Outline of the remainder of this book Chapter 2 This introduces the classical linear regression model (CLRM). The ordinary least squares (OLS) estimator is derived and its interpretation discussed. The conditions for OLS optimality are stated and explained. A hypothesis testing framework is developed and examined in the context of the linear model. Examples employed include Jensen’s classic study of mutual fund performance measurement and tests of the ‘overreaction hypothesis’ in the context of the UK stock market. Chapter 3 This continues and develops the material of chapter 2 by generalising the bivariate model to multiple regression -- i.e. models with many variables. The framework for testing multiple hypotheses is outlined , and measures of how well the model fits the data are described. Case studies include modelling rental values and an application of principal components analysis to interest rate modelling. Chapter 4 Chapter 4 examines the important but often neglected topic of diagnostic testing . The consequences of violations of the CLRM assumptions are described, along with plausible remedial steps. Model-building philosophies are discussed, with particular reference to the general-to-specific approach. Applications covered in this chapter include the determination of sovereign credit ratings. Chapter 5 This presents an introduction to time series models, including their motivation and a description of the characteristics of financial data that they can and cannot capture. The chapter commences with a presentation of the features of some standard models of stochastic ( white noise, moving average, autoregressive and mixed ARMA ) processes. The chapter continues by showing how the appropriate model can be chosen for a set of actual data, how the model is estimated and how model adequacy checks are performed. The generation of forecasts from such models is discussed, as are the criteria by which these forecasts can be evaluated. Examples include model-building for UK house prices, and tests of the exchange rate covered and uncovered interest parity hypotheses. Chapter 6 This extends the analysis from univariate to multivariate models . Multivariate models are motivated by way of explanation of the possible existence of bi-directional causality in financial relationships, and the simultaneous equations bias that results if this is ignored. Estimation techniques for simultaneous equations models are outlined. Vector autoregressive(VAR) models , which have become extremely popular in the empirical finance literature, are also covered. The interpretation of VARs is explained by way of joint tests of restrictions, causality tests, impulse responses and variance decompositions. Relevant examples discussed in this chapter are the simultaneous relationship between bid--ask spreads and trading volume in the context of options pricing, and the relationship between property returns and macroeconomic variables. Chapter 7 The first section of the chapter discusses unit root processes and presents tests for non-stationarity in time series . The concept of and tests for cointegration, and the formulation of error correction models , are then discussed in the context of both the single equation framework of Engle--Granger, and the multivariate framework of Johansen. Applications studied in chapter 7 include spot and futures markets, tests for cointegration between international bond markets and tests of the purchasing power parity hypothesis and of the expectations hypothesis of the term structure of interest rates .
Bernanke On Soaring Interest Rates: "We Were A Little Puzzled By That" Submitted by Tyler Durden on 06/19/2013 17:14 -0400 Ben Bernanke Carry Trade Federal Reserve Japan Liquidity Bubble Monetary Policy Real Interest Rates Almost exactly 8 years after Greenspan's now infamous "conundrum" comments about the unprecedented persistence of low, long-term interest rates, Bernanke is now "puzzled" at the dramatic rise in interest rates following his recent Taper remarks. Have no fear though, just as Greenspan noted, "I'm reasonably certain we would not automatically assume that it would mean what it meant in the past, " Bernanke said today that the "sharp rise in rates", was not about the Taper but "due to other factors, including optimism about the economy." Perhaps more importantly, today for the first time someone, not Hilsenrath of course, had the guts to ask Bernanke the hardest question: is the Fed's "Stock not Flow" worldview broken, and was it wrong all along (as we have been alleging all along )? Of course, the implications of the Fed being wrong on this most critical aspect of monetary theory opens up a hornet's next of Pandora's boxes: just what else is the Fed wrong about, and how much will Bernanke be "puzzled" when one by one all of his flawed theories are revealed to be nothing but religious dogma . And finally what happens to the BOJ when it too has to "taper" and it too realizes that it is all about the flow (in a country where the central bank is monetizing at a relative pace which is more than double the Fed's ), and the second sentiment shifts, the entire liquidity bubble comes crashing down, taking not only Japan, but Europe - which is funded courtesy of the Japan carry trade - down with it? To summarize: bonds collapsing - no worries... it's still the Stock... although not really... and optimism. From today's press conference: QUESTION : Mr. Chairman, you've always argued that it's the stock of assets that the Federal Reserve holds which affects long-term interest rates. How do you reconcile that with the very sharp rise in real interest rates that we've seen in recent weeks? And do you think the market is correctly interpreting what you think is most likely to be the future path of the Federal Reserve's stock of assets? Thank you. BERNANKE : Well, we -- we were a little puzzled by that . It was -- it was bigger than can be explained , I think, by changes in the ultimate stock of asset purchases within reasonable ranges, so I think we have to conclude that there are other factors at work, as well, including, again, some optimism about the economy , maybe some uncertainty arising . So I'm agreeing with you that -- that it seems larger than can be explained by a changing view of monetary policy. It's difficult to judge whether the markets are in sync or not. Generally speaking, though, I think that what I've seen from analysts and market participants is -- is not wildly different from what, you know, the committee is thinking and trying -- as I tried today to communicate , I think the most important thing that I just want to convey again is -- is that it's important not to say this date, that date, this time. It's important to understand that our policies are economic-dependent, and in particular, if financial conditions move in a way that make this economic scenario unlikely, for example, then that would be a reason for us to adjust our policy. It's really the stock, stupid... (right?) BERNANKE: And by the same token, as long as we're buying assets, we're adding to our holdings. We do believe -- although, you know, there's room for debate -- we do believe that the primary effect of our -- of our purchases is through the stock that we hold, because that stock has been withdrawn from markets, and the prices of those assets have to adjust to balance supply and demand, and we've taken out some of the supply, and so the prices go up, the yields go down . So that seems to me consistent with the -- with the idea that we're still adding liquidity, we're still adding accommodation to the system. Average: 5 Your rating: None Average: 5 ( 23 votes) Tweet !-- Login or register to post comments 29907 reads Printer-friendly version Send to friend Similar Articles You Might Enjoy: 2012 Year In Review - Free Markets, Rule of Law, And Other Urban Legends Guest Post: The Economic Death Spiral Has Been Triggered Guest Post: Bernanke's QE^X Box John Taylor Rips Apart Bernanke Claim That Fed Policy Did Not Cause Bubble Bill Dudley Hits Refresh On Yahoo Finance, Discusses Asset Bubbles
The Chart That The BoJ Is Most Worried About (And So Should You Be) Submitted by Tyler Durden on 05/26/2013 18:01 -0400 Bond CDS China Fail Japan Lehman Reality Repo Market Volatility Until the last few days, the attention of the mainstream business media has been on how 'wonderful' Japan's policy prescription must be since its stock market is soaring at a record pace. The reality is that the far bigger JGB market has been crumbling . As we explained here , this is a major problem for the bubble-blowers, as the extreme volatility (VaR shock) that the Japanese Government Bond market has been through in the last few weeks has some very large and painful consequences, that as yet, have not been discussed widely. The term 'shadow banking' has been one ZH readers are by now extremely familiar with as we have discussed this as the panacea of unseen leverage ( most recently in Europe and China ) for years; the funding markets in Japan, so heavily reliant on JGB repo for short-term liquidity and the efficient functioning of two-way markets in the bonds, are hitting a wall. As JPMorgan notes, the number of JGB 'fails' - where a repo deal breaks down - has more than doubled in the last week. For a market that represents 40% of the total Japanese money-market, this will be a critical area to watch for a JGB waterfall. Via JPMorgan: The sharp rise in JGB volatility has not left the JGB repo market unaffected. The 80tr large Japanese repo market accounts for 40% of the total size of Japanese money market (which it also includes CDs/CPs, currency swaps, BoJ money market operations, and Call transactions) and it is an important lubricant of the JGB market. This is because repos with JGBs as collateral, account for more than 99% of domestic repo transactions. The haircuts are typically very low in the JGB repo market ranging from zero to 2%. This is because market participants are comfortable or accustomed to control risks through margin calls without often setting a haircut upfront. But these margin calls or haircuts where applicable, tend to rise when volatility rises. And the rise in margin calls or haircuts has caused a rise in “fails” . 175 fails in the month of April represents a sharp increase from March but it is still much lower from the 1000 figures seen immediately post Lehman. A fail is a situation where a recipient of JGBs in a transaction does not receive the JGBs from the delivering party on the scheduled settlement date. Typically the number of fails in Japan is quite small, partly because market participants try to avoid fails in advance, and because some market participants have never experienced fails. According to the BoJ, the situation is quite different from that prevailing in US repo markets, where fails occur much more frequently than in Japan and where market participants take action in accordance with the fails practice on a daily basis. The retrenchment in Japanese repo market is then fed into the JGB market propagating the initial volatility (VaR) shock. The repo market is used by market participants for funding or short selling and its functioning is important in maintaining a two-way market for JGBs.
Just Two 'Recession' Indicators Submitted by Tyler Durden on 05/01/2013 12:14 -0400 David Rosenberg Gluskin Sheff Personal Income Recession Rosenberg Monday's income and spending (and implicitly 'saving') data provided plenty of fodder at the headline level for any and every opinion. We explained in great detail just how weak the data really was ( here and here ). But the following two charts suggest that any optimism of organic consumption-led exuberance is completely misplaced. Retail sales of clothing is growing at the slowest pace since 2010; but while major store sales are about to drop negative YoY for the first time in over 3 years, the utter collapse in general merchandise sales is worse that at the peak of the last recession at -5% . It seems tough to see how a nation with an economy built on 70% consumption is not in a recessionary environment. And while this alone is a dismal signal for the discretionary upside of the US economy/consumer; as Gluskin Sheff's David Rosenberg points out real personal income net of transfer receipts plunged at a stunning 5.8% annual rate in Q1 . The other seven times we have seen such a collapse, the economy was either in recession of just coming out of one . But apart from that, everything is fine... Retail Sales collapsing... and absent the might of the US deficit, real personal income is also collapsing... Charts: Bloomberg and Gluskin Sheff Average: 4.75 Your rating: None Average: 4.8 ( 12 votes)
Germany's Virtuous Circle Takeover Of Europe Submitted by Tyler Durden on 04/26/2013 15:01 -0400 France Germany Recession Reuters German finance minister Schaeuble just explained, in a seeming effort to assuage rising fears that the one core nation left in Europe will choose the game-theoretically optimal first-defection wins strategy, that "Germany benefits from the Euro more than others." Indeed it does; as German firms are buying up strong competitors, clients or suppliers at a time when those companies are struggling to stay afloat through years of recession in their home markets and as shaky banks restrict access to credit. It appears that the slow-and-steady bloodless invasion of Europe can be summed up by the following virtuous circle of Germany's hidden strategy. Of course, as Schaeuble explained later in his missive, "it is nonsense" that Germany wants a German Europe and that the Euro exchange rates is "Okay" for Germany. As Reuters notes , ... Strong companies are attracting interest among the "Mittelstand" , medium-sized and often family-owned manufacturing firms to which Germany owes much of its exporting prowess. That is in large part due to the economic and labour market reforms bailout countries have been forced to implement - making it easier to hire and fire and reducing wage costs - which less stricken countries such as France have been slower to embrace. "For financially strong German Mittelstand firms, the crisis is turning out to be an opportunity . They are increasingly active with acquisitions in Spain," ... German firms are buying up strong competitors, clients or suppliers at a time when those companies are struggling to stay afloat through years of recession in their home markets and as shaky banks restrict access to credit. ... What makes southern Europe alluring is the benefits from tough austerity measures and reforms that euro zone policymakers, led by Germany, have pushed for in return for financial bailouts. ... "The reforms Germany is pushing for there will massively strengthen these countries' competitiveness compared to Germany. It's not a surprise German companies say Europe is interesting ." ... "More often than not the companies have known one another for a long time, and the southern European ones want to be bought. They are the ones taking the initiative because they need money. "
"What The Left Hand Giveth, The Right Hand Taketh Away" Submitted by Tyler Durden on 10/08/2012 16:43 -0400 One of the most insidious side-effects of the centrally-planned New Normal has been the artificial role switch of the two main asset classes, equities and bonds, which as David Rosenberg explained previously , can be characterized as follows: stocks for the yield, bonds for the price. The trouble with this is that it is contrary to everything inherent in investor and trader psychology. This in turn touches on another topic: as a result of collapsing interest rates, interest income from debt has plunged by a whopping $450 billion/year in nominal terms , forcing public corporations to shelve out dividends, as Dividend income takes the place of Interest Income, merely to keep some investor interest in capital markets awake. There is a two-fold problem with the surge in equity dividends: i) it forces management teams to reallocate cash away from projects which generate higher IRR in the longer term, such as CapEx, RD, and innovation, or even simple MA, and ii) the dividend spike is simply not enough to offset the lost interest income. This precisely is one the points of UBS' George Magnus in his newsletter in which he asks Cui Bono from global uncoordinated easing. His observations: "In the US household interest income from assets has dropped to below $1 trillion, compared to $1.4 trillion in 2008. That $400 billion drop is equivalent to a fall from 11.5% to below 7.5% as share of personal income, and, in passing, to the size of President Obama’s stimulus programme in 2009." Of particular note: if interest income as a percentage of total personal income had remained at its 2008 level, the total would now be over $1.5 trillion. It is this $550 billion annual delta that the Fed has directly, though its policies, taken away from US consumers in terms of purchasing power. So while the Fed has taken away the bond market as a venue in which to generate current income, it is the structural failures of equities in a post-HFT world (stories of mini, amd maxi, Flash Crashes are now a daily occurrence) that prevent investors from having the same confidence about current income in a market in which terminal and fatal capital loss are all too real fears. And there are those who still wonder why the US consumer is withering away, and absent such crutches as soaring Federal non-revolving debt, used for anything but its designated purposes, would have less purchasing power now than before the crisis as a result of the Fed's failed policies. As George Magnus so poetically summarizes it " What the left hand giveth, the right hand taketh away ." And yet, it is not true that everyone loses equally from the Fed's policies. Bernanke does benefit one group of people: the ultra-wealthy, aka the "1%", which owns the bulk of its assets in America's $52 trillion in financial assets and which is the most direct beneficiary of QEternity. Magnus' conclusion: it is time Bernanke woke up and smelled the coffee, because what he is effectively doing via Monetary policy could be the most socially disruptive phenomenon seen in developed Western society in ages: Central banks don’t have a social welfare function in their remit. But it can’t make economic sense for them to pursue policies, ad nauseam, that drain interest income from the economy, threaten the solvency of pension plans, and redistribute wealth and income, in effect, to richer households with a low marginal propensity to consume . And it could result in a political backlash when the call for radical economic policy changes and innovative political thinking requires a high level of social cohesion. The flipside to this argument is to just let Bernanke continue with his catastrophic policy, and hope he accelerates the advent of the inevitable end even more, as the final outcome is merely one which ends with the tearing down of the Marriner Eccles building. Sadly at this point, that particular outcome is no longer a question of if, but when. Average: 5 Your rating: None Average: 5 ( 10 votes) Tweet Login or register to post comments 4881 reads Printer-friendly version Send to friend Similar Articles You Might Enjoy: How The Fed's Visible Hand Is Forcing Corporate Cash Mismanagement $450 Billion In ZIRPorized Purchasing Power: Two Charts That Explain The Baby Boomer Dilemma Next: The Great Recoupling The New Normal Of Investing: Bonds For The Price, Equities For The Yield David Rosenberg: "RIP Wealth Effect"
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