Economics 664. Applied International Finance

 

Last modified Oct 2, 2005

 

Prerequisites:

Economics 607 Macroeconomic Theory I, and Economics 629 (or concurrent).

 

Course Content:

Economics 664 surveys empirical research in International Macroeconomics and Finance and the dynamic econometric methods used in the field.  For each topic area, the course reviews canonical theory models, introduces appropriate econometric tools, and then studies how the theory model is evaluated against the data evidence.  Topics include  models of international macroeconomic equilibrium, empirical regularities of international prices, interest rates and exchange rates, models of nominal and real exchange rate determination, international capital flows and balance of payments crises.  

 

Term Paper:

The course will emphasize independent student research. You will write a 15-20 page paper on a topic of your choice. This paper should make extensive use of the econometric tools developed in the course to address an important question in the area of international macroeconomics and finance. A one-page description of your proposed topic (an abstract) will be due early in the term. I will then meet individually with each of you to discuss your research. The final draft of your paper will be due at the end of the term, and all students will give 30 minute presentations of their research during the final two weeks of the semester.

 

Article Presentations:

Class will be conducted in a seminar format that involves students in the presentation and discussion of the course material. With a classmate, you will be asked to lecture and lead discussion of one or more of the assigned readings. At the appropriate point during the term, you and your partner will present an overview of the reading, explaining its theoretical background, empirical methodology, results, and importance in the literature.

Presentation Guide

 

Readings:

Readings for the course will be taken from the journal literature and various texts. Primary readings (*) are indicated below. The other readings in the list are included because they give a useful alternative presentation of a topic, present related material, provide background information, or are historically important. You are responsible for all material covered in class and the associated articles or book chapters. For the most part, these will be the readings marked with an asterisk (*) in the reading list below. I may decide to skip some material in the list or assign other readings as the course progresses.

 

Grades:

The focus of the course is student independent research.  A term paper (including preliminary abstract and class presentations will count 75% of your grade, and article presentations are worth 25% of your grade.   All students will receive a letter grade (or P/F).  No incompletes will be given.

 

Important Dates:

 

Required Textbook:
Nelson C. Mark, International Macroeconomics and Finance : Theory and Econometric Methods, Blackwell, 2001. (aka IMF )

Other Recommended Textbooks

Charemza, Woiciech. W., and Derek F. Deadman, New Directions in Econometric Practice: General to Specific Modelling, Cointegration and Vector Autoregression, 2nd edition, Edward Elgar, 1997.  (aka CD)

Clements, Michael and David Hendry, Forecasting Economic Time Series , Cambridge University Press, 1998. 

Enders, Walter, Applied Econometric Time Series , John Wiley & Sons, Inc., 1995.

Granger, C. W. J., and P. Newbold, Forecasting Economic Time Series , second edition, Academic Press, Inc., 1986.

Greene, William H., Econometric Analysis , 5th ed., Prentice Hall, 2003.

Hamilton, James D. Time Series Analysis , Princetion University Press, 1994.

Harvey, A. C., Time Series Models , Phillip Allen, 1981.

Harvey, A. C., The Econometric Analysis of Times Series , second edition, The MIT Press, 1992.

Hendry, David F., Dynamic Econometrics , Oxford: Oxford University Press, 1995.

Hendry, David F. and Jurgen A. Doornik, Empirical Modelling Using PcGive 9.0 for Windows , International Thomson Business Press, 1996.  (aka HD)

Hendry, David F. and Jurgen A. Doornik, Modelling Dynamic Systems Using PcFiml 9.0 for Windows , International Thomson Business Press, 1997.  (aka HD )

Banerjee, Anindya, Juan Dolado, John W. Galbraith, and David F. Hendry, Co-integration, Error- Correction, and the Econometric Analysis of Non-Stationary Data , Oxford: Oxford University Press, 1993.

Handbook of Econometrics , volumes 1-4, Amsterdam: North Holland. Of particular relevance to our topics  on time series are two chapters in volume 4: Chapter 46 by James Stock, "Unit Roots, Structural Breaks, and Trends" and Chapter 47 by Mark Watson, "Vector Autoregression and Cointegration." These chapters update earlier surveys of these topics with numerous references to theoretical and applied papers.

Recommended Software

  1. PcGive 10.x   ( UH site license download )   Ox Console
  2. RATS   ( RATS textbook examples programs )
  3. STATA
  4. GAUSS IMF Web site with Gauss Procedures
  5. Matlab  ( LeSage Toolbox page )
  6. EViews

Reading List

Background Information


Notes on Writing, Talking and Listening, Eric Rasmusen, 1996.

*IMF ch. 1.

Section I. Some Useful time Series Methods


* IMF , ch. 2.

1.1 Stylized Facts

  1. A first DGP—the unit root process as a stylized fact of economic time series 
  2. Deterministic and Stochastic Trends 
  3. Stationary and Nonstationary DGPs
* Lectures1.pdf

* Stock J. H., and M. W. Watson. " Variable Trends in Economic Time Series, " Journal of Economic Perspectives , 3 (Summer 1988), 147-74.

Granger, C.W.J. and P. Newbold, "Spurious Regressions in Econometrics," Journal of Econometrics 2 (1974), 111-120.

CD, ch. 5,
HD (1996), chs. 3-4, 11.

1.2 Trend Stationary or Unit Root?

  1. Testing for trends and unit roots 
  2. Seasonality in economic time series 
  3. Testing for seasonal unit roots
  4. Structural change and outliers in tests for unit roots
*Lectures2.pdf

* Campbell, John, Y., and Pierre Perron, " Pitfalls and Opportunities: What Macroeconomists Should Know about Unit Roots ," NBER Macroeconomics Annual 1991 , edited by Olivier Jean Blanchard and Stanley Fischer, Cambridge: The MIT Press, 1991, 141-201.

* Kyung So Im, M Hashem Pesaran and Yongcheol Shin, “ Tesing for Unit Roots in Heterogeneous Panels ," Journal of Econometrics, 115 (July 2003), 53-74.

* Pesaran, M. H., “ General Diagnostic Tests for Cross Section Dependence in Panels ,” University of Cambridge Working Paper, June 2004.

* Pesaran, M. H., " A simple panel unit root test in the presence of cross section dependence ,”  September 2003, Revised January 2005 Cambridge University DAE Working Paper, number 0346 CD, ch. 5.

HD (1996), chs. 3-4, 16.

Balke, Nathan and Thomas B. Fomby (1994) "Large Shocks, Small Shocks, and Economic Fluctuations: Outliers in Macroeconomic Time Series," Journal of Applied Econometrics , Vol. 9, No. 2, pp. 181-200.

Dickey, D. A. and Wayne A. Fuller, " Distribution of the Estimators for Autoregressive Time Series with a Unit Root," Journal of the American Statistical Association , 74, June 1979, 427-31.

Levin, A., Lin, F. and C. Chu, (2002), “ Unit root tests in panel data: asymptotic and finite-sample properties ”, Journal of Econometrics, 108, 1-24.

Perron, P. " The Great Crash, the Oil Shock, and the Unit Root Hypothesis ," Econometrica 57 (1989) 1361- 1402.

Perron, Pierre, "Testing for a Unit Root in a Time Series with a Changing Mean," Journal of Business and Economic Statistics 8 (1990) 153-62.

Schwert, G.W., "Tests for Unit Roots: A Monte Carlo Investigation," Journal of Business and Economic Statistics 7 (1989) 147-59.

1.3 SEM: Cointegration and Error Correction Models

  1. Theoretical Concepts: Cointegration and Error Correction
  2. Testing for Cointegration
  3. Modeling Cointegrated Series Using Error Correction Models­long run solutions
  4. Hypothesis Testing in cointegrating framework
*Lectures3.pdf

* Engle, R. F. and C. W. J. Granger (eds) Long-Run Economic Relationships: Readings in Cointegration , Oxford University Press: New York, 1991, pp. 1-16.

* Hendry, D. F. " Econometric Modelling with Cointegrated Variables: an Overview ," Oxford Bulletin of Economics and Statistics , 48 (1986).

* Phillips, Peter, and Mico Loretan, "Estimating Long Run Economic Equilibria," Review of Economic  Studies 58 (1991) 407-36.

* Stock J. H., and M. W. Watson. " Variable Trends in Economic Time Series, " Journal of Economic Perspectives , 3 (Summer 1988), 147-74.

*Breitung, Jörg and M. Hashem Pesaran,“ Unit Roots and Cointegration in Panels ,” University of Cambridge Working Paper, August 2005.

Engle, R. F. and C. W. J. Granger, " Co-Integration and Error Correction: Estimation and Testing," Econometrica , 55,  Mar. 1987, 251-76.

Granger, C. W. J. " Developments in the Study of Cointegrated Economic Variables ," Oxford Bulletin of Economics and Statistics, 48 (1986).

Inder, Brett, "Estimating Long-Run Relationships in Economics," Journal of Econometrics  57 (1993) 53-68.

* Stock, J.H., and M.W. Watson," A Simple Estimator of Cointegrating Vectors in Higher Order Integrated  Systems ," Econometrica 61 (1993) 783-820.

1.4 VARS and their Limits

*Lectures4.pdf

  1. Introduction to VARS
  2. Estimation and identification
  3. Impulse Response Analysis
  4. Causality and Cointegration


* Dickey, D. A., D. W. Jansen, and D. L. Thorton, "A Primer on Cointegration with an Application to Money and Income," Economic Review (Federal Reserve Bank of St. Louis), 1991, 58-78.

*S. G. Hall, S.G.B. Henry, and J.V. Greenslade. “ On the identification of cointegrated systems in small samples: a modelling strategy with an application to UK wages and prices .” Journal  of Economic Dynamics and Control , 26, (August 2002) 1517–1537.

* Zhou, Allison, Carl Bonham, and Byron Gangnes, “ Identifying Long-run Cointegrating Relations: An Application to the Hawaii Tourism Model ”,  UHERO working paper.

Pedroni, P. (1997). Panel cointegration asymptotic and finite sample properties of pooled time  series tests with an application to the ppp hypothesis: New results. Working papers in economics.

Pedroni, P. (1999, November). “Critical values for cointegration tests in heterogeneous panels with multiple regressors.” Oxford Bulletin of Economics and Statistics, 61, 653–670.

Pedroni, P. (2000). “Fully modified ols for heterogeneous cointegrated panels,” In Nonstationary  Panels, Panel Cointegration, and Dynamic Panels , Volume 15 of Advances in Econometrics,  pp. 93–130. Connecticut: JAI Press.

CD chs. 6-7.

HD (1997) chs. 1-6, (7, 8-13)

Cooley, Thomas. F., and Steve.  Leroy, "Identification and Estimation of Money Demand," American Economic Review , 71 (December 1981), 825-844.

Cooley, Thomas F. and Steve LeRoy, "Atheoretical macroeconometrics: a critique," Journal of Monetary Economics , 1985, 16, pp. 283-308.

Runkle, David E. "Vector Autoregression and Reality," Journal of Business and Economic Statistics , 1987, 5, pp. 437-442 (and comments pp 443-454).

Sims, Christopher, " Macroeconomics and Reality ," Econometrica 48 (January 1980) 1-49.

1.5 Threshold Adjustment Models

* Enders, Walter and Piere L. Siklos (2001), " Cointegration and Threshold Adjustment ," Journal of Business Economics and Statistics , 19, 166-176.

Balke, N. S., and Fomby, T. (1997), " Threshold Cointegration ," International Economic Review , 38, 627-643.

Potter, Simon M., “ Nonlinear Time Series Modelling: An Introduction ,” Journal of Economic Surveys , 13, Dec 1999, 505-29.

1.8  GMM

* Clarida, Richard H., Jordi Gali, and Mark Gertler, "Monetary Policy Rules in Practice: Some International Evidence", European Economics Review, June 1998, 1033-1068.

* Hansen, Lars P. and Robert J. Hodrick, “ Forward rates as unbiased predictors of future spot rates .” Journal of Political Economy, 88, Oct. 1980, 829-53

Hansen, Lars P., “Large Sample Properties of generalized Method of Moments estimators,” Econometrica, 50, 1982, 1029-54.

Baum, C., M. F. Schafer, and S. Stillman, “ Instrumental Variables and GMM:

Estimation and Testing ,” Boston College WP 545.

Newey, W. and West, K. (1987). "Hypothesis testing with efficient method of moment estimators," International Economic Review, 28, 777-787.

1.9 Bootstrapping:

 Freedman, David A., and Stephen C. Peters, " Bootstrapping a Regression Equation: Some Empirical  Results ," Journal of the American Statistical Association, vol. 79 March 1984, 97-106.

MacKinnon, James G. " Bootstrap Inference in Econometrics ," Canadian Journal of Economics , 35, November 2002, 615-645.

Section II. Applications

2.1 Testing The Monetary Model:

*  IMF Chapter 3.

*   McDonald, Ronald and Mark P. Taylor, "The monetary approach to the exchange rate: rational expectations, long-run equilibrium, and forecasting," International Monetary Fund Staff Papers , 1993, 40, pp. 89-107.

*  Nelson C. Mark and Donggyu Sul, “ Nominal exchange rates and monetary fundamentals: evidence from a small post-Bretton Woods panel .” Journal of International Economics , 53, Feb. 2001, 29-52

* Chien Lo, Ming and Eric Zivot (2001), "Threshold Cointegration and Nonlinear Adjustment to the Law of One Price," Macroeconomic Dynamics , 5, 533-576.

* Froot, K. and K. Rogoff, 1995, " Perspectives on PPP and Long-Run Real Exchange Rates ," in Handbook of International Economics .

* Pedroni, P. “Purchasing Power Parity Tests in Cointegrated Panels,” Review of Economics and Statistics , 83, Nov. 2001, 727-31.

* Nelson Mark, 1995, " Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability ," American Economic Review , 85, Mar. 1995, 201-218.  

Cheung, Yin-Wong, Menzie Chinn, and Antonio Garcia Pascual, 2005, “Recent Exchange Rate Models: In-Sample Fit and Out-of-Sample Performance,” in Paul DeGrauwe (editor), Exchange Rate Modelling: Where Do We Stand ? (Cambridge: MIT Press for CESIfo).

Eichenbaum, Martin and Charles Evans "Some empirical evidence on the effects of shocks to monetary policy on exchange rates," Quarterly Journal of Economics , 1995, 110, pp. 975-1009.

Engle, Charles, " PPP may not hold after all " Journal of International Economics , 2000, 51, pp. 243-73.

Meese, Richard and Kenneth Rogoff, “Empirical exchange rate models of the 1970s: Do they fit out of sample?” Journal of International Economics 14, Feb. 1983, 3-24.

Papell, David H., " Searching for stationarity: purchasing power parity under the current float ," Journal of International Economics , 43, Nov. 1997, 313-32.

Sollis, R., “Evidence on purchasing power parity from univariate models: the case of smooth transition trend-stationarity,” Journal of Applied Econometrics, 20, 2005, 79-98.

 

2.2 Foreign Exchange Market Efficiency

*  IMF Chapter 6.

Deviations from UIP

*Hansen, Lars P. and Robert J. Hodrick, “ Forward rates as unbiased predictors of future spot rates .” Journal of Political Economy, 88, Oct. 1980, 829-53

* Fama, Eugene F. (1991) “Spot and forward exchange rates.”   Journal of Monetary Economics , 14,  319-38

Leona, Hyginus , Lucio Sarnob, and Giorgio Valenteb, “ Limits to Speculation and Nonlinearity in Deviations from  Uncovered Interest Parity: Empirical Evidence and Implications for the Forward Bias Puzzle ,”

Sollis, R. and Wohar, M.E. (2005), “"The real exchange rate - real interest rate relation: evidence from tests for symmetric and asymmetric threshold cointegration,” International Journal of Finance and Economics, forthcoming.

Testing Euler Equations

*Hansen, Lars P. and Ravi Jagannathan, “Implications of security market data for models of dynamic economies,” Journal of Political Economy , 99, 1991, 225-62.

*Hansen, Lars P. and Kenneth J. Singleton (1982) “ Generalized instrumental variables estimation of nonlinear rational expectations models .”  Econometrica 50, 1269-86

* Mark, Nelson C.,  “On time varying risk premia in the foreign exchange market: an econometric analysis.” Journal of Monetary Economics , 1985, pp. 3-18

Apparent Violations of Rationality: Survey Data , The Peso Problems, and Noise Traders

* Bonham, Carl, Richard Cohen, and Shigeyuki Abe, [2005], “Bias, Heterogeneity and Learning in the Tokyo Exchange Rate Market,” University of Hawaii Dept. of Economics Working Paper, No. ??05.

*Bonham, Carl and Rich Cohen, " Testing the Rationality of Price Forecasts: Comment ", The American Economic Review , 85, Mar. 1995, pp. 284-289.

*Frankel, Jeffrey A. and Kenneth A. Froot, "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," The American Economic Review , Vol. 77, No. 1. (Mar., 1987), pp. 133-153.

* Froot, K. and J. A. Frankel, " Forward discount bias: Is it an exchange risk premium ," Quarterly Journal of Economics , 104, 1989, 139-61.

* Ito, Takatoshi, “ Foreign Exchange Rate Expectations: Micro Survey Data ,” American Economic Review , Vol. 80, No. 3, June 1990,  434-49.

* Lewis, Karen (1989) “ Changing beliefs and systematic rational forecast errors with evidence from foreign exchange ,” American Economic Review , 79,  Sept. 1989, 621-36.

Frankel, J. A. and M. Chinn, "Exchange rate expectations and the risk premium: tests for a cross section of 17 currencies," Review of International Economics , 1, 1993, 136-44.

Mark, C. Nelson and Yangru Wu, "Rethinking deviations from the uncovered interest parity relationship," Economic Journal , 1998, 53, pp. 29-52.

Mark, N. C. and Y. Wu (1998), "Rethinking deviations from uncovered interest parity: the role of covariance risk and noise," Economic Journal , 108, 1686-706.

2.3 The Real Exchange Rate

* IMF Chapter 7.

* Clarida, Richard and Jordi Gali "Source of real exchange-rate fluctuations: How important are nominal shocks?," Carnegie-Rochester Conference Series on Public Policy , 1994, 41, pp. 1-56.

*Lothian, James R., and Mark P. Taylor, "Real exchange rate behavior: the recent float from the perspective of the past two centuries." Journal of Political Economy , 1996, 104, 488-509.

* Wu, Y. (1996). “Are Real Exchange Rates Nonstationary?  Evidence from a Panel Data Test, Journal of Money Credit and Banking,” 28, 54 - 63.

Canzoneri, M., R. Cumby, and B.Diba, “ Relative labor Productivity and the Real Exchange Rate in the Long Run; Evidence for a Panel of OECD Countries ,” Journal of International Economics , 47, April 1999, 245-66.

Frankel, Jeffrey and Andrew K. Rose (1996) “ A panel project on purchasing power parity: mean reversion within and between countries ,” Journal of International Economics , 40 , Feb. 1996, 209-24.

Frankel, J. and A. Rose, 1995, "Empirical Research on Nominal Exchange Rates," Chapter 33 in Handbook of International Economics,

2.4 Mundell Fleming

* IMF Chapter 8.

*  Eichenbaum Martin, and Charles Evans (1995) “Some empirical evidence on the Effects of shocks to monetary policy on exchange rates.”  QJE 100: pp. 975-1009.

*  Clarida, Richard and Jordi Gali (1994) “Sources of real exchange-rate fluctuations: How important are nominal shocks?” Carnegie-Rochester Conference Series on Public Policy 41: pp. 1-56.

2.5 Exchange Rate Movements and Financial Crises - Determinants and Consequences

* IMF Chapter 11.

* Frankel, Jeffrey and Andrew Rose, “ Currency Crashes in Emerging Markets. An Empirical Treatment ,” Journal of International Economics , 41, November 1996, 351-366.

* Hutchison, Michael and Ilan Noy (forthcoming). “How Bad are Twins? Output Costs of Currency and Banking Crises". Journal of Money Credit and Banking .

*  Obstfeld, Maurice (1994) “The logic of currency cries.”  Cahiers Economiqueset Monetaires, Bank of France: pp. 189-213. http://elsa.berkeley.edu/users/obstfeld/ftp/currency_crises/cc.html

Meese, R. 1986. "Testing for Bubbles in Foreign Exchange Markets: A Case of Sparkling Rates?" Journal of Political Economy 94 (April), 345-73.

Eichengreen, B., A. Rose and C. Wyplosz (1995):"Exchange Market Mayhem: The antecedents and aftermath of speculative attacks," Economic Policy 21: 249-312.

Bordo, Michael, Barry Eichengreen, Daniela Klingebiel, and Maria Soledad Martinez-Peria. (2001). "Is the Crisis Problem Growing More Severe?" Economic Policy 16, 53-82.

Kaminsky, Graciela and Carmen Reinhart (1999). “ The Twin Crises. The Causes of Banking and Balance-of-Payments Problems,” AER , 89(3), June, 473-500.