase in volatility implies an increase also in spreads, for sufficiently high levels of volatility this relationship turns negative. The chapter also presents a quantitative model of sovereign debt with default risk consistent with this feature and other characteristics of EME debt. The intuition for this result is the existence of a trade-off between prudential behavior in order to avoid large consumption fluctuations under autarky and the increased likelihood of a default, given default provides some short-run relief under a very bad realization of shocks. Chapter 2 addresses the determinants of the composition of cross-border investment positions. Using a novel database of bilateral capital stocks for all types of investment - FDI, portfolio equity securities, debt securities as well as loans - for a broad set of 77 countries, we show the importance of two key determinants of the composition of cross-border asset positions: information frictions and the quality of host country institutions. Overall, we find that in particular FDI, and to some extent also loans, are substantially more sensitive to information frictions than investment in portfolio equity and debt securities. We also show that the share as well as the size of FDI that a country receives are largely insensitive to corruption in host countries, while portfolio investment is by far the most sensitive to the quality of institutions. Chapter 3 focuses on a related topic to chapter 2. Using bilateral FDI stocks around the world, we explore the importance of a wide range of institutional variables as determinants of the location of FDI. While we find that better institutions have overall a positive and economically significant effect on FDI, some institutional aspects matter more than others do. Especially, the unpredictability of laws, regulations and policies, excessive regulatory burden, government instability and lack of commitment play a major role in deterring FDI. For example, the effect of a one standard deviation improvement in the regulatory quality of the host country increases FDI by a factor of around 2. These results are robust to different specifications, estimation methods and institutional variables. We also present evidence on the significance of institutions as a determinant of FDI over time.
Essays on Multiple Exchange Rate Systems
(2005-09-21) Avellan, Leopoldo Martin; Reinhart, Carmen M; Economics; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation measures the impact of multiple exchange rate systems on economic performance and on net capital flows in developing countries. The literature on the effectiveness of capital controls has some problems. Two of them are that it often ignores the endogeneity of capital controls, and that most of the evidence is dominated by some country specific studies. This dissertation fills this gap. It uses a multicountry panel to quantify the effects of parallel rates in the economy, but in doing so it explicitly models the endogeneity of multiple exchange rates. The dissertation is structured as follows. Chapter 1 evaluates the relationship between parallel exchange rates and economic performance in the post Bretton Woods period (1974-2001). The main findings are not only that parallel exchange rates are more likely to be adopted when economic performance is bad, but also that they hurt economic performance, indicating the existence of a negative feedback mechanism linking economic performance and parallel markets. It also finds that liability dollarization and high debt service are possible determinants of the likelihood to segment the foreign exchange market. Chapter 2 evaluates the effectiveness of multiple exchange rates systems as a policy tool to stop capital outflows. Controlling for push and pull factors that drive capital flows, and using data from 46 developing countries for the 1980-2001 period, it cannot find empirical support for the claim that segmenting the foreign exchange market stops capital outflows. The evidence suggests that multiple exchange rates systems do not have any effect on capital outflows, at best. At worst, the evidence suggests that parallel exchange rate systems increase capital outflows rather than discouraging them. This last result can be rationalized with a policy signaling model for capital controls.
The Lending Channel in Emerging Economies: A Look at the International Evidence
(2005-04-21) Vazquez, Francisco; Reinhart, Carmen; Economics; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This thesis studies the role of banks in the transmission of nominal shocks into credit markets in emerging countries. It builds on the lending channel hypothesis, which states that, due to imperfections in capital markets, banks may not be able to completely offset a negative shock to deposits with other sources of finance. As a result, they may choose to cut credit, affecting the financing possibilities of bank-dependent firms and amplifying the effects of monetary shocks on economic activity. Empirical work on the lending channel in emerging countries is scarce. This thesis argues that, since the mechanism relies on the presence of imperfections in capital markets, it should be expected to be stronger in emerging countries. Therefore, looking at the cross-country evidence provides a source of variation that has not been previously exploited in the literature. The thesis is divided in three chapters. The first develops a model of the lending channel in a small open economy to study how differences in the severity capital market imperfections affect the power of the mechanism. The second takes of the model to the data, using a bank-level panel dataset of 832 banks in 27 countries during 1986-1998. The chapter tests for systematic cross-sectional differences in the response of loan growth to monetary conditions across banks of various characteristics and across developed and emerging countries. The third chapter further looks at the evidence from emerging markets, using differences in bank ownership to proxy for unobserved financial constraints facing banks. In particular, it builds on the presumption that foreign banks operating in emerging markets are less financially constrained than domestic. The test exploits a novel bank-level dataset comprising 1565 banks in 20 emerging countries during 1989-2001, to look for systematic differences across domestic and foreign banks. The results are supportive of the existence of a lending channel mechanism that is stronger in emerging countries. On the other hand, the behavior of domestic and foreign banks is not found to be markedly different, which may imply that foreign banks in emerging countries are prevented from freely resorting to upstream financing from their mother institutions.
Essays in International Economics
(2004-08-09) Mukerji, Purba; Panagariya, Arvind; Economics; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation consists of two essays. The first essay investigates the impact of capital account convertibility on the volatility of economic growth. Previous work has concentrated on the impact of convertibility on mean growth and has found contradictory results. Existing theoretical work suggests that impact of convertibility on volatility could differ across economies depending on their level of financial development. I test this hypothesis using a system of equations that allow for simultaneous determination of three endogenous variables: volatility, mean growth and financial development. I also allow for spillover effects in economic growth and its volatility. I find that financially developed economies are better able to handle capital account convertibility in the sense that convertibility does not lead to excess fluctuations in those economies. However less financially developed economies suffer a higher level of fluctuations with an open capital account. These results are robust to alternative measures of financial development and to removal of the top and bottom 10% of my sample. I also find significant spillovers from growth of trade partners on the mean growth of the domestic economy. The second essay builds on Romer's (1994) idea that when there are fixed costs of entry into export markets, even low trade barriers can lead to the complete disappearance of some products and impose costs that are much larger than the conventional costs of protection. I incorporate Romer's insight into a fully specified general equilibrium model. In a two-country, differentiated goods model, assuming that firms are heterogeneous with respect to the costs of entry into the export market, I show that firms are divided into those that sell exclusively at home and those that also sell abroad. Larger firms export more and are also characterized by higher average productivity. The cost of protection is significantly higher when I allow products to disappear as a result of the tariff. My work is closely related to Melitz (2003) and Helpman, Melitz and Yeaple (2002) but differs in the mechanism underlying the results. Data from the Indian trade liberalization of the 1990s appears be in line with the results of the model.
Bank Fundamentals, Bank Failures and Market Discipline: An Empirical Analysis for Emerging Markets During the Nineties
(2004-06-03) Arena, Marco Antonio; Reinhart, Carmen M; Economics; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
After the East Asian crisis, there has been a renewed interest in both academic and policy circles about the role that bank weaknesses play in contributing to systemic banking crisis. Even though, it has been recognized in the recent theoretical literature on banking crises that both macroeconomic and bank-level fundamentals have to be taken into account in the explanation of systemic banking crisis, to date, there is little cross-country empirical evidence for emerging markets on the role of bank weaknesses in contributing to both sudden deposit withdrawals and bank failures. In this context, my thesis analyzes the episodes of systemic banking crisis in Latin America (Argentina, 1995; Mexico, 1994; and Venezuela, 1994) and East Asia (Indonesia, Korea, Malaysia, Philippines, and Thailand in 1997) using bank-level data in order to answer the following questions. First, to what extent, did financial conditions of individual banks explain bank failures? Did only the weakest banks, in terms of their fundamentals, fail in the crisis countries? Second, did depositors in crisis countries discipline riskier banks by withdrawing their deposits in such a way that deposit withdrawals could be considered an act of market discipline? The results for East Asia and Latin America show that bank-level fundamentals both affect significantly the likelihood of failure and explain a high proportion of the likelihood of failure of failed banks (around fifty percent). In East Asian crisis countries, there was little overlap in the distribution of logit propensity scores between failed and non-failed banks, implying that mainly the weakest banks failed. However, in Latin American crisis countries, there was a much clear overlap in the distribution of logit propensity scores, implying that banking system and macroeconomic shocks are relatively much more important in Latin America. Regarding market discipline, a stable model of bank-level fundamentals explains the growth rate of deposits in both regions even during the peak of the crisis periods. However, in both regions, the relative contribution of bank level fundamentals during the peak of the crisis periods declined. In this context, to some degree, the observed deposit withdrawals represented an informed market response to observable bank weaknesses.
DOES THE EXCHANGE RATE MATTER FOR MONETARY POLICY UNDER INFLATION TARGETING? EVIDENCE FROM MEXICO, NEW ZEALAND AND CANADA
(2003-11-13) Trevino, Juan Pedro; Reinhart, Carmen M; Economics
Recently, many developed and developing countries have adopted inflation targeting as the monetary policy framework. There is large debate regarding the importance of external variables, such as the exchange rate, for monetary policy decisions under this framework, particularly in small open economies. In the first chapter I explore the extent to which the adoption of an explicit inflation target in Mexico can be associated to a de facto change in the behavior of the central bank in terms of how it responds to changes in the exchange rate and other external variables, along with conventional variables considered relevant for monetary policy. The results indicate the presence of a change in the behavior of the central bank in Mexico associated to the adoption of an explicit inflation target in January of 1999. Variables such as policy credibility and the output gap tend to become more important for monetary policy, while the exchange rate becomes relatively less relevant when the inflation target is in operation. As compared to the cases of New Zealand and Canada -two small open economies that have successfully followed this policy prescription- the results suggest that monetary policy implementation in Mexico has become much more like in those countries. In the second chapter I present a modified version of Drazen and Masson (1994), where instead of assuming exogenous unemployment persistence, an endogenous externality from choosing positive inflation is imposed on unemployment. In face of an adverse shock to unemployment, a policymaker that generates surprise inflation to offset such shock will generate a negative spillover that will translate into future higher unemployment. The result is that this constitutes an additional channel for commitment to zero inflation other than the signaling/reputation channel. This modification may contribute to explain, on the one hand, why a policymaker that is highly committed to lower inflation may still inflate under extreme circumstances, and, on the other, why the central bank in countries like Mexico, where credibility may still be an issue, continue to follow a stringent monetary policy at a cost of "sluggish" economic growth.
Output structure, debt denomination, and exchange rate regimes
(2004-04-20) Magud, Nicolas Ernesto; Reinhart, Carmen; Economics
The dissertation analyzes the choice of an exchange rate regime for a small open economy indebted in foreign currency, incorporating the financial accelerator. Conventional wisdom suggests that floating regimes should insulate the economy from real shocks. I show that this result depends on the degrees of openness of the economy and foreign currency indebtedness and, in fact, does not hold for relatively closed economies. The transmission mechanism relies on nonlinearities in the impact of unanticipated real price changes on the external finance premium, similar to Fisher (1933). To test this, a VAR with exogenous terms of trade shocks is performed: a 32 country sample for the period 1980-2001 is split according to the degree of openness of the economy. The results confirm the theoretical conclusions.

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