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This short paper provides an overview of the special issue “Rethinking Risks in International Financial Markets: Modeling Tools and Applications” which features high-quality research papers that have been presented at the 7th International Finance Conference (IFC7). This selection of papers tackles an important issue in financial economics, which is “risk modeling, assessment and management” at both firm and market levels in the aftermath of the recent global financial crisis 2008–2009.

This paper examines a consumption-portfolio allocation and information trading problem with recursive utility in continuous time when stock returns are unobservable and when investors have to learn about it by using the stock price and the information products they purchase. We derive optimal consumption, portfolio policies, and information trading strategies in a semi-closed-form. Our quantitative analysis shows that ignoring information trading opportunities leads to significant economic losses for investors, particularly in a high-uncertainty case. More importantly, using the recursive utility, we innovatively find that the elasticity of intertemporal substitution (EIS) has a significant impact on an investors’ information trading. In particular, the lower the EIS of the investor, the more information products purchased by the investor. This paper provides an important economic foundation regarding trading information products in the financial market.

This paper investigates the impact of government corruption on corporate tax avoidance in China. A new method of weighted imputed profit is introduced to measure the firm's true profit to improve the measurement of tax avoidance. Employing a large sample of nearly 600,000 firms from 1998 to 2007, the empirical results illustrate that government corruption is positively related to tax avoidance. More specifically, I find that a one standard deviation increase in government corruption corresponds to a 6% increase in tax avoidance by firms. I find consistent evidence when using a natural experiment, Tax Sharing Act in 2002. In addition, I find that domestic private firms tend to avoid a larger portion of their tax liabilities than foreign or state-owned firms. Moreover, this paper confirms that tax avoidance increases with tax rates. Overall, this paper suggests that fighting corruption in local governments may lead to higher rates of tax collection.

This paper fills a gap in the literature of gender bias in household expenditure by analyzing how institutional norms affect behavioral preferences in the context of Iran’s household expenditure allocation. Although Iran’s institutional norms and culture show gender bias in various forms, there is no information about gender bias in household expenditure. Using descriptive statistics, Engel Curve method and Tobit method with Household Income and Expenditure Survey data from 1987 to 2007, the paper examines the presence of gender bias in Iran’s household expenditure. Findings show that women and girls suffer bias in food expenditure, an important determinant of female health outcomes such as fertility, prenatal and neonatal conditions. However, other expenditure allocations mostly work favorably for them. These findings are significant for policy prescriptions designed for generating equity in the allocation of household expenditure to foster economic development and creating a template for countries where girls and women face similar constraints.

This paper examines whether and to what extent development of the local-level financial sector improves SMEs’ performances. While only a handful of studies examines the relationship between local financial development and firm growth, no theoretical basis has been provided in those studies to understand transmission channels and instruments through which local financial development works in favor of firm growth. This paper attempts to fill that gap. In a theoretical framework, this paper shows that an optimal number of bank branches in an area works as an instrument of the transmission channel from financial development to growth, which helps reduce excess liquidity and increase SMEs’ access to bank credit by creating links between the demand and supply of liquidity. Banks default credit risk and cost of branch expansion determine the optimal number of branches in an area: a higher number of branches will reduce asymmetry of information about borrowers and monitoring costs, leading to lower default risks. Using new firm-level survey data of 1084 SME manufacturing firms from Bangladesh, our empirical analysis suggests that there is a threshold level of bank branches that can improve SME performance at the sub-district level. Our findings highlight the importance of potential returns to an optimal branching strategy of banks at the sub-national level that will lead to inclusive finance and growth within a country.

Based on a sample of Listed Companies in China between 2007 and 2018, this paper analyzes the impact of stock market mispricing on company’s innovation. The results demonstrate that when the stock price is overvalued, a company’s innovation investment will be higher, that is, overvaluation by the stock market is significantly positively related to firm innovation. In the path analysis, this paper finds that about 10% (RII, RVI, MPI) or 20% (MFFLOW) influence of stock mispricing on enterprise innovation is from financing demand. Further, this paper finds that the level of firm growth and stock turnover play a moderating role in the relationship between them. The conclusions of this paper are robust after a series of tests, such as instrumental variable, sub-sample test, two-way fixed effect and two-way cluster analysis.

Military spending in relation to national GDP and government budgets in both advanced and developing economies has fallen considerably since the end of Cold War. The previous papers have studied convergence in military spending by deploying methodologies used to analyze convergence in country growth rates and other economic variables. In this paper, we employ an improved technique and more up-to data for 138 countries during 1970–2019 to study convergence in military spending. We find that there is indeed convergence in military spending across countries, but in 3 distinct groups, with each group comprising both advanced and developing countries. A country’s membership of a group is influenced by political stability and risk of violence in the country, the level of its social spending and military spending by its neighbors. Our empirical results have important implications for a key budget component in both advanced and developing countries.

This paper analyses the role of the global financial cycle in determining domestic economic cycles, defined as business and credit cycle, of India and Indonesia, two key open lower-middle income emerging economies in Asia. The paper particularly examines to what extend the global financial cycle can explain the variation in domestic economic cycles in the two countries and analyses the differences. Using quarterly data from 2000 to 2018, and employing various econometric techniques such as concordance index, DCC-GARCH model and standard SVAR, the study finds: (i) the domestic credit cycle is highly synchronized with global financial cycle for India, whereas in the case of Indonesia the synchronization is muted and indirect, (ii) exchange rate appreciation leads to credit boom in India, indicating risk taking behaviour through the financial channel; while in Indonesia, credit boom is driven mainly by the indirect impact of global financial cycle through the domestic real economy, (iii) the Reserve Bank of India responds to output gap strongly, suggesting an adherence to inflation targeting framework, and (iv) Bank Indonesia also responds to exchange rate volatility and credit cycle as an approach to mitigate the risks associated with large and often volatile capital flows. These differences in monetary policy approach may explain the differences in transmission of spill-over effects of global financial cycle on domestic economic cycles in the two countries.

Zombie firms cause serious, widespread harm to the economy. It is thus important to clarify the reasons for their formation. This paper empirically investigates the effects of government intervention on the formation of zombie firms. It suggests that a greater degree of government intervention can increase the risk that a firm will become a zombie firm. Robustness tests and endogeneity tests confirm this finding. Further, we undertake a preliminary exploration of the mechanism of government intervention on the formation of zombie firms, and study how government behaviors affect the formation of such firms from various perspectives. Analysis reveals that government induces the formation of zombie firms by means of subsidies, resource support, financial support, and tax. To a certain extent, the conclusions of this paper could guide the formulation and revision of government policies, which would be conducive to adjusting the direction and intensity of government intervention and providing new ideas for supply-side structural reforms in China. The Chinese government should further increase the role of market force in its reforms.

This paper adds a government subsidy variable to expand the WWY (Wang, C., Wang, N., Yang, J., 2012) model, which is a three-stage entrepreneurial dynamic partial equilibrium model and a useful theoretical tool to analyze entrepreneurial realities after government intervention factors are considered. We analyze the productivity shock and market portfolio risk, endogenous entry and exit, investment, consumption, enterprise value and so on, using 15 parameters and 21 variables. The paper explains the present hi-tech entrepreneurial competitive advantage of US, even Chinese government provides lump sum financial subsidy. Although subsidies lower the initial entrepreneurial condition, significantly increase the number of startups, but would not improve entrepreneurial quality such as the investment and the growth of the hi-tech entrepreneurial wealth. The ongoing market deepening reforms such as IPO reform and venture capital cooperation will finally improve model parameters of China and weaken US’s advantage. Another conclusion is that debt-based entrepreneurship should not be encouraged. The conclusions will have some important policy significance.

This paper investigates the influence of wealth accumulation on household risk tolerance. We analyze the influence of several household characteristics on risk tolerance using data from the Chinese Household Finance Survey. We further explore the effects of age, personal experience with famine, level of regional trust and income threshold on this relationship. The empirical results indicate the following. First, the accumulation of household wealth can significantly increase household risk tolerance. Second, this relationship weakens with age, and for elderly people, experience with famine offsets this enhancing effect. Third, higher levels of regional trust help increase a household’s ability to withstand risks. Fourth, the enhancing effect of income level on household risk tolerance is more significant for high-income families than for low- and middle-income families. Finally, the level of social security does not have a significant impact on a household’s risk tolerance. This paper provides a clear understanding of the determinants of risk tolerance and the effects on household risk tolerance.

This paper explores the role of Bitcoin in diversifying investment risks during periods of high global economic policy uncertainty. It employs the bootstrap full- and sub-sample rolling-window Granger causality tests to investigate the mutual causal influence between global economic policy uncertainty and Bitcoin returns. It finds that global economic policy uncertainty has both positive and negative causal impacts on Bitcoin returns, suggesting that Bitcoin cannot always be viewed as a new basket for eggs since it can not always be considered to hedge policy uncertainty. The paper finds a positive reverse causal impact of Bitcoin returns on global economic policy uncertainty, indicating that the Bitcoin market contains useful information to forecast global economic policy uncertainty. Additional analyses suggest that global economic policy uncertainty also contains valuable information to improve the prediction of returns and volatility in the Bitcoin market. Under the recent global trade tensions and complex economic environment, these analyses imply that investors and countries can exploit the Bitcoin market to optimize their investment.

This paper examines the impact of economic policy uncertainty on non-executive employees from the perspective of pay-performance sensitivity (PPS). Economy-wide uncertainty can trigger adverse impacts for businesses, and in response enterprises may adjust employee pay to maintain their level of activity. Using firm-level data on A-share companies listed on the Shanghai and Shenzhen Stock Exchanges during 2003–2016, this paper finds that better-performing firms pay higher wages on average, which they adjust only during uncertain times. We also show that the impact of economic policy uncertainty on PPS is more pronounced in the context of labor-intensive, highly competitive industries and state-owned enterprises, because they tend to respond to uncertainty via wage adjustment. The evidence demonstrates that the pay-performance link is much weaker during uncertain times, when different subgroups react differently. However, our finding of a robust pay-performance relation holds, even with a range of firm-level controls and accounting for different levels of firm heterogeneity.

Smooth transition exponential smoothing (STES) uses a logistic function of a user-specified transition variable as adaptive time varying smoothing parameter. This paper empirically addresses three aspects of the use of STES for volatility forecasting. Previous empirical results showed the method performing well in comparison with fixed parameter exponential smoothing and a variety of GARCH models. However, those results related only to forecasting weekly volatility. In this paper, we address the use of STES for forecasting daily volatility. A second issue that we evaluate is the robustness of STES in the presence of extreme outlying observations. The third aspect that we consider is the use of trading volume within a transition variable in the STES method. Our simulation results suggest that STES performs well in terms of robustness, when compared with standard methods and several alternative robust methods. Analysis using stock return data shows that STES has the potential to outperform standard and robust forms of fixed parameter exponential smoothing and GARCH models. The results suggest the use of the sign and size of past shocks as STES transition variables, and provide no clear support for the incorporation of trading volume in a transition variable.

This paper investigates the effect of antidumping on multi-product firms’ adjustment in export quality using highly disaggregated Chinese exports data at the firm-product-country level for the period 2000–2014. In response to antidumping, firms tend to upgrade the quality of their exports for targeted products in affected markets by product adjustment, with this effect being more pronounced for firms with ex ante higher product quality. Antidumping induces resource reallocation across firms for a product such that higher-quality firms upgrade the quality while lower-quality firms are unaffected, and reallocation across products within a firm with the quality of products of higher competency increasing more substantially under antidumping policy. Our paper contributes to our understanding on how a multi-product firm adjusts by reallocating resources across products in the face of trade policy shocks.

This paper sheds light on the effects of two different types of R&D financing sources respectively from a supply-demand combined perspective, namely subsidy from government and venture capital in market, on the innovation process. Our empirical analysis is based on a unique data set of industrial enterprises located in Beijing ZhongGuanCun Science Park during the period 2008–2015. In terms of the two stages of the innovation process, this paper untangles and compares the effects of the two financing sources on R&D input, patent output as well as profit outcome. We find that both supply- and demand-side external R&D financing channels have differential effects on the innovation process in terms of input, output or outcome as well as the different-sized enterprises. Supply-side subsidy tends to be more effective at the front end of the innovation process, while venture capital shows a demand-side consideration on technology evolution by focusing more on the back end of the innovation process. Both government subsidy and venture capital can have a significantly positive impact on the entire innovation process of small and micro enterprises, whereas for large and medium-sized enterprises, subsidy has no significant impact on profit outcome and venture capital can only affect patents positively. These findings suggest that the Chinese government should focus more on small and micro firms and increase such firms’ access to venture capital through a process of certification, so as to achieve an effective combination of government functions and market functions.

This paper investigates whether market competition encourages firms to be more socially responsible. We find that firms in more competitive markets exhibit better overall social performance, as measured by doing well (“strength”) and doing badly (“concern”) in areas such as community, environment, human rights, and treatment of employees. To deal with endogeneity, we instrument market competition on entry barrier and observe that market competition only significantly reduces social concerns but not increases social strengths. Thus, firms are more reactive in reducing social concerns than proactive in augmenting their social strengths. Amongst these concerns, firms appear to be more active in reducing environmental concerns. The paper underscores the limitations in relying on the “invisible hand” of the market to deal with the multi-dimensional challenges of firms’ social performance.

The aim of this paper is to investigate the semi-strong market efficiency hypothesis with respect to fiscal policy information, in the context of the Bucharest Stock Exchange. Taking into account that macroeconomic data series of emerging countries usually have a limited size and may be plagued by inconsistencies and structural breaks, this paper proposes an ARDL Bounds testing approach for studying the relationship between stock returns and lagged macroeconomic variables. Moreover, this approach allows us to examine both the long and short-term relationship between fiscal policy and stock returns. The results indicate that, in the long run, stock prices fully and efficiently reflect information on past fiscal policy. However, in the short run, the Romanian stock market reacts efficiently only to unexpected fiscal policy news, while anticipated fiscal policy information displays a significant lagged relationship with current stock returns. In addition, the results also showed that monetary policy information is not incorporated efficiently into stock prices, both in the short and the long run, and its impact on stock returns is larger than the one exerted by fiscal policy.

Do all aspects of social capital improve repayment behavior in group lending programs? The group lending literature typically uses one or few measures of social capital in a linear form, and systematically understates the uncertainty of results and model specifications. As a result, many papers conclude that specific measures of social capital do not matter. This paper introduces Bayesian Model Averaging to the group lending literature and simultaneously tests the validity of six different measures of social capital. While the initial analysis suggests that only few measures matter, this result becomes invalid when using model selection criteria and Bayesian Model Averaging while allowing for nonlinearity and interactions between different aspects of social capital. We find geographical proximity, trust, friendship, group homogeneity, and acquaintanceship to be important factors in explaining group repayment with mixed evidence for relatives. Our results suggest that microfinance institutions should target borrowing groups with more social capital.

This paper develops a model for analyzing skewness in returns when an investor observes a novel skew-normally distributed signal about a risky asset's payoff. The equilibrium third moment increases with the signal's skewness, and its magnitude increases with the signal's noisiness. Using institutional ownership and market capitalization as proxies for information precision, we find that both proxies are significantly and negatively correlated with the future absolute third moment in firm returns in China. We show that these relations are mainly driven by the negative third moment. The two proxies are positively correlated with future skewness, which contradicts the corresponding relations found in the US. Our model can reconcile the opposite findings if the US evidence is driven by positive skewness. This paper suggests that it is more appropriate to forecast positive and negative skewness separately when using information-precision proxies.

Investments in research and development (R&D) have played a key role in promoting productivity improvements and economic growth. This paper explores the economics effects of public R&D investment funding in Brazil, taking into account the changes in total factor productivity (TFP) in high-, medium- and low-technology sectors. Public funding plays an important role in the development of R&D activities in Brazil and its participation has increased since 2010. Our paper simulates a withdrawal of R&D investments and TFP linked to public financing from an R&D-based computable general equilibrium (CGE) model, which recognizes the stock-flow relation between R&D investment and knowledge capital. Without public R&D investment funding, the main findings indicate losses in TFP, adverse effects on the formation of physical capital, shrinkage of more intensive R&D industries, and more future dependence on the public sector for knowledge stock, especially for education.

This paper studies the (de)stabilizing effects of income tax rules in a two-sector small open economy with production externalities. The paper shows that in the model with positive sector-specific externalities in the investment sector and negative sector-specific externalities in the consumption sector (or positive aggregate investment externalities), a regressive income tax rule can stabilize such an economy against indeterminacy, whereas a progressive income tax rule can increase the tendency for indeterminacy to occur. This paper also studies two variants that consider an imperfect world bond market and an endogenous labor supply, respectively, and shows that the qualitative results stated above remain valid. Moreover, increasing the level of sector-specific investment externalities can decrease (increase) the minimal level of tax progressivity required for indeterminacy if the investment externalities are below (above) a certain critical value and if the negative externalities in the consumption sector are taken as given.

This paper identifies the heterogeneity issue as a key challenge that is central to but not fully addressed when measuring global value chains. To resolve this issue, we propose an extended input-output model that is consistent with the theoretical framework of heterogeneous firms. Empirically, we use China as a prominent example of a country that is engaged in both normal trade and the processing trade under a dual-trade regime, and we synthesize methods for constructing China’s extended input-output dataset for the period 1997 to 2015. Our results show that when alternative generic datasets are used, this is likely to result in overestimating the domestic content in China’s exports by as much as 44%, compared to a model that uses an extended database that incorporates production heterogeneity, as does the one in this study. This paper’s proposed methodology and rich dataset may be useful to a wider range of empirical applications.

The T+1 trading mechanism is unique in the Chinese stock market, thus providing a natural experimental field to study the trading mechanism and price behaviors. This paper proposes and proves that T+1 trading mechanism causes negative overnight return, the overnight return can serve as a proxy of the T+1 trading mechanism. The paper finds that the overnight return of the Chinese stock market is significantly negative, whereas those under the T+0 trading mechanism, such as China’s stock index futures, Hong Kong stocks, and major international indices, all have around 0 or positive overnight returns. T+1 trading mechanism has greater impacts on stocks with more divergent investor opinions, higher risk, more individual investor percentages, higher arbitrage restrictions, and less liquidity. The T+1 trading mechanism distorts the price generation mechanism of stocks. The paper contributes to the understanding of impact of trading mechanism on stock prices.

This paper provides new insights into the study of technology spillover effects through the interaction between industrial and spatial linkages. We develop a theoretical model that provides a useful modeling framework for spillover research, and then empirically test the model inferences using Chinese firm-level data. Input-output tables and spatial decay measurements are combined to construct the key spillover variables. Using seemingly unrelated regressions, the paper finds that vertical spillover effects are more significant than horizontal spillover effects, both within- and between-regions; regional characteristics have greater impacts on vertical spillovers than on horizontal spillovers; and regional spillover effects vary across different regions. Regional policies and regional endowments, including human capital, transportation infrastructure, and enterprise ownership, are crucial in explaining these heterogeneities in regional technology spillover. Our empirical results provide many policy implications including strengthening the connection between upstream and downstream industries and devoting more R&D to upstream industries.

This paper studies the impact of tax cuts on enterprises’ R&D intensity. We use a natural experiment involving China’s business tax changing to value-added tax (“BT to VAT”) to identify any causality. The results reveal that this tax reform has prompted enterprises to increase their research and development (R&D) investment. Specifically, a stronger ability to transfer tax, results in this change having a more significant promotional effect on enterprises’ R&D intensity. Further analysis demonstrates that firms with different ownership types and in different industries respond differently to the “BT to VAT” policy. Our findings are only significant for non-state-owned and other modern service enterprises. This paper provides a theoretical and empirical basis for detailed analyses of the effects of “BT to VAT” policy, particularly the government’s subsequent improvement to the tax reform policy, to further stimulate enterprise investments in R&D as well as industrial upgrading.

This paper analyzes the implementation of the optimal policies at the Zero Lower Bound (ZLB) by the Taylor rule in the presence of a cost channel. We find that, the presence of a cost channel significantly impairs the ability of the Taylor rule to implement optimal policies when economy is subject to the ZLB. The main findings of the paper are, (i) the Taylor rule with optimally chosen inflation target partially implements the optimal discretionary policy but cannot implement the optimal policy under commitment, and (ii) the T-only policy, which follows discretion after an optimally chosen exit date from the ZLB, is the best that can be implemented by the Taylor rule in the presence of cost channel.

The idea that heightened uncertainty among firms contributed to the Great Recession and the lacklustre subsequent recovery has inspired a substantial literature examining the impact of changes in uncertainty on output and investment decisions. Yet to date there has been little research on business uncertainty in emerging markets. This paper is one of the first to develop a set of survey-based proxies for business uncertainty for an emerging market, South Africa, based on micro-data from business tendency surveys. These survey-based proxies are combined with more common measures of uncertainty, based on financial data and text mining, to obtain a composite measure of economic uncertainty. The paper then examines whether the uncertainty indicators have plausible and significant relationships with real economic activity, even after controlling for other economic variables. The indicators exhibit a significant negative correlation with real GDP growth, consistent with the findings for developed countries, and a positive shock to uncertainty is generally followed by a significant decrease in real activity growth.

This paper examines the implications of growing international production fragmentation-induced trade in intermediate goods on environmental quality. Specifically, by making use of a general equilibrium framework, this paper explores the link between trade in intermediate goods and pollution in a setting of endogenous environmental policy. The paper shows that international trade in intermediate goods, through an increase in the number of components available to the international producers, affects the level of pollution and environmental quality. Specifically, developed countries may reduce pollution at the cost of more pollution in developing countries.

While recent surveys have taken a special interest in culture to explain the failure of existing regulation, empirical evidence on the role of culture in influencing the bank capital-performance link is still largely unexplored. In this paper, we ask the following: Should regulators and policy makers make room for culture as an effective tool for a successful bank regulatory environment? We identify three proxies for cultural values derived from Hofstede (1980, 2001) and the World Values Survey and investigate to what extent individualism, masculinity, and trust can enhance or impede the capital-performance link for conventional and Islamic banks. Analyzing a panel of 729 banks operating in 33 countries from 1999 to 2013, our findings provide empirical evidence that cultural values enhance the capital-performance link for the two bank types. Our results have important policy implications: our paper represents a first initiative and provides evidence that culture has merits and can be used as an additional tool to implement regulatory guidelines in a successful way.

This paper constructs a theoretical model which captures the recent slowing-down of Chinese economy. In contrast with the previous literature which largely confines its focus on the resource misallocation between inefficient state-owned enterprises (SOEs) and more efficient private firms under a closed economy setting, this paper re-examines the dynamics of the growth of Chinese economy from the perspective of an open economy. In particular, this paper incorporates heterogeneous outputs and relative prices into the model, where private firms are assumed to be the major exporters and the remaining large SOEs create increasing import demand from the home country. By adding downward sloping world demand curve, our paper predicts a turning point during the transition process, as the falling relative price for exports starts to constrain and eventually slow down the growth; SOEs begin to co-exist with private firms in the economy before it is fully transformed. Our paper provides a theoretical foundation in terms of understanding the current dynamics and institutional change of Chinese economy. Additionally, this paper also provides quantitative evidence on the effects of financial development during the China's economic transition process.

This paper takes a holistic view and examines the environmental effect of the home country on firms’ outward foreign direct investment (OFDI) decisions. We construct an economic growth index to assess the overall economic environment of Chinese regions and find that the home country’s business environment is negatively associated with firms’ decisions to invest abroad, and that such a negative relationship can be intensified for firms with state ownership or without an export network. Moreover, unlike previous literature, we look at both the environmental effect on OFDI decisions and the consequential impact of OFDI on firm performance. We employ propensity score matching and difference-in-differences methods, as well as the Heckman two-step model, for our estimations. Our results show that OFDI does indeed improve Chinese firms’ productivity and sales. This paper, therefore, contributes to the literature by identifying a range of home country business environmental factors that have a combined effect on firms’ OFDI decisions, adding to a more comprehensive understanding of OFDI originating from emerging economies.

This paper estimates the impacts on The Philippines of deep integration in a modern mega-preferential trade agreement, the Regional Comprehensive Economic Partnership. The paper assesses how the results differ with three versions of market structure: (i) perfect competition, Armington style; (ii) monopolistic competition Krugman style; and heterogeneous firms, Melitz style. The paper develops a new numerical model of foreign direct investment with heterogeneous firms where firms produce in the host country and demand corresponds to the “proximity burden,” and is the first to apply a heterogeneous-firms model of foreign direct investment to preferential trade analysis. It also develops an extension of the Krugman model that allows small countries to impact the number of varieties. Both of these model extensions, as well as market structure, are crucial to the results. The trade and foreign direct investment responses are held constant across the three market structures. Lowering trade costs is examined from: (i) the reducing non-tariff barriers in goods; (ii) lowering barriers against foreign services providers, from foreign direct investment and cross-border; and (ii) facilitating trade. The results show that in all three market structures, there are substantial gains from deep integration, but virtually no gains from preferential tariff reduction. Both Krugman and Melitz style models produce significantly larger welfare gains than the Armington structure, especially in the impacts of foreign direct investment or with wider spillover effects on non- Regional Comprehensive Economic Partnership regions. The relationship between the welfare gains in the Krugman versus Melitz models is complex.

The primary aim of the paper is to consider the problems and issues raised when the data exhibit time heterogeneity in the context of linear models. Ignoring time heterogeneity will undermine the reliability of inference and will give rise to untrustworthy evidence. Accounting for it using trend polynomials, however, is non-trivial because it raises several modeling issues. First, when the degree of the polynomial is greater than 4, or so, one needs to deal with the near-multicollinearity problem that arises. The second issue pertains to the type of polynomial that will adequately account for the time heterogeneity. Third, when the trend polynomials are treated as additional regressors, they will give rise to highly misleading statistical results. The paper investigates how different types of polynomials could deal with the near-multicollinearity and the modeling issues they raise, and makes recommendations to practitioners.

It is commonly observed that high grade loans with better ratings are often associated with low recoveries if they default (i.e. with relatively high loss-given-default (LGD)). To address the mismatch problem, this paper proposes a credit risk approach by minimizing LGD for higher rated loans as a risk-rating matching standard in the sense that the decreasing LGD from creditors’ perspective is associated with higher credit rating for the borrower. This standard forces customers’ credit rating of each grade to be optimally determined in correspondence to its LGD, which means the LGD of high grade loans tends to be low. The approach is then tested using three credit datasets from China, i.e. credit data from 2044 farmers, 2157 small private businesses and 3111 SMEs. The empirical results show that the proposed approach indeed guides the way to solve the mismatch phenomenon between credit ratings and LGDs in the existing credit rating literature. By optimally determining credit ratings, the findings derived from this paper help provide a valuable reference for bankers, and bond investors to manage their credit risk.

Statistics show that many zombie firms in China still enjoy a wide variety of government subsidies. This paper explores the impact of this phenomenon from the perspective of capacity utilization. Specifically, it uses a sample of Chinese zombie firms from 2007 to 2016 to empirically analyze the effect of government subsidies on the capacity utilization of zombie firms. This paper finds that government subsidies have a negative effect on the capacity utilization of zombie firms, and the capacity utilization of subsidized zombie firms is lower than that of unsubsidized zombie firms. Robustness tests and endogeneity tests confirm this finding. Further analysis reveals significant differences in the effects of government subsidies on zombie firms subject to different forms of ownership, different government interventions, and different quality of financial reports. The negative effect of government subsidies on the capacity utilization of zombie firms is more significant in state-owned zombie firms, zombie firms subject to low levels of government intervention, and zombie firms with low quality of financial reports. Government subsidies also distort the investment behaviors of subsidized zombie firms, which in turn leads to poor performance. This paper not only answers the difficult question of whether the government should continue to subsidize zombie firms, but also provides theoretical support for government policy makers. The findings suggest that the government should use subsidies more carefully to help zombie firms “get out of the woods,” and formulate fiscal policies specifically related to zombie firms.

Many economists believe that recessions arise when aggregate demand is insufficient to support full employment. However, replicating this intuition within a real business cycle (RBC) model has proven surprisingly challenging. Rather than eliciting a contraction, lower consumer demand leads to greater household savings in many such models, fueling new investment and causing the economy to expand. The present paper proposes a novel way to resolve this apparent paradox: risk-averse firms. In the model to follow, cautious firms reduce their demand for investment prior to a recession. This contraction in the demand for capital overcomes the increased supply arising from consumer savings and restores intuitive business cycle behavior. In particular, the paper demonstrates that the model economy contracts when subjected to an uncertainty shock in consumer demand, mimicking a pre-recessionary environment in which firms, fearing a lack of orders, precipitate the downturn by reducing capital expenditures. These results are consistent with microeconomic evidence that uncertainty, particularly uncertainty about future demand, is the primary reason for firms shedding workers or scaling down operations in advance of an economic downturn. More generally, they imply that firm's attitudes towards risk shouldn't be ignored in modern macroeconomic models.

This paper analyses the effects of prudential policies on leverage and insolvency risk in eleven Central and Eastern Europe banking systems in the 2005–2014 period. It explores the relationship between leverage, insolvency risk and regulation variables, and the temporal patterns of this relationship. It also examines whether the effects of prudential policies on leverage and insolvency risk are influenced by bank ownership structure and financial cycle. The paper finds a consistent link between prudential regulation and leverage, which varies over the sample period. Conversely, the insolvency risk shows a stronger relationship with macroprudential policies. The estimates reveal that prudential policies work better on leverage and z-score for foreign banks. Both leverage and insolvency risk are better mitigated over booms. Finally, prudential policies have similar effects on both domestic and foreign banks' stability in normal times, while the effects are opposite during turbulences. These dissimilarities are raising challenges to the conduct of prudential policies.

This paper investigates whether foreign aid volatility affects economic growth in countries with an effective institution. Specifically, we examine the role of institutional quality in aid volatility-growth nexus using data from 45 Sub-Saharan African countries over the period 1980–2017. We account for different aid types, namely, aid commitment and aid disbursement. Our results show that, unlike foreign aid disbursement, foreign aid commitment is growth-enhancing, but aid volatility adversely impacts on economic growth. We find that although institutional quality and its sub-dimensions enhances economic growth, it fails to curtail the adverse effect of aid volatility on economic growth. With regard to aid flows, aid benefits a country only if the donor commits to provide the aid to the recipient country. Exploiting aid flows’ policy implication, the paper further uncovers that promoting an effective institution could enhance aid effectiveness in Sub-Saharan Africa.

This paper models the portfolio investment performance with options by using a risk index, which is defined as the average loss below the risk-free interest rate. Using a risk-free interest rate as the uniform reference rate for all portfolios, the risk index offers an easier-to-compare loss value than the value-at-risk return, where portfolio specific references are used to calculate the average losses. Besides, uncertainty theory is used in the paper to derive the portfolio decision when stock prices are subject to experts' estimations. By analytical computation and empirical analysis, we find that portfolios considering options generate better return than the ones without options. The empirical analysis reveals that the options can effectively hedge the risk, and the call option with a higher exercise price offers higher return per unit of option premium. Furthermore, our proposed model produces higher expected return in most cases than the model where the risk is measured by the chance of the total return failing to reach the threshold level of return.

This paper explores whether and how media serves as an information intermediary in the capital market and predicts value creation from mergers and acquisitions (M&As). Using a sample of 288 M&A deals in the U.S. market from 2000 to 2015, this paper examines whether pre-merger news about acquirers correlates to M&A performance. The empirical evidence shows that a positive media attitude before merger announcements has predictive power for stock returns in both the short and long run. Moreover, media pessimism is associated with higher bid premiums, meaning that acquirers must raise the bid price to offset the negative effects produced by the media. These findings suggest that media news contains information relevant to M&A performance and thus has implications for shareholder wealth.

The paper introduces a new way of linking microsimulation models with dynamic general equilibrium frameworks to obtain an evaluation of the impact of detailed tax and benefit measures on the aggregate economy. In the approach presented in this paper, income heterogeneity interacts with the macro-economy via aggregated individual labour supply decisions which influence, and are influenced by, the dynamic evolution of the real wage rate. The method involves a reduced-form representation of the information flow between the macroeconomic and microeconomic blocks. The practical usefulness of the approach is demonstrated by evaluating actual and hypothetical tax reforms that involve abandoning the flat tax system in Slovakia. A hypothetical move to a highly progressive tax structure is shown to generate some employment gains but is associated with a drop in aggregate income and tax revenue.

Emerging market economies (EMEs) have experienced waves of market volatility since the global financial crisis, with some commentators ascribing this at least partly related to monetary policy decisions in advanced economies. This paper examines volatility spillovers from changes in the size of the balance sheets of the Federal Reserve (FED) and European Central Bank (ECB) to EMEs from 2003 to 2018. We find that volatility spillovers to EME currency markets are greater in magnitude from the FED, while EME stock and bond markets are also vulnerable to volatility spillovers in a similar magnitude from both the ECB and the FED. We find only limited evidence of volatility transmission to the real economy of EMEs following the monetary policy actions of the FED and ECB. Finally, we show that the proportion of the volatility in EMEs that is accounted for by changes in FED and ECB balance sheets shifts over time. Our paper has important policy implications for EMEs, notably in respect of volatility transmission channels.

This paper investigates the key factors that explain the documented decline in the exchange rate pass-through in South Africa over the past two decades. The paper finds that this outcome is largely due to improved monetary policy credibility. The South African Reserve Bank has become more credible since the adoption of the inflation target regime through improved communication, transparency, and independence. We show that credibility is enhanced through a gradual disinflation process and reduction of inflation volatility. As result, expectations of agents have become well-anchored at levels that are consistent with its objectives of keeping inflation within the official target range of 3–6 percent even in the presence of external shocks. This in turn reduces the exchange rate pass-through. This finding is important from a monetary policy perspective not only for South Africa but other emerging economies such as Turkey as it shows that improving monetary policy credibility is a key ingredient to reducing exchange rate pass-through.

This paper examines the relationships between the asset bubble and the banking stability from both theoretical and empirical perspectives. The theoretical analysis demonstrates that the moral hazard caused by the deposit insurance and limited liability might facilitate the banks to hold bubble assets for the purpose of risk premium. Meanwhile the supervisory intensity, leverage ratio and credit spread provide the conditions for banks to hold bubble assets through their effects on risk premium. Once the banks hold the bubble assets, their stability will deteriorate because of four types of effects, namely internal leverage, cash withdrawal, credit friction and network effects. This paper also utilizes the BMA-PVAR model to test the theoretical findings by employing the data from 26 representative economies for a period between 2000 and 2014. The empirical evidences are consistent with the theoretical findings that the equity bubbles will lower the banking stability. The empirical evidences also suggest that the banking instability will be detrimental to the economic growth.

Economic freedom (freedom from the intervention of government) is essential for doing business, so economic freedom of both the home country and the host country are important for bilateral foreign direct investment. However, though some literature has investigated the role of host country's economic freedom in bilateral direct investment, no literature has studied the role of home country's economic freedom. This paper has studied this issue in a gravity model with a sample of 155 countries. This paper has also employed some effective estimation techniques of gravity model to incorporate the zero observations and adopted quantile regression method. The findings indicate that economic freedom of both the home country and the host country are positively correlated with bilateral direct investment, and the economic freedom of home country has even stronger explanatory power for foreign direct investment. Hence, promoting the economic freedom may encourage more outward foreign direct investment than inward direct investment.

The major challenge for filling the financing gaps of green energy is lower rate of return of green projects comparing to fossil fuels. Electricity tariffs are often regulated by governments; It has to be kept in low price to serve for every households as a necessary goods. Sources of revenue from green energy comes only from user charges. Hence it is not so much attractive for private investors. The paper is proposing a model for utilization of the tax revenue spillover of green energy supply by returning the portion of it to green energy projects in order to increase their rate of return. In addition, the paper is proposing a social community based funding scheme for smaller scale green projects (e.g. solar and wind). The paper theoretically and empirically shows that utilizing spillover effect in form of tax return for funding green energy projects will increase the rate of return and make them feasible and interesting for the private investors.

Based on the case of Venezuela, an oil exporter with a multiple exchange rate regime, this paper explains two counterintuitive phenomena. First, a fall in oil revenue can drive a steep rise in inflation by reducing foreign exchange for imports and raising the fiscal deficit financed by money growth. Second, when foreign exchange is rationed, a devaluation of the official exchange rate could produce a transitory fall in inflation by reducing the fiscal deficit and subsidies for buying foreign exchange. The paper also shows that the black market exchange rate can be rising far faster than overall inflation if it is driven by prices in the most distorted goods markets. The channels emphasized in this paper for determining inflation and the black market exchange rate are novel in the literature and may provide avenues of future research on commodity exporters and foreign exchange constraints.