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Empirical Methods in International Finance
Summer School in Economics 2002,
European University at St. Petersburg
Wojciech W. Charemza
Professor of Economics, University of Leicester
__________________________________________________________________________________
Course Goals:
1.
2.
3.
4.
To give an overview of modern methodologies used for empirical analysis of
international financial markets
To make participants familiar with modern econometric software
To provide an empirical correspondence (through examples and discussion of
empirical policy issues) to the parallel course Theory of International Finance
and in particular in the modelling of covered and uncovered interest parity,
purchasing power parity and efficient market analysis of international financial
markets.
To create a constructive contribution towards the development of a syllabus
for a contemporary course in empirical analysis of international financial
markets.
Outcomes:
On the completion of the course the participants should be able to:
1
Evaluate critically existing models used in modelling international financial
markets
2
To use modern econometric software.
3
To be able to develop curricula which, subject to local constraints, would be
appropriate for teaching a similar course at undergraduate and postgraduate
levels.
4
To be able to apply some of the relevant methods in their own research
Transferable skills:
On completion of the course, participants should be able to:
1.
Read and critically interpret academic literature related to the subject.
2.
Prepare an essay-style written reports.
3.
Participate in academic discussions.
4.
Present lectures with the use of some modern lecturing techniques (computers
and computer-generated OHP’s)
5.
Foresee and be ableto deal with potential problems and misunderstandings
which might arise in the process of interactive teaching.
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Teaching methodology and time schedule:
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2.
3.
4.
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6.
7.
Traditional lectures (with the use of computers and OHP)
Interactive lectures
Curriculum development seminars
Problem solving seminars
Computer seminars
Other interactive sessions (question and answers,
recapitulation and problem identification, etc.)
Examination (final test)
Total teaching time
10 hours
10 hours
4 hours
2 hours
6 hours
4 hours
2 hours
38 hours
The time schedule above does not include own study, office hours and the time spent
in the computer laboratory during unsupervised computer sessions.
The course will concentrate on three case studies covering relevant topics of
international finance: covered and uncovered interest parity, efficient market analysis
and purchasing power parity. However, the sequence of the case studies is not
necessarily the same as the sequence taught in the theoretical part of the Summer
School. It corresponds to the development of empirical techniques, starting from the
easiest to the most advanced. In particular, the correspondence between the particular
subjects and the techniques taught is the following:
1. Covered and uncovered interest parity: simple and multiple regressions, stationary
dynamic models
2. Efficient market analysis: concept of rational expectations, autocorrelation analysis,
testing for stationarity.
3. Purchasing power parity: cointegration analysis
There are two types of textbooks recommended for the course:
1. Textbooks in applied international finance
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2.
3.
Baillie, R. and P. McMahon, The foreign exchange market, 1990.
Hallwood, C.P. and R. MacDonald, International money and finance, 3rd ed.,
Blackwell, 2000.
Pentecost, E.J., Exchange rate dynamics, Edward Elgar, 1993.
2. Textbooks in econometrics and applied econometrics
4.
5.
Charemza, W. W. and D.F. Deadman,New directions in econometric practice 2nd
ed., Edward Elgar, 1997.
Stewart, J. and L. Gill, Econometrics, 2nd ed., Prentice Hall, 1998
Each of these books covers a different area and they are complements rather than
substitutes each other. Considering the amount of material covered, the most relevant
books are those by Hallwood and MacDonald and Charemza and Deadman.
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Assessment strategies:
1.
2.
Participants will prepare 2 courseworks which will be assessed within two
days and on which written feedback will be given. One of the courseworks
will be related to curriculum development (identification of important topics,
assessment of the degree of difficulty) and another will be a sort of a ‘mock
exam’. Feedback will be given on this and it is anticipated that this will help
participants not only in the preparation for their final test, but also with the
transferable skills of report writing.
Final two-hour test, similar to a typical graduate final examination.
Participants will be assessed not only for their technical knowledge of the subject, but
also for their ability to develop a typical course curriculum, problem identification and
transferable skills.
Topics, timetable and main readings
Day 1:
Morning lectures 1-2: Empirical analysis of covered and uncovered interest
parity (CIP and UIP)
Lectures 1-4 are directly related to parts 2 and 7 (and, partially, to part 4) of the course
in the Theory of International Trade delivered earlier within the Summer School.
(1)
(2)
(3)
Covered and uncovered interest rate parities: recapitulation of theories and their
empirical consequences
Simple regression models of CIP and UIP.
Testing of the CIP and UIP hypotheses in static models
Readings:
Hallwood, and MacDonald, chapter 3
Pentecost, chapter 5
Stewart and Gill, chapter 2
Morning lectures 3-4 (interactive): More advanced analysis or the CIP and UIP
hypotheses
(1)
(2)
(3)
Distribution of exchange rates
Exchange rate regimes: multicollinearity, Haavelmo bias, dummy variables and
heteroscedasticity in stationary models
Dynamic analysis of the CIP and UIP models
Readings:
Stewart and Gill, chapter 5.3 - 5.4 and 6.1 – 6.6.
Baillie, and McMahon, chapter 5
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Afternoon session (2 hours): Seminar on curriculum development: Participants,
divided in groups, will critically assess advantages and limitations of the CIP
and UIP hypotheses.
Program of the seminar
1.
What are the origins of the CIP and UIP hypotheses?
2.
What are the advantages and disadvantages of static analysis of these
hypotheses?
3.
Why is the short-run and long-run analysis relevant?
The above questions should be discussed separately for undergraduate and graduate
teaching.
Day 2
Morning lectures 5-6: Introduction to the empirical analysis of market efficiency
Lectures 5- 16 are directly related to the parts 8 and 17-20 of the course in the Theory
of International Finance delivered earlier within the Summer School.
(1) Concept of market efficiency
(2) Mathematical properties of rational expectations
(3) Nonstationarity: an intuitive approach
Readings:
Baillie. and McMahon, chapter 2
Charemza and Deadman, chapter 5.1-5.4
Hallwood and MacDonald, chapter 11
Morning lectures 7-8 (interactive): Further analysis of efficient foreign exchange
markets.
(1)
(2)
Testing efficiency with the use of spot and forward exchange rates
Efficiency and autocorrelation analysis
Readings:
Baillie and McMahon, chapter 6
Stewart and Gill, chapter 6.7
Afternoon computer session: (2 hours): Interaction with computers and real data
estimation of the CIP and UIP models
This session will familiarise participants with E-Views econometric software.
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Day 3
Morning lectures 9-10: Efficient market hypothesis and nonstationarity
(1)
(2)
More formal approach to understanding nonstationarity
Consequences of nonstationarity to the efficient market hypothesis
Readings:
Charemza and Deadman, chapter 5.1-5.3
Stewart and Gill, chapter 6.7
Morning lectures 11–12 (interactive). Testing for exchange rates nonstationarity
(1)
(2)
Simple tests for the level of integration
Integration analysis and Monte Carlo
Readings:
Charemza and Deadman, chapter 5.4
Stewart and Gill, chapter 7.6
Afternoon computer session: (2 hours) Introductory analysis of the efficient
market hypothesis
Day 4
Morning lectures 13 - 14: More complicated nonstationary processes of exchange
rates I
(1)
(2)
Augmented and sequential testing
Problems of changes in exchange rate regimes
Readings:
Charemza and Deadman, chapter 5.5
Stewart and Gill, chapter 7.7
Morning lectures 15-16 (interactive) : More complicated nonstationary processes
of exchange rates II
(1)
(2)
Fundamental and speculative processes of exchange rates formations
Nonstationarity and speculative processes: some empirical problems
Readings:
Hallwood and MacDonals, chapter 9.
Pentecost, chapter 4
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Afternoon problem solving session: (2 hours): Understanding of nonstationarity
of financial time series.
Program of the seminar:
1.
What are the consequences of stationary and nonstationary in international
finance data?
2.
To what extent Monte Carlo methods might help to analyse nonstationary in
time series
3.
What are the advantages and disadvantages of the Dickey-Fuller approach to
testing nonstationarity?
Day 5
No lectures are planned for this day. Instead, there will be activities related to
participants’ assessments tasks.
Morning interactive session (2 hours): Recapitulation and identification (with
discussion) of tasks and subjects for the ‘mock exam’ assessment
Program of the session:
Particular parts of the program worked out on days 1-5 will be discussed and
participants will be encouraged to answer the following questions:
1.
What are the most important (from the point of view of their empirical
applications) of the empirical analysis of international financial markets?
2.
What are the principal (hidden and revealed) assumptions behind the most
relevant methods?
3.
Which areas of applied international finance are either not developed enough or
are, in some ways, neglected?
Morning curriculum development seminar (2 hours):
Program of the seminar:
(1) What are the essential differences in the ‘old style’ and ‘modern applied’
curricula, regarding the empirical approach to international financial analysis?
(2) Is it always true that the ‘new’ approach towards international financial analysis
is better (for the sake of discussion the participants should be split into groups
consisting of those for and those against new approach)
Afternoon curriculum development seminar (2 hours): Recapitulation and
identification (with discussion) of tasks and subjects for the ‘curriculum
development’ assessment
Program of the seminar:
1.
2.
To what extent the new approach is relevant for teaching applied international
finance?
Identify (prioritise) particular topics relevant for undergraduate and graduate
students of both old and new approaches.
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3.
How would you draft a curriculum for a) a short undergraduate course, b) a long
undergraduate course, c) a selected postgraduate course?
By the end of this day, assessment topics will be allocated to participants.
Day 6
Morning lectures 17-18: Empirical analysis of the purchasing power
parity (PPP) I.
Lectures 17- 20 are directly related to parts 4 and 6 of the course in the Theory of
International Finance delivered earlier within the Summer School.
(1)
(2)
Concept of weak and strong PPP and its empirical consequences
The concept of cointegration. (An intuitive guide, long-run relationships and
error-correction mechanisms, the Engle-Granger definition of cointegration,
seasonal cointegration, examples of cointegrating series.)
Readings:
Morning lectures 19-20 (interactive) Empirical analysis of the purchasing power
parity (PPP) II
(1)
(2)
Testing for weak and strong PPP.
Modelling long-run PPP relationships (the two-step Engle-Granger method and
simple extensions).
Readings:
Charemza and Deadman, chapter 5.5-5.9
Hallwood and MacDonald, chapter 7
Afternoon computer session (2 hours): Empirical modelling of real life exchange
rate relationships. Participants will use sets of exchange rates data (one historical
one and the other contemporary) and try to decide upon the existence of PPP.
Day 7
There will be no formal classes and seminars on this day. Participants are expected to
work on preparation of their assignment papers and examination.
Morning questions and answers session (2 hours): ‘mock exam’ assignment
Morning questions and answers session (2 hours): ‘curriculum development’
assignment.
Afternoon is reserved for extensive individual consultations.
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Day 8
Morning: written 2-hours examination
Afternoon: marking papers
Evening: Summing up and final discussion ‘where do we from here?’
Further development and follow-on
It is expected that further exchange between participants and the lecturers will
continue after the end of the Summer School. In particular the lecturers will help,
through the e-mail communication to develop curricula at particular universities.
There are two possible scenarios of further development in this respect. The more
ambitious one is to create an informal Internet discussion group on various aspects of
teaching applied international finance. The less ambitious scenario is to organise a
‘virtual conference’ in about one year’s time, in which former participants and
lecturers will exchange information regarding various aspects of curriculum
development. It is difficult to decide at this stage which way will be implemented, as
this depends crucially on the final outcome of the Summer School. Judging from the
experience of earlier Summer Schools it is also likely that a closer academic
collaboration resulting in joint research projects will develop.