Working Papers
2007
September 1, 2007
Capital Market Development in a Small Country: The Case of Slovenia
Description: Small emerging economies, despite their significant growth, lack the scale to develop thriving capital markets from their local investor and issuer base that are able to deliver the benefits of a large, mature market. Slovenia is such an example. Despite the necessary infrastructure in place, trading has remained thin and issuance activity has been dormant. This paper proposes a two-pronged strategy for capital market development that leverages the existing setup in the context of regional integration such as within the EU. While using the case of Slovenia, this path might be indicative for other small countries that are part of a larger economically integrated region.
September 1, 2007
The Determinants of Corporate Risk in Emerging Markets: An Option-Adjusted Spread Analysis
Description: This study explores the determinants of corporate bond spreads in emerging markets economies. Using a largely unexploited dataset, the paper finds that corporate bond spreads are determined by firm-specific variables, bond characteristics, macroeconomic conditions, sovereign risk, and global factors. A variance decomposition analysis shows that firm-level characteristics account for the larger share of the variance. In addition, the paper finds two asymmetries. The first is in line with the sovereign ceiling "lite" hypothesis which states that the transfer of risk from the sovereign to the private sector is less than 1 to 1. The second is consistent with the popular notion that panics are common in emerging markets where investors are less informed and more prone to herding.
September 1, 2007
India: Asset Prices and the Macroeconomy
Description: This paper examines rising asset prices in India. For the most part, asset prices in India reflect structural factors but the risk of a correction cannot be ruled out. However, at this juncture monetary policy may not be the most effective tool to safeguard financial stability because (i) India's economy is undergoing rapid structural change making it difficult to identify price misalignments; (ii) the macroeconomic impact of an asset price correction is likely to be small; and (iii) the relationship between monetary policy and asset prices is also weak. Targeted changes in financial regulations are better tools to address potential risks.
September 1, 2007
Political Budget Cycles in Papua New Guinea
Description: This paper assesses the presence of opportunistic electoral budget cycles in Papua New Guinea. Using quarterly time series data, a clear pattern emerges of pre-election manipulations of fiscal policy by incumbent governments, mainly in the form of increased development spending and overall primary expenditure, followed in some cases by retrenchment in post-election periods. These findings are consistent with the predictions of rational opportunistic political business cycle theory. It is noteworthy that revenue was not statistically significantly related to elections, either in the pre- or post-election period. In this regard, electoral swings in fiscal deficits reflect a preference for influencing expenditures rather than taxation.
September 1, 2007
Ethnic Diversity, Democracy, and Corruption
Description: I study the link between ethnic diversity, democracy, and corruption. In a static model, I show that contrary to conventional wisdom, corruption might emerge as a negative externality of democracy. This occurs through ethnicity, which appears as a rent-extracting technology in a democratic society. Extending the model into a dynamic framework, I find that this technology of extraction operates only at the early stage of democracy. Its impact tends to phase out as democracy matures. In other words, the model predicts that democracy exhibits a threshold effect on corruption.
September 1, 2007
Banking Competition and Capital Ratios
Description: We use data for more than 2,600 European banks to test whether increased competition causes banks to hold higher capital ratios. Employing panel data techniques, and distinguishing between the competitive conduct of small and large banks, we show that banks tend to hold higher capital ratios when operating in a more competitive environment. This result holds when controlling for the degree of concentration in banking systems, inter-industry competition, characteristics of the wider financial system, and the regulatory and institutional environment.
September 1, 2007
Bank Ownership, Market Structure and Risk
Description: This paper presents a model of a banking industry with heterogeneous banks that delivers predictions on the relationship between banks' risk of failure, market structure, bank ownership, and banks' screening and bankruptcy costs. These predictions are explored empirically using a panel of individual banks data and ownership information including more than 10,000 bank-year observations for 133 non-industrialized countries during the 1993-2004 period. Four main results obtain. First, the positive and significant relationship between bank concentration and bank risk of failure found in Boyd, De Nicolò and Al Jalal (2006) is stronger when bank ownership is taken into account, and it is strongest when state-owned banks have sizeable market shares. Second, conditional on country and firm specific characteristics, the risk profiles of foreign (state-owned) banks are significantly higher than (not significantly different from) those of private domestic banks. Third, private domestic banks do take on more risk as a result of larger market shares of both state-owned and foreign banks. Fourth, the model rationalizes this evidence if both state-owned and foreign banks have either larger screening and/or lower bankruptcy costs than private domestic banks, banks' differences in market shares, screening or bankruptcy costs are not too large, and loan markets are sufficiently segmented across banks of different ownership.
August 1, 2007
Debt Stabilization Bias and the Taylor Principle: Optimal Policy in a New Keynesian Model with Government Debt and Inflation Persistence
Description: We analyse optimal monetary and fiscal policy in a New-Keynesian model with public debt and inflation persistence. Leith and Wren-Lewis (2007) have shown that optimal discretionary policy is subject to a 'debt stabilization bias' which requires debt to be returned to its pre-shock level. This finding has two important implications for optimal discretionary policy. Firstly, as Leith and Wren-Lewis have shown, optimal monetary policy in an economy with high steady-state debt cuts the interest rate in response to a cost-push shock - and therefore violates the Taylor principle. We show that this striking result is not true with high degrees of inflation persistence. Secondly, we show that optimal fiscal policy is more active under discretion than commitment at all degrees of inflation persistence and all levels of debt.
August 1, 2007
The Golden Rule and the Economic Cycles
Description: The present formulation of the golden rule in the United Kingdom allows fiscal performance to be tested explicitly on an ex-post basis. However, it requires precise dating of the economic cycle, which can lead to significant controversy. Also, the need to aim for current balance or better "over the cycle" may force fiscal policy to be procyclical toward the end of cycles. Using dynamic stochastic simulations, the paper suggests that making the formulation of the golden rule forward-looking and independent of the dating of the economic cycle would reduce the risk of procyclicality and enhance macroeconomic stability.
August 1, 2007
Structuring and Restructuring Sovereign Debt: The Role of a Bankruptcy Regime
Description: In an environment characterized by weak contractual enforcement, sovereign lenders can enhance the likelihood of repayment by making their claims more difficult to restructure ex post. We show however, that competition for repayment among lenders may result in a sovereign debt that is excessively difficult to restructure in equilibrium. This inefficiency may be alleviated by a suitably designed bankruptcy regime that facilitates debt restructuring.