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Emerging financial markets: spatial risks, elicitability of risk models, and shape shift contagion
(2020) Junior, Peterson Owusu; Owusu Junior, Peterson
The need to compare and contrast emerging market economies (EMEs) has never been greater, especially following shocks to the global financial system. The quest to characterise EMEs does not only emanate from risk mitigation purposes but also to maximise investment returns and to articulate appropriate policy reforms even amidst financial turmoil. Moreover, increasing integration of otherwise segmented economies has been largely amplified by the impact of these market disturbances as seen in episodes of contagion. While the extant literature is ripe with studies aimed at unearthing the differences and similarities in EMEs, most of them have centred on all too ubiquitous dimensions such as returns and volatility behaviour, macroeconomic fundamentals, and even cultural ethos, among others. Although these attributes are helpful, they fail to provide deeper insights into EMEs for the rich understanding needed to make the best of investment and policy decisions. This thesis provides empirical examination of additional dimensions by which to characterise EMEs in order to provide a broader insight for prudent investment and policy strategies. The thesis comprises three empirical studies on spatial risks, elicitability of risk models, and “shape shift-contagion” of emerging markets equities, as the subtle extents by which to compare and contrast EMEs, using advanced econometric techniques. The first empirical study contrasts time-varying and spatial risks in order to assess systemic vulnerabilities that affect emerging markets equity returns as well as to aid portfolio diversification. The study spanned between Eurozone Crisis-Global Financial Crisis (EZC-GFC) and post-GFC to represent turbulent and tranquil periods. With the joint (VaR, ES) models and Global Liquidity Indicators (GLIs) for 12 EMEs which indicate time-varying and time-invariant (spatial) risk measures, respectively, the study provides evidence that, the ranking of joint (VaR, ES) forecasts and spatial autocorrelations differ significantly. The results reveal that the overall spatial autocorrelation between the 12 EMEs is smaller and negative for post-GFC as opposed to positive and bigger for EZC-GFC periods. This suggests that EMEs may have employed prudent liquidity policies to enhance their resilience to systemic susceptibilities as bitter lessons learnt from crises experiences. The implications are that (VaR, ES) forecasts rankings are irrelevant, since time-invariant systematic debacles have no respect for time-varying tail risks. For investors, international portfolio diversification tends to yield its expected risk-minimising outcomes during the post-GFC period. The study posits “Financial distance” as an extension of Cultural, Administrative/Political, Geographic, and Economic (CAGE) distance dimensions to characterise markets. This study is a subtle departure from the use of returns and volatilities used in describing economies. The second study examines the dynamics of emerging markets tail risk modelling and selection behaviour under comparative back testing requirement in the Basel III paradigm. The study does not only contribute to the growing need to correctly forecast and select the best tail risk model for internal risk management purposes, but it also fits well into the aim of reducing regulatory arbitrage. Across three market periods signifying tranquil and turbulent times, the study finds evidence of time-, percentile-, equity-, and market period-dependent Superior Set Models (SSMs) for 24 EMEs. These imply homogeneous vis-à-vis heterogeneous risk models which provide portfolio diversification impetus for specific markets. Further, while some of the equities show similar SSMs, there is no definite factor (such as either size of the market, geographical proximity, and financial market maturity, among others) that can be attributed to this pattern. This study throws a further challenge to the mechanism of “bucketing” different markets into one class – a typical practice of indexing institutions. The last study investigates the role of higher moments in establishing the levels of connectedness and contagion in EMEs under time-varying conditions. The findings surmise that EMEs respond differently to both asymmetric and extreme returns across the spectrum of tranquil and turbulent market periods. The novel rolling-window based generalised lambda distribution (GLD), combined with the wavelet multiple correlation (WMC) and wavelet multiple cross correlation (WMCC), and Baruník and Křehlík (2018) (BK18) spillover techniques show frequency dependent connectedness and time-dependent fleeting higher moment contagious episodes which are removed from the EZC and GFC periods. The results also expose the dominance of some EMEs in the transmission of shocks instead of the United States, for instance. Nonetheless, the United States emerges a net transmitter of shocks rather than a net recipient. These dynamics sound caution to policy makers and investors alike to be more wary of shocks emanating from EMEs as compared to those from the United States and by extension, other large developed markets. Finally, the study establishes “shape shift-contagion” in emerging markets equities in the short-term post both EZC and GFC episodes. This is consistent with shift-contagion and delayed shift-contagion hypotheses. Moreover, it corroborates the notion that shock transmissions tend to amplify even for an appreciable lapse in time after crisis episodes have died-off. Nevertheless, this phenomenon varies from one EME to another. Hence this points to usefulness of employing higher moments shocks to augment the mechanisms of classifying market economies. The results from all three empirical studies have one thing in common: EMEs are alike albeit dissimilar in terms of spatial liquidity susceptibilities, the behaviour of equities risk models pertaining to the reduction of regulatory arbitrage, and how they respond to financial market shocks. These are some important fronts to distinguish EMEs from each other that are hitherto missing from the literature. A number of investment and policy recommendations arising from the findings in this thesis are offered for stakeholders to take advantage of the unique characteristics of EMEs.
Foreign direct investment, spillover effects and economic growth in Africa
(2020) Asafo-Agyei, George Obodum-Kusi
This study examined the relationship between Foreign Direct Investment (FDI) and economic growth in Sub-Saharan Africa. The Hansen threshold regression model was used to examine the nature of the relationship between FDI and economic growth as well as the mediating role of absorptive capacity of the selected countries in Sub-Saharan Africa. Battesse and Coelli stochastic frontier was employed to examine efficiency gains from FDI inflows in the selected countries of Sub-Saharan Africa. Pedroni panel cointegration approach was used to assess the relevance of sectoral FDI on sectoral growth of the selected countries in Sub-Saharan Africa. Finally, the study employed OLS for the estimation of spillover effects of FDI inflows on the productivity of domestic manufacturing firms in the selected countries of Sub-Saharan Africa. This study establishes that the relationship between FDI and economic growth of the selected countries in Sub-Saharan Africa is non-linear in nature. The threshold level in this study has been estimated to be approximately US$ 44.93 per annum. The study also found that inflows into the selected Sub-Saharan Africa countries improve the level of efficiency in the production structure. The study further established that sectoral FDI inflow emanating from primary sources proffer significant effect on the economic growth of the selected countries in Sub-Saharan Africa. Sectoral FDI inflows from secondary sources do not significantly contribute to economic growth of selected countries in the region. However, FDI inflows from tertiary sources exert significant effect on economic growth in Sub-Saharan Africa. Finally, the study revealed that FDI spillover exerts significant effects on domestic manufacturing firms’ productivity of the selected countries in Sub-Saharan Africa. It is recommended that heads of investment promotion agencies of the selected countries should market their economies well to attract the required level of FDI ($44 FDI per capita and beyond) to enhance the growth prospects of those economies. The marketing strategies could for instance take the form of organisation of international conferences on the prospects of high domestic demand of FDI products, the hospitability and hardworking nature of a country’s citizens and to mention a few.
Monetary policy and macroeconomic stabilization: an application of new Keynesian framework for forecasting and policy analysis in Ghana
(2020) Akosah, Nana Kwame
The role of monetary policy in macroeconomic stabilization remains an important research focus for central banks, particularly in frontier and developing economies where the institutional structure are not quite complete, integration with the world economy is partial and also just at the beginning of a process of growth and transformation. These economies are also confronted with relatively large and recurrent correlated shocks entirely different from their developed counterparts. Notwithstanding, there is paucity of studies on monetary policy making in frontier and developing economies as the bulk of the literature has concentrated on either advanced economies or emerging markets where there is stable institutional structure and relatively predictable economic linkages. One of such leading frontier markets is Ghana. The West African nation became the 28th economy in the world but second Africa country after South Africa to officially opt for inflation targeting framework of monetary policy in May 2007. Regardless of the well-formulated price stability objective and operational independence clearly preserved in the Bank of Ghana (BOG) Acts 2002 (Act 612) after the adoption of inflation targeting regime, inflationary pressures have lingered over the years in Ghana. Without a doubt, Ghana’s consumer price inflation has been among the highest in sub-Saharan African economies, and the inflationary developments are often linked to large internal and external aggregate demand and supply-side shocks. The BOG has over the years adopted different policy stance in an attempt to steer inflation towards its medium term target of 8±2 percent, and hence, to ensure overall macroeconomic stability. The disinflationary process has often been short-lived, triggering controversy in policy and academic discourses regarding the appropriateness of the current monetary policy regime in Ghana. At the same time, some fast pace of GDP growth has recently been recorded, placing Ghana among the fastest growing economies in Africa. In the midst of these uneven macroeconomic outcomes, it is of paramount interest to comprehend the effectiveness and the dominant channel of monetary policy transmission mechanism in Ghana. Also given the fact that BOG currently follows a certain policy rule, it is necessary to ascertain how BOG has reacted to macroeconomic shocks over the years. Furthermore, available empirical literature is inconclusive on the extent of the policy pass-through (i.e. via interest rate) to the real economy in Ghana amid large segment of unbanked population (i.e. nonRicardian consumers) and continuous fragile fiscal profile. Besides, the New Keynesian framework for monetary policy analysis and forecasting adopted in frontier and developing economies still follows the representative agents’ approach - which assumes that all households have complete access to the financial system and hence, able to smooth consumption - even though a large segment of the population face acute financial constraints and are thus “hand-to-mouth” consumers. Given the pace of financial integration and international trade dynamics, evidence of shock transmission and interdependence of macroeconomic variables could provide meaningful suggestions for monetary policy implementation in a small but highly opened economy like Ghana with underdeveloped financial market. This thesis addresses these gaps inherent in extant literature and offers empirical solutions for the Ghanaian case by investigating the monetary and business cycle dynamics, exploring interdependence (spillovers) between policy instruments and targeted macroeconomic variables, estimating monetary policy reaction function, developing a New Keynesian DSGE framework with and without non-Ricardian consumers for monetary policy forecasting and analysis as well as for consumption effects of monetary and fiscal policies. On a whole, the thesis is methodically organized into six essential and interrelated empirical chapters, each significantly touching on peculiar theme(s) that form the crux of the problems or research questions on monetary policy and macroeconomic stability while employing advanced macroeconometric techniques and models that underpin monetary policy transmission mechanism in a leading frontier market, Ghana. The first four empirical chapters of the thesis judiciously use empirical macroeconometric methods to investigate four aspects of monetary policy making in Ghana. In particular, the first empirical chapter focuses mainly on the institutional and practical architecture of the current monetary policy framework in Ghana. In a sense, it comprehensively explores the level of transparency, accountability and credibility of Bank of Ghana, following much of the literature. The salient finding is that monetary policy framework is consistent with inflation forecast targeting and exhibits moderate levels of policy transparency and credibility. The second empirical chapter investigates the macroeconomic benefits of inflation targeting strategy in Ghana using business cycle analysis and standard econometric methods. This chapter shows significant interconnectedness with business cycle and that the inflation targeting strategy has been broadly beneficial in Ghana compare to the previous policy regimes. The third empirical chapter investigates monetary policy transmission mechanism and its overall effectiveness with particular focus on the macroeconomic interdependence or volatility spillovers among money market interest rate on one hand and among the policy (interest) rate, exchange rate and the real sector (i.e. inflation and output gap) on the other hand, over time and in multiscale domain. Using appropriate models such as three-dimensional continuous Morlet wavelet coherency technique, parametric and nonparametric Granger non-causality tests, as well as the generalized forecast error variance decomposition (GFEVD) methods, the chapter mainly suggests moderate levels of interconnectedness among money market interest rates across time and multiscale domains in Ghana. The third empirical chapter further reveals that the degree of interdependence among the policy interest rate, exchange rate and the real macro-variables are scale-dependent, as strong interlinkages are observed at the longer time-scale. The fourth empirical chapter looks at macroeconomic policy reaction functions with the view to determining monetary policy preference across economic cycles and political regimes in Ghana using generalized least squares and quantile regression methods. The basic finding of the fourth empirical chapter is a clear evidence of an asymmetric monetary policy rule with vivid vacillation in the key policy parameters across business cycles and time, strong interest rate inertia and weak evidence of heterogeneous policy preference in different political regimes, surmising the exercise of monetary policy independence. Together, the findings of the preceding four chapter form the basis for the development of small-open economy general equilibrium model in the subsequent two empirical chapters. Notably, the fifth empirical chapter develops and estimates a small-open economy New Keynesian general equilibrium model with representative agent (i.e. RANK) for monetary policy analysis in Ghana. It empirically tests the RANK model with the view to analyzing and determining the optimal monetary policy rule for Ghana. The salient finding is that forward-looking monetary policy rule is optimal for Ghana. However, the impulse response function demonstrated that model is prone to price puzzle. Given the large proportion of unbanked population in Ghana, we further extend the analysis of the preceding chapter to accommodate heterogeneous household behaviour. Accordingly, the sixth empirical chapter develops a small-open economy New Keynesian general equilibrium model with heterogeneous agent (i.e. HANK) with the view to exploring the implications of the inclusion of non-Ricardian households on monetary and fiscal policy transmissions in Ghana. Thus, the empirical chapter six assesses the relative suitability of the HANK model for monetary policy analysis in Ghana. Though the findings corroborate the earlier support for forward-looking monetary policy rule for Ghana, the HANK model in chapter six rather generates meaningful impulse response functions and hence, more suitable for monetary policy investigations in Ghana. Collectively, the findings of the thesis provide new and unique perspectives that extend current understanding of the monetary policy framework and its interconnectedness with the real sector within a frontier or developing economy saddled with underdeveloped financial markets as well as heterogeneous economic agents.
Monetary policy reaction function and transmission effectiveness: evidence from full-fledged inflation targeting Sub-Saharan African countries
(2020) Iddrisu, Abdul-Aziz
The relevance of monetary policy rules in providing a framework for policy coherence, stability and optimality has long been acknowledged. The eventual impact of optimal monetary policy response on the real economy, dependent on the effectiveness of the channels of transmission of monetary policy impulses, is even more crucial. Much as empirical literature on monetary policy rules and transmission effectiveness abound, substantial limitations still persist. The continuous focus on linear policy rules in the face of observed asymmetry in monetary policy behaviour; the dilemma and constraints posed to monetary policy responses by rising public debt levels; the direct approach to transmission channel exposition that is far from theoretical prescription; the assumption of homogeneity in prices that confront all agents in an economy which is far from reality; and the egregious neglect of the stabilizing effect of monetary policy on food prices despite the colossal role of the latter in the overall inflation dynamics of developing and poor economies are important research gaps in the monetary policy rule and transmission literature. Meanwhile, appropriate policy characterization and succinct comprehension of the dynamics of transmission are critical in shaping optimal and welfare-enhancing monetary policy. This thesis is centred on four thematic areas, with each considering an important gap (as a distinct essay) relating to monetary policy characterization and transmission. The first essay considers a nonlinear Taylor rule for the characterization of the monetary policy responses of the only two full-fledged inflation targeting central banks in Africa (Bank of Ghana and the South African Reserve Bank) and whether the said responses are constrained by rising public debt levels. With the aid of the sample splitting and threshold estimation technique, we find asymmetric reaction to inflation and output gaps when inflation falls below or exceeds our estimated optimal thresholds of 16.4% and 5.2% for Ghana and South Africa respectively, with the South African Reserve Bank being relatively more aggressive in its response to inflation gap above the threshold. The Bank of Ghana is not responsive to output gap on either side of the threshold. Importantly, we find that the monetary policy behaviour of the two central banks is far from the linear characterization and parametrization so common in the literature. For Ghana, we question the logic behind the prevailing upper and lower bounds given the evidence to the contrary. In respect of debt constraint on monetary policy, our estimated threshold level of debt to GDP ratio for Ghana and South Africa are respectively 35.1% and 33.7%. For Ghana, although policy response to inflation gap exhibits relative aggression above the estimated debt to GDP threshold of 35.1%, the extent of response is woefully disproportionate, a key indication of debt constraint and inflation accommodation. For South Africa, we find that the policy response in the low debt regime to inflation gap is negative, on the back of accommodative monetary policy when inflation exceeded the upper limit of the announced target in the midst of challenging growth path. Although the response to inflation gap in the high debt regime is positive, it is substantially constrained. The extent to which monetary policy decisions exact the desired results in the real economy is essentially a function of the effectiveness of the channels of monetary policy transmission. Comprehending the architecture and dynamics of the workings of these channels is thus critical for the monetary policymakers, as it helps them to determine how and when their decisions eventually impact the real economy and the nature of instruments to adopt. We revisit, in the second essay, the workings of the interest rate and bank lending channels in an indirect and systematic approach anchored on the theoretical prescriptions and a major departure from empirical literature. With the aid of the three stage least square technique (3SLS) in a system of equations, we find that the interest rate and the lending channels are operative in Ghana and South Africa. We find that whiles the lending channel is more effective relative to the interest rate channel in South Africa, the reverse is the case in Ghana. The fact that different regions/provinces have different economic structures and endowments is an ample reason to expect that price developments in these regions/provinces and their responses to monetary policy would necessarily be distinct. Literature has largely assumed homogeneity in the prices that confront economic agents with dire consequences for welfare. The third essay, therefore, looks at asymmetric effect of monetary policy on regional and provincial inflation in Ghana and South Africa. Using wavelet-based quantile regression for the first time in this strand of the literature, we provide a multi-layered asymmetric exposition on regional inflation-monetary policy relationship. We find that regions/provinces respond differently to changes in monetary policy. For Ghana, we find that for Central, Eastern, Greater Accra, Northern and Western regions, a restrictive monetary policy exacts mixed effect. Whiles monetary policy delivered stability across distinct quantiles in some scales, it fueled inflationary momentum in other scales, especially the higher scales or longer horizons. The responses are also distinct across scales and quantiles for each of the regions and across regions. In the case of Ashanti, Brong Ahafo and Volta regions, we find that a restriction in monetary policy only destabilizes prices across quantiles and in distinct scales. For South Africa, we find that whiles restrictive monetary policy delivers stability in the prices of Gauteng, Mpumalanga and North West provinces, it is destabilizing for prices in Eastern Cape, KwaZulu-Natal, Limpopo, Northern Cape and Western Cape provinces. For Free State province, the effect of a restrictive monetary policy on prices is mixed, depending on the horizon and the quantile involved. Food prices continue to play an important role in the overall inflation dynamics of many countries. For inflation targeting central banks and monetary policymakers in developing and low-income countries in particular, food prices pose even more challenges both from the perspective of achieving inflation targets and the welfare of the many poor households in these economies. In the fourth essay, we look at the stabilizing effect of monetary policy on food inflation in Ghana and South Africa using the quantile regression analysis. For Ghana, we find that monetary policy exerts positive effect on food prices across all the quantiles but the said effect is only statistically significant at the 25th quantile. For South Africa, monetary policy positively influences prices of food and the effect is significant across all the quantiles and prominently at the right tail. Thus, rising food prices in these countries are destabilized even further when monetary policy response is restrictive. On policy front, the relative inflation accommodation on the part of these central banks is deleterious to their credibility and disastrous for anchoring expectations of inflation which is exacerbated by the observed debt constraint. The findings on the operations of the bank lending and interest rate channels provide policy directions for the authorities to exact the required impact on the real economy and inflation in particular. Such policy directions are enhanced by the invaluable information on the heterogeneous regional responses to policy and the colossal role played by food prices in the African setting.
Towards a framework for asset pricing in developing equity markets
(2021) Nduga, Wycliffe Ouma
The need to accurately determine risk-return trade-offs in financial markets is an important question that has occupied minds of various players in capital markets for over five decades now. In this study, we addressed this question by attempting to determine the drivers of returns in developing equity markets. Further, we test the ability of the identified factors to command significant and reasonable risk premiums in the returns of developing equity markets. The results of this analysis were compared with those of a select group of emerging and developed equity markets. This study employed monthly stock price data from 20 developing equity markets, starting January 1, 1996, and ending February 1, 2020, resulting in 290 months of observation. Countries are included in the study as their data became available. Monthly stock price data were used to calculate individual stock returns for the first phase of the study, which involved determining the covariance matrix of returns. This was done through a dimensionality reduction technique of Asymptotic Principal Components Analysis and standard PCA whenever data permitted. The underlying drivers of returns variations determined through these procedures resulted in a few significant principal components (PCs) driving overall stock variations. The next step related the identified PCs to the candidate risk factors ensuring that empirical testing of asset pricing factors only included factors with important influence on stock variations. The study has found important empirical results on asset pricing in developing equity markets. First, the study has established that only a few fundamental drivers influence returns in the sampled 20 developing equity markets. At country level, factor identification strategy employed discovered that only a few principal components were significantly related to the covariance matrix of returns. Canonical correlations analysis largely confirmed the results as vi | P a g e factors such as excess market returns, book-to-equity and aggregate volatility significantly influenced returns variations in most of the individual markets in the sample. The empirical evaluation of the identified factors further established that excess market returns (MKT), book-to-market (value) factor (HML), profitability factor (RMW), momentum factor (UMD), unanticipated inflation factor (UI), aggregate volatility (VOL), and trade weighted US dollar index (TW$) were significantly priced in the returns of developing equity markets. Although FM regression did not price UI and TW$, the associated 𝑡 −statistic of their coefficients were closer to the threshold value of 2. For instance, UI and TW$ respectively produced 𝑡 −stat 1.952 and 1.929, which are significant at the 10% level. The GMM analysis, used for robustness checks, confirmed that MKT, HML, UMD and VOL were significantly priced, but further found that both UI and TW$ were not only significant drivers of risk variations, but also priced in the returns of developing equity markets. Further, DS-LASSO was used to check the robustness of the entire system starting from the factor identification to testing the identified factors. The results largely corroborate the conclusions of GMM, that MKT, HML, UMD and TW$ significantly explain returns variations of frontier equity style portfolios and are priced. The results also indicated that UI is marginally priced with a 𝑡 −stat of 1.958. This study puts forward some recommendations. First, we recommend a favourable policy environment to accelerate capital market development and investment in developing countries. Since accounting information has been established to proxy for common pervasive risk drivers in stock markets, financial reporting standard is, therefore, crucial to the quality accounting information disseminated. Developing equity markets need to institute prudent and harmonised accounting practices and strong corporate governance systems to ensure quality reporting. Debt variables such as corporate bonds and government bonds form a significant component of vii | P a g e capital market investment and are important drivers of returns in these stock markets. Unfortunately, developing equity markets do not have well-functioning debt markets rendering the variables irrelevant in their risk-return equation. Thus, these countries should institute deliberate policy measures to ensure growth of debt markets.

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