WO R K I N G PA P E R S E R I E S N O / M A R C H 0 STOCKS, BONDS, MONEY MARKETS AND EXCHANGE RATES MEASURING INTERNATIONAL FINANCIAL TRANSMISSION by Michael Ehrmann, Marcel Fratzscher and Roberto Rigobon WO R K I N G PA P E R S E R I E S N O / M A R C H 0 STOCKS, BONDS, MONEY MARKETS AND EXCHANGE RATES MEASURING INTERNATIONAL FINANCIAL TRANSMISSION by Michael Ehrmann 2, Marcel Fratzscher and Roberto Rigobon In 2005 all ECB publications will feature a motif taken from the €50 banknote This paper can be downloaded without charge from http://www.ecb.int or from the Social Science Research Network electronic library at http://ssrn.com/abstract_id=676403 We are grateful to Terhi Jokipii for excellent research assistance.We also would like to thank an anonymous referee for the ECB Working Paper series, as well as Jon Faust, Dimitrios Malliaropulos, Mark Spiegel, Cedric Tille and the participants of the ECB-IMF conference on “Global financial integration, stability and business cycles”, of the New York Fed conference on “Financial globalization” and seminars at Trinity College Dublin and at Frankfurt University for comments and suggestions.This paper presents the authors’ personal views and does not necessarily reflect the views of the European Central Bank European Central Bank, Kaiserstrasse 29, D – 60311 Frankfurt, Germany; e-mail: Michael.Ehrmann@ecb.int European Central Bank, Kaiserstrasse 29, D – 60311 Frankfurt, Germany; e-mail: Marcel.Fratzscher@ecb.int Massachusetts Institute of Technology, Cambridge MA 02142-1347, USA; e-mail: rigobon@mit.edu © European Central Bank, 2005 Address Kaiserstrasse 29 60311 Frankfurt am Main, Germany Postal address Postfach 16 03 19 60066 Frankfurt am Main, Germany Telephone +49 69 1344 Internet http://www.ecb.int Fax +49 69 1344 6000 Telex 411 144 ecb d All rights reserved Reproduction for educational and noncommercial purposes is permitted provided that the source is acknowledged The views expressed in this paper not necessarily reflect those of the European Central Bank The statement of purpose for the ECB Working Paper Series is available from the ECB website, http://www.ecb.int ISSN 1561-0810 (print) ISSN 1725-2806 (online) CONTENTS Abstract Non-technical summary Introduction Related literature Measuring domestic and international financial Integration 11 3.1 The “structural-form” and the “reduced-form” models 11 3.2 Identification through heteroskedasticity 13 3.3 Identification restrictions 14 3.4 Controlling for common shocks and identified macro shocks 18 Results 19 4.1 Domestic transmission 21 4.2 International transmission 24 4.3 Response of the exchange rate 27 4.4 Variance decomposition 28 Robustness 30 Conclusions 32 References 34 Tables 38 Figures 44 European Central Bank working paper series 46 ECB Working Paper Series No 452 March 2005 Abstract The paper presents a framework for analyzing the degree of financial transmission between money, bond and equity markets and exchange rates within and between the United States and the euro area We find that asset prices react strongest to other domestic asset price shocks, and that there are also substantial international spillovers, both within and across asset classes The results underline the dominance of US markets as the main driver of global financial markets: US financial markets explain, on average, more than 25% of movements in euro area financial markets, whereas euro area markets account only for about 8% of US asset price changes The international propagation of shocks is strengthened in times of recession, and has most likely changed in recent years: prior to EMU, the paper finds smaller international spillovers JEL classification number: E44, F3, C5 Keywords: international financial markets; integration; transmission; financial market linkages; identification; heteroskedasticity; asset pricing; United States; euro area ECB Working Paper Series No 452 March 2005 Non-technical summary Financial markets have become increasingly integrated, both domestically and internationally The nature of this integration and the transmission channels through which shocks dissipate are, however, still not well understood One strand of the literature focuses exclusively on spillovers across different domestic asset prices, whereas another strand concentrates on international spillovers only for individual asset prices However, understanding the increasingly close domestic and international linkages of asset prices requires a complete and comprehensive modeling of all transmission channels that are at play In this paper we measure the intensity of the transmission mechanisms among different asset markets within a country, and across countries The main limitation the literature has faced in measuring these propagation channels has been the endogeneity of asset prices In this paper, we estimate the propagation of shocks by modeling each asset price with a multifactor model, and then using the heteroskedasticity that exists in the data to estimate the contemporaneous financial transmission coefficients More precisely, we make identifying assumptions in order to solve the model These assumptions are well in line with VAR and monetary policy models now standard in the literature For instance, we interpret innovations to the short rate as monetary policy shocks, to the long rate as inflationary expectations, to the stock market as productivity or supply shocks, and to the exchange rate as relative demand shocks Under these interpretations, we can restrict the signs of several coefficients that allow us to estimate the model We use this approach to analyze the nature of financial integration and the transmission channels within as well as between the two largest economies in the world – the United States and the euro area The empirical model concentrates on daily returns over a 16-year period of 1989-2004 for seven asset prices: short-term interest rates, bond yields and equity market returns in both economies, as well as the exchange rate The results of the paper underline the importance of international spillovers, both within asset classes as well as across financial markets Although the strongest international transmission of shocks takes place within asset classes, we find evidence that international cross-market spillovers are significant, both statistically as well as economically For instance, shocks to US short-term interest rates exert a substantial influence on euro area bond yields and equity markets, and in fact explain as much as 10% of overall euro area bond market movements But the transmission of shocks also runs in the opposite direction as in particular short-term interest rates of the euro area have a significant impact on US bond and equity markets Overall, US financial markets explain on average more than 25% of euro area financial market movements in the period 1989-2004, whereas euro area markets account for 8% of the variance of US asset prices ECB Working Paper Series No 452 March 2005 A second key result of the paper is that in almost all cases the direct transmission of financial shocks within asset classes is magnified substantially, mostly by more than 50%, through indirect spillovers through other asset prices These two results underline that a better understanding of financial linkages requires the modeling of international cross-market financial linkages, which so far has been missing in the literature We also confirm some familiar results of the literature as, in particular, we find that financial markets are mostly driven by country-specific and market-specific factors However, we detect a rich interaction between asset prices domestically and our methodology allows us to quantify domestic financial market transmissions much more accurately by controlling for foreign and other types of shocks A highly revealing finding is the difference in the asset price interaction within US markets versus within euro area markets For the US, we find that short-term interest rates react significantly to changes in domestic equity markets, whereas euro area short-term rates are not affected by stock markets By contrast, euro area short rates and equity markets are more responsive to shocks in bond yields and exchange rates than US markets These findings thus also identify some important differences in the financial transmission processes within the two economies, which may reflect differences in economic structure, in the degree of openness as well as different policy objectives Finally, we conduct several sensitivity tests and show that the results are broadly robust, although we find some suggestive indication that the international transmission channel has intensified over time, and in particular since EMU Furthermore, we find that the international propagation of shocks is strengthened in times of recession ECB Working Paper Series No 452 March 2005 I Introduction Financial markets have become increasingly integrated, both domestically and internationally The nature of this integration and the transmission channels through which shocks dissipate are, however, still not well understood One strand of the literature focuses exclusively on spillovers across different domestic asset prices, whereas another strand concentrates on international spillovers only for individual asset prices However, understanding the increasingly close domestic and international linkages of asset prices requires a complete and comprehensive modeling of all transmission channels that are at play Policy makers and practitioners are well aware of the existence of these linkages, but very little is known about their strength and scope.1 The main limitation the literature has faced in measuring these propagation channels has been the endogeneity of asset prices, even at daily frequencies Clearly, macroeconomic shocks such as shocks to productivity, monetary policy, inflation expectations, risk premia, etc have an effect on all asset prices; and therefore, estimating the impact of one innovation on the others requires identifying shocks that are unobservable at these frequencies In this paper, we estimate the propagation of shocks by modeling each asset price with a multifactor model, and then using the heteroskedasticity that exists in the data to estimate the contemporaneous financial transmission coefficients In order to solve the problem of identification we need to make simplifying or identifying assumptions The most important ones are related to the interpretation of the multifactor models We assume that each asset price is given by a structural equation, although we understand that they are linearized versions of more complex equations describing the economy These assumptions are well in line with VAR and monetary policy models now standard in the literature For instance, we interpret innovations to the short rate as monetary policy shocks, to the long rate as inflationary expectations, to the stock market as productivity or supply shocks, and to the exchange rate as relative demand shocks Under these interpretations, we can restrict the signs of several coefficients that allow us to estimate the model In particular, we employ an empirical methodology that exploits the heteroskedasticity of asset prices as a tool for identification of financial shocks.2 This means that we can determine different regimes based on the heteroskedasticity of the underlying asset prices to pin down the direction of financial transmission process It also implies that all The two possible exceptions are Andersen et al (2004), which studies the transmission among stock markets for each country, and then across countries for each type of asset market separately; as well as Dungey and Martin (2001) who also study the propagation of shocks across countries and markets We discuss below in which dimensions our approach differs from these two papers See Wright (1928), Sentana and Fiorentini (2001), Rigobon (2003), and Rigobon and Sack (2003a) for the theory and some applications of the methodology ECB Working Paper Series No 452 March 2005 of the restrictions imposed are over-identifying restrictions that can be verified empirically We then use this approach to analyze the nature of financial integration and the transmission channels within as well as between the two largest economies in the world – the United States and the euro area The empirical model concentrates on daily returns over a 16-year period of 1989-2004 for seven asset prices: short-term interest rates, bond yields and equity market returns in both economies, as well as the exchange rate The results of the paper underline the importance of international spillovers, both within asset classes as well as across financial markets Although the strongest international transmission of shocks takes place within asset classes, we find evidence that international cross-market spillovers are significant, both statistically as well as economically For instance, shocks to US short-term interest rates exert a substantial influence on euro area bond yields and equity markets, and in fact explain as much as 10% of overall euro area bond market movements But the transmission of shocks also runs in the opposite direction as in particular short-term interest rates of the euro area have a significant impact on US bond and equity markets Overall, US financial markets explain on average more than 25% of euro area financial market movements in the period 1989-2004, whereas euro area markets account for 8% of the variance of US asset prices A second key result of the paper is that in almost all cases the direct transmission of financial shocks within asset classes is magnified substantially, mostly by more than 50%, through indirect spillovers through other asset prices For instance, the coefficient for the direct effect of shocks to US bond yields on euro area bond markets is 0.30, but it rises to 0.48 when allowing for indirect spillovers of these shocks via other US and euro area asset prices – where the indirect effect measures how the US shocks affect other asset prices and the exchange rate, and how those asset prices ultimately alter the euro bond rate These two results underline that a better understanding of financial linkages requires the modeling of international cross-market financial linkages, which so far has been mostly missing in the literature We confirm some familiar results of the literature as, in particular, we find that financial markets are mostly driven by country-specific and market-specific factors However, we detect a rich interaction between asset prices domestically and our methodology allows us to quantify domestic financial market transmissions much more accurately by controlling for foreign and other types of shocks A highly revealing finding is the difference in the asset price interaction within US markets versus within euro area markets For the US, we find that short-term interest rates react significantly to changes in domestic equity markets, whereas euro area short-term rates are not affected by stock markets By contrast, euro area short rates and equity markets are more responsive to shocks in bond yields and exchange rates than US markets These findings thus also identify some ECB Working Paper Series No 452 March 2005 important differences in the financial transmission processes within the two economies, which may reflect differences in economic structure, in the degree of openness as well as different policy objectives Finally, we conduct several sensitivity tests and show that the results are broadly robust, although we find some suggestive indication that the international transmission channel has intensified significantly over time, and in particular since EMU Furthermore, we find that the international propagation of shocks is strengthened in times of recession The paper is organized in the following way Section II briefly reviews the literature on domestic and on international financial linkages and integration The methodology based on identification through heteroskedasticity is summarized in Section III Section IV outlines the data and the empirical findings for domestic and international asset market spillovers between the United States and the euro area Section V discusses caveats and robustness results and Section VI summarizes and concludes with some policy implications arising from the findings II Related literature The literature on financial linkages has evolved along two separate strands in recent years One of these strands has been focusing on the domestic transmission of asset price shocks and its determinants Another direction of the literature has been to analyze international linkages, whereby the focus, however, has been mostly on individual asset prices in isolation – usually equity markets or foreign exchange markets Linkages across domestic financial markets are increasingly well-understood Earlier work on the spillovers across different domestic asset prices often finds a positive correlation between stock returns and bond yields, such as Shiller and Beltratti (1992) and to some extent Barsky (1989) and Campbell and Ammer (1993) for the United States, though the analysis of those studies is mostly based on low-frequency data More recent work finds that equity prices react strongly to monetary policy shocks in the United States (Bernanke and Kuttner 2004, Ehrmann and Fratzscher 2004a) At the same time, monetary policy has been shown to respond to equity markets (Rigobon and Sack 2003a) In a simultaneous analysis of bond prices, short-term interest rates and equity markets, Rigobon and Sack (2003b) find that the causality of the transmission process may run in several directions, as for instance the correlation between US short-term interest rates and equity prices may change from positive to negative depending on which of the asset prices is dominant in particular periods A closely related literature focuses on explaining the price discovery process in domestic asset prices through economic fundamentals Several papers concentrate thereby on ECB Working Paper Series No 452 March 2005 References Andersen, T.G and Bollerslev, T (1998), “Deutsche Mark-Dollar Volatility: Intraday Activity Patterns, Macroeconomic Announcements, and Longer Run Dependencies,” Journal of Finance, 53, 219-265 Andersen, T.G., Bollerslev, T., Diebold, F.X and Vega, C (2003), “Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange,” American Economic Review, 93, 38-62 Andersen, T., Bollerslev, T., Diebold, F and C Vega (2004) Real-Time Price Discovery in Stock, Bond and Foreign Exchange Markets Mimeo Bae, K.-H., Karolyi, A., Stulz, R., 2003 A New Approach to Measuring Financial Contagion Review of Financial Studies, 16, 717-763 Balduzzi, P., Elton, E.J Green, T.C (2001), “Economic News and Bond Prices: Evidence From the U.S Treasury Market,” Journal of 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International transmission of stock returns and volatility Review of Financial Studies 7, 507–538 Pavlova, A and R Rigobon (2004) “Asset Prices and Exchange Rates”, Mimeo, MIT Rigobon, R (2003), “Identification Through Heteroskedasticity,” Review of Economics and Statistics, 85, 777-792 Rigobon, R and Sack, B (2002), “The Impact of Monetary Policy on Asset Prices,” NBER Working Paper No 8794, Cambridge, Mass Rigobon, R and Sack, B (2003a), “Measuring the Reaction of Monetary Policy to the Stock Market,” Quarterly Journal of Economics, 118, 639-669 36 ECB Working Paper Series No 452 March 2005 Rigobon, R and Sack, B (2003b), “Spillovers Across U.S Financial Markets,” NBER Working Paper No 9640, Cambridge, Mass Sentana, E and G Fiorentini (2001) “Identification, Estimation and Testing of Conditionally Heteroskedastic Factor Models”, Journal of Econometrics, 102, 143-164 Shiller, R J and Beltratti, A E (1992), “Stock Prices and Bond Yields,” Journal of Monetary Economics, 30, 25-46 Sims, C (1980) “Macroeconomics and Reality”, Econometrica, 48, 1-48 Thornton, D.L (1998) “Tests of the market’s reaction to Federal funds rate target changes”, Federal Reserve Bank of St Louis Review, pp 25-36 Wright, P (1928) “The Tariff on Animal and Vegetable Oils”, Macmillan Company, New York Zapatero, F (1995) “Equilibrium Asset Prices and Exchange Rates,” Journal of Economic Dynamics and Control, 19, pp 787–811 ECB Working Paper Series No 452 March 2005 37 Table 1: Parameter estimates with traditional VAR methodologies Choleski decomposition max Sign restrictions max USA α12 0.3998 0.4003 -0.2964 0.0000 α13 0.0707 0.2373 -0.0435 -0.0010 α21 0.2901 0.2912 -0.4016 0.0000 α23 -0.4166 -0.3478 0.0069 0.0073 α31 0.0010 0.0030 0.0000 2.9641 α32 -0.0073 -0.0069 0.0000 0.4170 0.3275 0.3327 -0.2903 -0.0204 α46 -0.8787 -0.6168 -0.0181 0.0000 α54 0.1532 0.1551 -1.1081 0.0000 α56 -0.8830 -0.7874 0.0000 0.0070 α64 α65 -0.0032 -0.0022 0.0794 5.6990 -0.0070 -0.0059 0.0000 0.9244 Euro area α45 Note: The table shows parameter estimates obtained through standard identification schemes It reports the smallest and largest estimates that can be obtained by changing the order of variables in models identified through Choleski decompositions in the left panel, and the borders of the parameter space that is identified in a model with sign restrictions in the right panel 38 ECB Working Paper Series No 452 March 2005 Table 2: Parameter estimates and bootstrap results of structural-form model point estimate mean bootstrap std dev p-value Domestic transmission USA α12 α13 α21 α23 α31 α32 -0.1714 -0.0113 -0.6150 0.0146 0.7575 0.1469 *** *** *** *** *** * -0.1750 -0.0115 -0.5895 0.0142 0.7546 0.1845 0.0493 0.0036 0.0651 0.0045 0.1377 0.1649 0.0000 0.0020 0.0000 0.0080 0.0080 0.0778 ** -0.1413 -0.0022 -0.2969 -0.0004 2.0737 0.5908 0.0488 0.0021 0.0624 0.0028 0.1403 0.2290 0.0140 0.1397 0.0020 0.5509 0.0000 0.0020 International transmission US to euro area -0.2997 *** -0.2551 0.0890 β41 -0.3032 *** -0.2957 0.0535 β52 -0.6143 *** -0.5817 0.0630 β63 0.0100 0.0000 0.0000 Euro area to US -0.2123 * β14 -0.5512 *** β25 -0.0022 β36 0.0682 0.0508 0.0612 0.0599 0.0000 0.1517 Exchange rate effects *** -0.0316 0.0070 ** -0.0123 0.0077 0.0180 0.0841 *** 0.0591 0.0059 0.0072 0.0056 *** -0.5577 0.0430 *** 1.6754 0.1753 *** 0.6701 0.1737 ** 0.0882 0.0431 *** -5.6036 0.2020 -0.0052 0.0212 -0.0115 0.0190 0.0040 0.0399 0.4291 0.0000 0.1118 0.0000 0.0000 0.0080 0.0499 0.0000 0.8044 0.4611 Euro area -0.1474 α45 -0.0010 α46 -0.2771 α54 0.0001 α56 2.0888 α64 0.5328 α65 γ17 γ27 γ37 γ47 γ57 γ67 γ71 γ72 γ73 γ74 γ75 γ76 -0.0368 -0.0117 0.0081 0.0600 0.0079 -0.5766 1.7095 0.6688 0.0776 -5.6871 0.0000 0.0000 *** *** *** -0.1535 -0.5583 -0.0362 Note: the table reports the parameter estimates of model (1) obtained in the identification through heteroskedasticity *,**,*** denote significance at the 90%, 95% and 99% level, respectively The significance is judged through the p-value obtained in a bootstrap ECB Working Paper Series No 452 March 2005 39 Table 3: Parameter estimates and bootstrap results of reduced-form model point estimate mean bootstrap std dev p-value Domestic transmission USA a11 a21 a31 a12 a22 a32 a13 a23 a33 1.2514 1.0240 -1.1012 0.2627 1.4300 -0.4083 0.0089 -0.0102 0.9964 *** *** *** *** *** *** ** * *** 1.2255 0.9799 -1.1394 0.2699 1.4424 -0.4916 0.0092 -0.0097 1.0098 0.1264 0.2491 0.2757 0.1216 0.1982 0.2672 0.0040 0.0065 0.0284 0.0000 0.0000 0.0000 0.0040 0.0000 0.0080 0.0140 0.0539 0.0000 *** *** 0.9145 0.4001 -0.0473 0.2275 1.3370 -1.2663 0.0018 0.0011 1.0211 0.0721 0.1407 0.2135 0.0928 0.1470 0.3830 0.0019 0.0038 0.0276 0.0000 0.0040 0.7645 0.0000 0.0000 0.0000 0.1816 0.4092 0.0000 International transmission US to euro area b41 0.4487 *** 0.4016 0.1323 b51 0.4364 *** 0.4231 0.1649 b61 -1.9541 *** -1.9380 0.3407 b42 0.1726 *** 0.1707 0.0736 b52 0.4845 *** 0.4901 0.1635 b62 -1.0957 *** -1.1632 0.3418 b43 0.0062 *** 0.0067 0.0024 b53 -0.0010 -0.0002 0.0028 b63 0.5705 *** 0.5414 0.0618 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.4371 0.0000 Euro area to US 0.4431 *** b14 b24 0.5443 *** b34 -0.4502 * b15 0.2099 *** b25 0.8682 *** b35 -0.2923 *** b16 0.0005 b26 0.0005 b36 0.0018 0.1297 0.1714 0.2966 0.1047 0.2116 0.1821 0.0011 0.0026 0.0653 0.0040 0.0020 0.0619 0.0020 0.0000 0.0000 0.1018 0.3293 0.3174 Exchange rate effects -0.3679 0.4822 ** -0.4272 0.2884 * -0.0546 0.0332 *** 4.1953 0.2490 0.3577 0.3766 0.0154 0.0191 *** 0.0197 0.0049 ** 0.0139 0.0081 -0.0128 0.0600 *** -0.0393 0.0031 *** -0.0126 0.0045 *** 0.4937 0.0456 *** 0.7403 0.0209 0.1537 0.0200 0.0639 0.0000 0.1118 0.1178 0.0060 0.0299 0.3912 0.0000 0.0060 0.0000 0.0000 Euro area 0.9363 a44 a54 0.3909 a64 0.0034 0.2326 a45 a55 1.3245 a65 -1.1370 a46 0.0009 a56 0.0003 a66 1.0013 c71 c72 c73 c74 c75 c76 c17 c27 c37 c47 c57 c67 c77 -0.1872 -0.3924 -0.0508 4.2383 0.4062 0.0041 0.0211 0.0154 -0.0232 -0.0389 -0.0120 0.4967 0.7340 *** *** *** *** 0.3659 0.5065 -0.4342 0.2073 0.8861 -0.3570 0.0012 0.0010 0.0367 Note: the table reports the parameter estimates of model (2) obtained in the identification through heteroskedasticity *,**,*** denote significance at the 90%, 95% and 99% level, respectively The significance is judged through the p-value obtained in a bootstrap 40 ECB Working Paper Series No 452 March 2005 Table 4: Variance decomposition of benchmark model r t US µ r,t US µ b,t US µ s,t US µ r,t EA µ b,t EA µ s,t EA µ e,t µ c,t b t US s t US r t EA b t EA s t EA et 80.17% 22.41% 1.54% 21.22% 9.80% 3.38% 0.09% 4.44% 54.96% 0.27% 3.95% 15.19% 1.34% 0.48% 0.32% 0.17% 97.59% 0.31% 0.00% 22.36% 0.50% 6.11% 3.85% 0.16% 56.16% 4.78% 0.00% 27.10% 1.70% 12.16% 0.08% 4.31% 68.15% 0.86% 0.31% 0.00% 0.00% 0.00% 0.01% 0.00% 60.26% 0.00% 1.20% 0.27% 0.04% 8.41% 0.39% 11.50% 70.42% 6.05% 6.17% 0.33% 5.63% 1.70% 0.30% 1.10% Note: the table reports the share of the variance of each series that is explained by the various structural shocks ECB Working Paper Series No 452 March 2005 41 Table 5: Parameter estimates of reduced-form, alternative models 5-day window point estimate bootstrap p-value 2-day window pre-EMU 1989-1998 point bootstrap estimate p-value 2-day window excl NBER recessions point bootstrap estimate p-value Domestic transmission USA a11 a21 a31 a12 a22 a32 a13 a23 a33 0.9917 0.2531 -0.7523 0.0031 0.5363 -1.1155 0.0735 0.1888 0.7499 *** 0.0000 *** 0.0000 ** 0.0419 ** 0.0279 *** 0.0000 0.1138 0.1437 0.4731 *** 0.0000 1.0411 0.2293 -0.6020 0.3195 1.1325 -0.9045 -0.0008 -0.0371 1.0262 *** 0.0000 *** 0.0100 *** 0.0020 *** 0.0000 *** 0.0000 ** 0.0240 0.4910 ** 0.0339 *** 0.0000 1.2015 0.7165 -0.1798 0.2787 1.2501 -0.0940 0.0007 -0.0174 1.0109 *** 0.0000 *** 0.0000 *** 0.0000 *** 0.0060 *** 0.0000 *** 0.0040 0.4331 ** 0.0379 *** 0.0000 Euro area a44 0.9892 a54 0.4299 a64 -0.7626 a45 0.0076 a55 1.0963 a65 -1.1719 a46 0.0478 a56 0.0480 a66 1.0859 *** 0.0000 *** 0.0000 ** 0.0120 ** 0.0399 *** 0.0000 ** 0.0499 0.2994 0.5649 *** 0.0000 0.9579 0.0594 -0.0022 0.0904 1.0464 -0.0852 0.0022 -0.0198 1.0016 *** 0.0000 ** 0.0240 0.3214 ** 0.0200 *** 0.0000 0.1737 0.2715 ** 0.0299 *** 0.0000 0.9359 0.0296 0.0004 0.2309 1.1006 -0.3947 0.0049 0.0010 1.0476 *** 0.0000 0.1497 0.4930 *** 0.0000 *** 0.0000 *** 0.0020 * 0.0519 0.3194 *** 0.0000 International transmission US to euro area b41 0.3084 b51 0.1810 b61 -0.8599 b42 -0.0872 b52 0.0817 b62 -1.1993 b43 0.0113 b53 0.0452 b63 0.4755 *** 0.0000 *** 0.0020 *** 0.0080 0.6048 *** 0.0020 *** 0.0040 0.2455 0.6148 *** 0.0000 0.1305 0.0150 0.4631 0.0734 0.1449 -0.9229 0.0001 -0.0145 0.5480 *** 0.0040 ** 0.0339 0.3074 *** 0.0020 *** 0.0000 *** 0.0020 0.2595 *** 0.0060 *** 0.0000 0.2431 0.1311 -0.2679 0.0954 0.2164 -0.2204 0.0057 -0.0006 0.6068 *** 0.0000 *** 0.0000 ** 0.0160 *** 0.0020 *** 0.0000 ** 0.0120 ** 0.0339 0.2056 *** 0.0000 Euro area to US b14 0.0034 b24 0.1338 b34 -0.3866 b15 0.0007 b25 0.4267 b35 -0.9273 b16 0.0284 b26 0.1082 b36 0.0564 ** 0.0160 *** 0.0100 ** 0.0220 0.1038 *** 0.0040 *** 0.0020 0.1218 0.1138 ** 0.0160 0.1290 0.0882 -0.5277 0.1019 0.4117 -0.4860 -0.0014 -0.0075 0.0072 ** 0.0319 ** 0.0140 *** 0.0060 ** 0.0120 *** 0.0000 *** 0.0000 0.1277 ** 0.0240 0.1617 0.2400 0.0866 -0.3950 0.1705 0.5662 -0.1215 0.0021 -0.0011 -0.0004 *** 0.0040 ** 0.0240 * 0.0579 *** 0.0060 *** 0.0000 *** 0.0100 0.2236 0.6587 0.8443 Note: the table reports the parameter estimates of model (2) obtained in the identification through heteroskedasticity *,**,*** denote significance at the 90%, 95% and 99% level, respectively The significance is judged through the p-value obtained in a bootstrap 42 ECB Working Paper Series No 452 March 2005 Table 6: Variance decomposition of alternative models A 5-day estimation window r t US µ r,t µ b,t US µ s,t US µ r,t EA µ b,t EA µ s,t EA µ e,t µ c,t US b t US s t US r t EA b t EA s t EA et 89.34% 3.15% 4.77% 11.05% 2.88% 4.70% 1.99% 0.00% 34.88% 25.82% 2.18% 1.45% 22.50% 21.00% 6.26% 22.38% 60.39% 0.19% 2.29% 18.31% 14.70% 0.00% 0.60% 0.85% 76.86% 10.99% 2.50% 1.14% 0.00% 5.42% 4.38% 0.00% 63.93% 5.27% 3.38% 0.44% 3.49% 0.16% 1.60% 1.23% 45.32% 1.88% 1.91% 23.04% 3.47% 7.68% 8.25% 0.14% 52.16% 2.05% 7.05% 0.16% 0.42% 8.99% 1.25% 3.75% B pre-EMU period: 1989-1998 r t US µ r,t US µ b,t US µ s,t US µ r,t EA µ b,t EA µ s,t EA µ e,t µ c,t b t US s t US r t EA b t EA s t EA et 82.89% 2.81% 0.60% 2.82% 0.02% 0.25% 4.95% 9.69% 85.26% 1.67% 1.11% 2.54% 1.21% 0.68% 0.00% 4.01% 94.39% 0.00% 1.12% 18.74% 0.09% 0.74% 0.24% 0.27% 88.73% 0.20% 0.00% 8.80% 0.61% 6.94% 0.30% 1.03% 81.49% 0.01% 1.02% 0.01% 0.17% 0.00% 0.04% 2.08% 62.76% 0.00% 3.02% 0.02% 1.67% 5.87% 1.44% 16.25% 84.20% 3.03% 0.55% 1.10% 0.39% 11.10% 0.78% 0.25% C excluding NBER recession periods r t US µ r,t µ b,t US µ s,t US µ r,t EA µ b,t EA µ s,t EA µ e,t µ c,t US b t US s t US r t EA b t EA s t EA et 85.32% 15.77% 0.04% 9.18% 1.36% 0.06% 0.37% 6.27% 65.61% 0.01% 1.93% 5.05% 0.05% 0.00% 0.00% 0.79% 99.39% 0.42% 0.00% 24.21% 0.03% 1.83% 0.12% 0.10% 72.97% 0.04% 0.00% 14.41% 1.65% 9.48% 0.02% 7.97% 92.06% 0.12% 0.97% 0.02% 0.00% 0.00% 0.31% 0.01% 70.15% 3.73% 0.04% 0.93% 0.41% 7.10% 1.27% 3.67% 80.41% 4.86% 7.29% 0.03% 0.12% 0.22% 1.74% 0.08% Note: the tables report the share of the variance of each series that is explained by the various structural shocks ECB Working Paper Series No 452 March 2005 43 44 ECB Working Paper Series No 452 March 2005 1.00 0.4 -0.60 0.50 -0.40 -0.20 2.00 2.00 0.00 -0.80 -0.02 -0.04 -0.01 -0.03 -0.60 0.00 0.02 0.04 0.06 0.08 0.1 0.12 -0.02 0.01 -0.01 0.03 0.01 -0.20 0.02 0.00 0.14 0.04 0.02 -1.00 -0.30 -0.50 -0.20 0 -0.10 0.10 3.00 0.00 -0.80 -0.60 -0.20 0.35 -0.40 -0.30 -0.20 0.50 1.00 1.50 2.50 0.10 0.15 0.20 0.25 -8.00 -6.00 1.00 2.00 -4.00 -2.00 0.7 4.00 0.6 0.05 0.00 0.02 0.03 0.2 0.3 0.4 0.05 0.04 0.5 0.06 0.07 0.00 0.1 0.2 0.3 0.4 0.5 0.6 0.1 3.00 -0.40 0.02 0.04 0.06 0.08 0.1 0.12 0.00 0.00 0.05 0.1 0.15 0 0.00 0.00 0.00 0.00 0.1 0.2 0.3 0.4 0.5 0.6 0 0.2 0.25 0.02 0.04 0.06 0.08 0.1 0.12 0.3 0.35 0.4 0.14 0.16 0.18 0.01 2.00 0.00 0.02 0.04 0.06 -0.04 -0.02 -0.80 -0.60 -0.40 -0.20 -0.40 0.5 0.45 -0.30 0.00 0.1 0.2 0.3 0.4 0.5 0.6 0.7 -0.20 1.00 -0.10 2.00 0.00 0.1 0.2 0.3 0.5 0.4 0.6 0.8 0.7 0.9 3.00 0.00 0.05 0.1 0.2 0.15 0.25 -0.08 -0.06 -0.04 -0.02 0.1 0.12 0.00 0.02 0.20 0.00 0.05 0.1 0.15 -0.03 -0.02 -0.01 0.25 -0.10 0.10 4.00 -0.20 -0.03 -0.15 -0.02 -0.10 -0.01 0.1 -0.05 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.00 0.05 0.00 0.1 0.2 0.3 0.4 0.5 0.6 0.01 0.01 0.00 0.1 0.2 0.3 0.4 0.5 0.05 0.02 0.02 -0.80 -0.04 0.00 0.02 0.04 0.06 0.08 0.1 0.12 -0.40 -0.60 -0.02 0.02 -0.20 0.06 -0.40 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.04 0.00 0.02 0.04 0.06 0.08 0.1 0.12 -0.20 0.02 0.08 0.20 0.00 0.02 0.04 0.06 0.08 0.2 0.15 0.08 0.10 -0.06 0.3 0.4 0.1 0.6 -0.08 0.04 0.25 0.35 0.3 0.05 -1.00 0.12 0.45 0.2 2.50 0.10 0.02 0.04 0.06 0.08 0.1 0.06 0.08 0.2 0.20 -0.10 1.50 -0.20 1.00 -0.30 0.02 0.04 0.06 0.12 0.14 0.16 0.1 0.12 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0 -0.20 -0.40 0.50 -0.40 0.05 0.08 0.1 0.12 0.14 0.16 0.18 0.14 0.16 0.18 -0.60 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.00 2.00 0.00 0.00 1.50 -0.20 1.00 -0.40 0.50 -0.60 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 -0.50 0.1 0.2 0.3 0.4 0.5 0.6 -0.80 0.1 0.15 0.2 0.25 Figure 1: Distribution of structural coefficients of the benchmark model in 500 bootstrap replications 0.00 0.01 0.03 0.02 0.04 0.05 0.06 0.07 0.08 0.09 0.1 0.04 0.10 0.40 0.02 0.02 ECB Working Paper Series No 452 March 2005 45 1.00 1.00 1.50 1.50 2.00 -0.50 0.05 0.50 0.1 0.15 0.2 0.25 0.50 2.00 2.50 0.05 0.1 0.15 0.2 0.25 -4.00 -6.00 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 -2.00 -4.00 0.00 0.05 0.1 0.15 0.2 0.25 -2.00 1.00 -2.00 -3.00 2.00 -4.00 -3.00 -2.00 -1.00 0.00 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 -2.00 1.00 -1.00 2.00 0.00 0 -4.00 0.05 0.05 -5.00 0.1 0.1 0.00 0.15 2.00 0.15 1.50 0.80 1.00 0.2 1.00 0.60 0.00 0.25 0.50 0.40 -1.00 0.2 0.00 0.20 -3.00 4.00 1.50 0.25 1.50 0.00 0.50 0.00 0.2 0.18 0.16 0.14 0.12 0.1 0.08 0.06 0.04 0.02 0.02 0.02 0.18 0.04 0.04 1.00 0.06 0.06 0.80 0.08 0.08 0.60 0.1 0.40 0.12 0.20 0.14 -4.00 0.16 1.00 0 0.00 0.05 0.05 0.1 -1.00 0.1 0.1 0.12 -2.00 0.15 0.15 0.14 -3.00 0.2 0.16 -4.00 0.3 3.00 0.25 2.00 0.2 1.00 1.00 0.3 0.00 0.50 0.25 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18 0.00 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 -0.20 0.00 0.02 0.04 0.06 0.08 0.1 0.12 -0.02 0.00 0.1 0.09 0.08 0.07 0.06 0.05 0.04 0.03 0.02 0.01 0.90 0.05 0.1 0.15 0.2 0.25 -0.04 -0.02 -0.15 0.01 -0.10 0.02 1.05 0.00 0.1 0.09 0.08 0.07 0.06 0.05 0.04 0.03 0.02 0.01 0.40 0.03 0.05 0.60 0.02 0.02 1.10 0.02 0.02 0.01 -0.05 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.20 -0.01 0.01 0.95 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.01 1.00 0.00 0.02 -0.02 -0.01 0.04 0.06 0.08 0.1 0.12 0.14 0.10 0.80 0.03 0.03 1.15 0.04 0.04 0.00 0.05 0.1 0.15 0.2 0.25 -4.00 -0.50 0.00 0.02 0.04 0.06 0.08 0.1 0.12 -2.00 -0.50 -0.20 1.00 4.00 1.50 6.00 0.00 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 1.00 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.80 1.00 0.60 -1.00 0.50 0.40 -2.00 0.50 0.50 -1.00 2.00 -3.00 0.00 0.2 0.18 0.16 0.14 0.12 0.1 0.08 0.06 0.04 0.02 0.20 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.00 0.1 0.09 0.08 0.07 0.06 0.05 0.04 0.03 0.02 0.01 8.00 1.00 2.00 1.50 1.00 1.50 1.00 -2.00 -6.00 0.00 0.05 0.1 0.15 0.2 0.25 0.00 0.05 0.1 0.15 0.2 0.25 -2.00 0.00 0.05 0.1 0.15 0.2 0.25 -0.50 0.00 0.5 0.45 0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 1.00 0.80 4.00 -2.00 2.00 0.60 0.00 0.2 0.18 0.16 0.14 0.12 0.1 0.08 0.06 0.04 0.02 2.00 0.50 -0.50 2.00 0.40 -1.00 -4.00 0.20 -1.50 1.00 0.00 0.05 0.1 0.15 0.2 0.25 6.00 0.00 0.05 0.1 0.15 0.2 0.25 0.3 0.35 3.00 1.00 0.50 3.00 1.00 -0.05 0.90 0.2 0.18 0.16 0.14 0.12 0.1 0.08 0.06 0.04 0.02 -0.02 -0.02 -0.10 -0.02 -0.02 0.00 0.05 0.1 0.15 0.2 0.25 0.00 0.05 1.00 0.00 0.02 0.04 0.06 0.08 0.1 0.12 -0.01 0.2 0.18 0.16 0.14 0.12 0.1 0.08 0.06 0.04 0.02 0.10 0.00 0.05 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 -0.01 0.95 -0.01 -0.01 0.00 0.1 0.2 0.3 0.4 0.5 0.6 0.7 -0.01 -0.01 0.1 0.15 0.2 0.25 0.10 1.05 0.01 0.01 0.20 0.01 0.01 0.15 1.10 0.02 0.01 0.30 0.02 0.01 0.20 1.15 0.03 0.02 0.40 0.03 0.02 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 -0.04 -0.06 -0.30 -0.04 -0.02 Figure 2: Distribution of reduced-form coefficients of the benchmark model in 500 bootstrap replications 0.20 0.1 0.60 0.00 0.02 0.04 0.06 0.08 0.01 0.20 0.80 0.60 -0.02 0.10 0.06 0.04 0.04 0.12 0.40 -0.01 0.00 0.1 0.09 0.08 0.07 0.06 0.05 0.04 0.03 0.02 0.01 0.02 0.02 0.40 -0.02 -0.04 -0.10 0.00 0.02 0.20 -0.03 -0.20 -0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 1.00 0.80 0.02 0.00 0.02 0.04 0.06 0.08 0.1 0.12 0.30 0.08 0.06 European Central Bank working paper series For a complete list of Working Papers published by the ECB, please visit the ECB’s website (http://www.ecb.int) 419 “The design of fiscal rules and forms of governance in European Union countries” by M Hallerberg, R Strauch and J von Hagen, December 2004 420 “On prosperity and posterity: the need for fiscal discipline in a monetary union” by C Detken, V Gaspar and B Winkler, December 2004 421 “EU fiscal rules: issues and lessons from political economy” by L Schuknecht, December 2004 422 “What determines fiscal balances? An empirical investigation in determinants of changes in OECD budget balances” by M Tujula and G Wolswijk, December 2004 423 “Price setting in France: new evidence from survey data” by C Loupias and R Ricart, December 2004 424 “An empirical study of liquidity and information effects of order flow on exchange rates” by F Breedon and P Vitale, December 2004 425 “Geographic versus industry diversification: constraints matter” by P Ehling and S B Ramos, January 2005 426 “Security fungibility and the cost of capital: evidence from global bonds” by D P Miller and J J Puthenpurackal, January 2005 427 “Interlinking securities settlement systems: a strategic commitment?” by K Kauko, January 2005 428 “Who benefits from IPO underpricing? Evidence form hybrid bookbuilding offerings” by V Pons-Sanz, January 2005 429 “Cross-border diversification in bank asset portfolios” by C M Buch, J C Driscoll and C Ostergaard, January 2005 430 “Public policy and the creation of active venture capital markets” by M Da Rin, G Nicodano and A Sembenelli, January 2005 431 “Regulation of multinational banks: a theoretical inquiry” by G Calzolari and G Loranth, January 2005 432 “Trading european sovereign bonds: the microstructure of the MTS trading platforms” by Y C Cheung, F de Jong and B Rindi, January 2005 433 “Implementing the stability and growth pact: enforcement and procedural flexibility” by R M W J Beetsma and X Debrun, January 2005 434 “Interest rates and output in the long-run” by Y Aksoy and M A León-Ledesma, January 2005 435 “Reforming public expenditure in industrialised countries: are there trade-offs?” by L Schuknecht and V Tanzi, February 2005 436 “Measuring market and inflation risk premia in France and in Germany” by L Cappiello and S Guéné, February 2005 437 “What drives international bank flows? Politics, institutions and other determinants” by E Papaioannou, February 2005 438 “Quality of public finances and growth” by A Afonso, W Ebert, L Schuknecht and M Thöne, February 2005 46 ECB Working Paper Series No 452 March 2005 439 “A look at intraday frictions in the euro area overnight deposit market” by V Brousseau and A Manzanares, February 2005 440 “Estimating and analysing currency options implied risk-neutral density functions for the largest new EU member states” by O Castrén, February 2005 441 “The Phillips curve and long-term unemployment” by R Llaudes, February 2005 442 “Why financial systems differ? History matters” by C Monnet and E Quintin, February 2005 443 “Explaining cross-border large-value payment flows: evidence from TARGET and EURO1 data” by S Rosati and S Secola, February 2005 444 “Keeping up with the J oneses, reference dependence, and equilibrium indeterminacy” by L Stracca and Ali al-Nowaihi, February 2005 445 “Welfare implications of joining a common currency” by M Ca’ Zorzi, R A De Santis and F Zampolli, February 2005 446 “Trade effects of the euro: evidence from sectoral data” by R Baldwin, F Skudelny and D Taglioni, February 2005 447 “Foreign exchange option and returns based correlation forecasts: evaluation and two applications” by O Castrén and S Mazzotta, February 2005 448 “Price-setting behaviour in Belgium: what can be learned from an ad hoc survey?” by L Aucremanne and M Druant, March 2005 449 “Consumer price behaviour in Italy: evidence from micro CPI data” by G Veronese, S Fabiani, A Gattulli and R Sabbatini, March 2005 450 “Using mean reversion as a measure of persistence” by D Dias and C R Marques, March 2005 451 “Breaks in the mean of inflation: how they happen and what to with them” by S Corvoisier and B Mojon, March 2005 452 “Stocks, bonds, money markets and exchange rates: measuring international financial transmission” by M Ehrmann, M Fratzscher and R Rigobon, March 2005 ECB Working Paper Series No 452 March 2005 47 ... them” by S Corvoisier and B Mojon, March 2005 452 ? ?Stocks, bonds, money markets and exchange rates: measuring international financial transmission? ?? by M Ehrmann, M Fratzscher and R Rigobon, March... E R I E S N O / M A R C H 0 STOCKS, BONDS, MONEY MARKETS AND EXCHANGE RATES MEASURING INTERNATIONAL FINANCIAL TRANSMISSION by Michael Ehrmann 2, Marcel Fratzscher and Roberto Rigobon In 2005... on Stocks, Bonds and Exchange Rates? ??, Journal of International Money and Finance, 22, 307-341 Faust, J., Rogers, J., Wang, S., Wright, J (2003), “The High Frequency Response of Exchange Rates and