IFM Program Meeting

March 12, 2010
Roberto Chang and Kristin Forbes, Organizers

Andrew Karolyi, Cornell University, and Rose C. Liao, Rutgers University
What is Different about Government-Controlled Acquirers in Cross-Border Acquisitions?

Karolyi and Liao examine the motives for and consequences of 5,317 failed and completed cross-border acquisitions constituting $619 billion of total activity that were led by government-controlled acquirers over the period from 1990 to 2008. The authors benchmark this activity at the aggregate-country level and also at the deal level with cross-border acquisitions involving corporate acquirers over the same period. They find that government-led deal activity is relatively more intense for geographically-closer countries, but also relatively less sensitive to differences in the level of economic development of the acquirer's and target's home countries, in the quality of their legal institutions and accounting standards, and to how stringent are restrictions on FDI flows in their countries. Government-led acquirers are more likely to pursue larger targets with greater growth opportunities and more financial constraints. But, the share-price reactions to the announcements of such acquisitions are not different. Among those deals involving government-controlled acquirers, the authors do find important differences involving sovereign wealth funds (SWFs). SWF-led acquisitions are less likely to fail, they are more likely to pursue acquirers that are larger in total assets and with fewer financial constraints, and the market reactions to SWF-led acquisitions, while positive, are statistically and economically much smaller. They discuss policy implications in terms of recent regulatory changes in the United States and other countries that seek to restrict foreign acquisitions by government-controlled entities.

Steven B. Kamin and Laurie Pounder, Federal Reserve Board
How Did a Domestic Housing Slump Turn into a Global Financial Crisis?

The global financial crisis clearly started with problems in the U.S. subprime sector and spread across the world from there. But was the direct exposure of foreigners to the U.S. financial system a key driver of the crisis, or did other factors account for its rapid contagion across the world? To answer this question, Kamin and Pounder assessed whether countries that held large amounts of U.S. mortgage-backed securities (MBS) and were highly dependent on dollar funding experienced a greater degree of financial distress during the crisis. The researchers found little evidence of such "direct contagion" from the United States to abroad. Although CDS spreads generally rose higher and bank stocks generally fell lower in countries with more exposure to U.S. MBS and greater dollar funding needs, these correlations were not robust, and they fail to explain the lion's share of the deterioration in asset prices that took place during the crisis. Accordingly, channels of "indirect contagion" may have played a more important role in the global spread of the crisis: a generalized run on global financial institutions, given the opacity of their balance sheets; excessive dependence on short-term funding; vicious cycles of mark-to-market losses driving fire sales of MBS; the realization that financial firms around the world were pursuing similar (flawed) business models; and global swings in risk aversion. The U.S. subprime crisis, rather than being a fundamental driver of the global crisis, may have been merely a trigger for a global bank run and for disillusionment with a risky business model that already had spread around the world. Keywords: financial crisis, transmission, mortgage-backed securities.

Cosmin Ilut, Duke University
Ambiguity Aversion: Implications for the Uncovered Interest Rate Parity Puzzle

Empirically, high-interest-rate currencies tend to appreciate in the future relative to low-interest-rate currencies, rather than depreciating as uncovered interest rate parity (UIP) states. The explanation for the UIP puzzle pursued here is that the agents' beliefs are systematically distorted. This perspective receives some support from an extended empirical literature that relies on survey data. Ilut constructs a model of exchange rate determination in which ambiguity-averse agents need to solve a filtering problem to form forecasts but face signals about the time-varying hidden state that are of uncertain precision. In the presence of such uncertainty, ambiguity-averse agents take a worst-case evaluation of this precision and respond stronger to bad news than to good news about the payoffs on their investment strategies. Importantly, because of this endogenous systematic underestimation, agents in the next periods will perceive positive innovations about the payoffs on average, which will make them re-evaluate the profitability of the strategy upwards. As a result, the model's dynamics imply significant ex-post departures from UIP as equilibrium outcomes. In addition to providing a resolution to the UIP puzzle, consistent with the data the model predicts positive profitability, negative skewness, and excess kurtosis for payoffs of currency speculation.

Kalina Manova, Stanford University and NBER; Shang-Jin Wei, Columbia University and NBER; and Zhiwei Zhang, Hong Kong Monetary Authority
Firm Exports and MNC Activity under Credit Constraints

Manova, Wei, and Zhang provide firm-level evidence that credit constraints restrict international trade flows and affect the pattern of foreign direct investment. Using detailed data from China, they show that foreign-owned firms and joint ventures have better export performance than private domestic firms, and this advantage is systematically greater in sectors at higher levels of financial vulnerability measured in a variety of ways. This confirms that financial frictions restrict international trade and is consistent with foreign affiliates being less credit constrained because they can tap internal funding from their parent company. The researchers also find that private Chinese firms are relatively more successful exporters than state-owned enterprises (SOEs) in financially dependent industries. Since SOEs enjoy easier access to lending from Chinese state-owned banks, this pattern suggests that they use resources less efficiently. These results imply that FDI can compensate for domestic financial market imperfections and alleviate their impact on aggregate growth, trade, and private sector development. Credit constraints and host-country financial institutions thus offer a new explanation for the sectoral and spatial composition of MNC activity.

Fabrizio Perri, University of Minnesota and NBER, and Vincenzo Quadrini, University of Southern California and NBER
International Recessions

The international synchronization of the 2008-9 crisis has been one of the key features of the recent recession as most countries have experienced large macroeconomic contractions. Another feature of the crisis has been the sharp fall in employment but not in productivity. These two features-international synchronization and absence of significant productivity fall-are not present in many of the previous contractions. Perri and Quadrini develop an explicit model of financial frictions to show that these changes are consistent with the view that "credit shocks" have been playing a more prominent role as a source of business cycle fluctuations in an environment with international mobility of capital.

Martin Bodenstein, Christopher Erceg, and Luca Guerrieri, Federal Reserve Board
The effects of foreign shocks when interest rates are at zero

Bodenstein, Erceg, and Guerrieri note that in a two-country DSGE model, the effects of foreign demand shocks on the home country are greatly amplified if the home economy is constrained by the zero lower bound for policy interest rates. This result applies even to countries that are relatively closed to trade such as the United States. The duration of the liquidity trap is determined endogenously. Adverse foreign shocks can extend the duration of the liquidity trap, implying more contractionary effects for the home country; conversely, large positive shocks can prompt an early exit, implying effects that are closer to those when the zero bound constraint is not binding.

Sebnem Kalemli-Ozcan, University of Houston and NBER; Herman Kamil; and Carolina Villegas-Sanchez, University of Houston
What Hinders Investment in the Aftermath of Financial Crises: Balance-Sheet Mismatches or Access to Finance?

Kalemli-Ozcan, Kamil, and Villegas-Sanchez use a new firm-level database from six Latin American countries between 1990 and 2005 to study the effect of financial crises on firms' performance. The depreciated currency provides new investment opportunities in the tradeable sector. Yet firms may not exploit these prospects, given the decreased supply of credit as a result of failing banks and fleeing foreign investors. Firms also might become credit constrained if their reliance on foreign-currency-denominated debt before the crisis (and the associated currency mismatch on their balance sheets) reduces their net worth after the depreciation. In contrast to the previous studies, this one is able to differentiate between these two main sources of financial constraints by relying on firm-level information, not only on the share of debt denominated in foreign currency but also on the export orientation and the ownership structure of the firm. Using a differences-in-differences methodology, the authors show that firms who hold short-term foreign-currency-denominated debt do worse only if they are domestic firms. Foreign owned firms do better, both in terms of sales and investment, than the domestic firms in the post-crisis period, even if they hold foreign currency debt. The authors conclude that limited access to finance plays a critical role in hindering investment during crises.

Olivier Jeanne, Johns Hopkins University and NBER
The Global Liquidity Trap

Jeanne presents a two-country model of the world economy with money and nominal stickiness in which countries may be affected by demand shocks. He shows that a negative demand shock in one country may push the world economy in a global liquidity trap with unemployment and zero nominal interest rates in both countries. Global monetary stimulus (a temporary increase in both countries' inflation targets) may restore the first-best level of employment and welfare. Fiscal stimulus may restore full employment but distorts the allocation of consumption between private and public goods. He also studies the international spillovers associated with each policy, and the risk that they lead to trade protectionism.