The paper by B. Chowdhry and J. Howe examines if production delocalization can play a useful role for corporate exchange rate risk management. Such “operational hedging” transfers the production costs into the foreign currency area and may thus reduce the operating exposure of a firm. The authors claim that operational hedging emerges only if a firm faces a combination of exchange rate and demand uncertainty. Exchange rate uncertainty alone cannot justify production delocalization because it can be hedged with foreign exchange instruments. Only the interaction of exchange rate risk with demand uncertainty can justify delocalization to the extend that market incompleteness prevents insurance of demand risk. The authors derive their conclusions from ad hoc assumptions which lack proper microfoundations. They concede this flaw in a short note on page 4 without fixing it. Two assumptions are in contradiction to microeconomic principles: First, the authors assume that local prices of a multinational firm are fixed in advance and do not change for any given exchange rate change. Second, they assume that the quantity sold in each market and the exchange rate are independent variables. Both assumptions present a dubious starting point and need to be rectified. The following section tries to clean up their model setting. Thereafter, I proceed to the central claim of the paper about the necessity of both demand and exchange rate uncertainty for delocalizations. It turns out this claim cannot be sustained if firm pricing behavior is properly modeled.

[Should capital cost calculations be based on a global or local market benchmark? The December 2000 redefinition of the Morgan Stanley Capital International (MSCI) global equity index was a natural experiment addressing this question. It is argued that this event triggered a portfolio shift (by index funds) large enough to affect the residual asset supplies constituting the global and local market benchmarks of all actively managed capital. Changes in the market benchmarks imply distinct and predictable changes to global and local stock betas. Exploring whether global or local beta changes best explain the cross-section of event returns reveals that stocks in developed markets are priced globally and not locally.]

Should capital cost calculations be based on a global or local market benchmark? The December 2000 redefinition of the Morgan Stanley Capital International (MSCI) global equity index was a natural experiment addressing this question. It is argued that this event triggered a portfolio shift (by index funds) large enough to affect the residual asset supplies constituting the global and local market benchmarks of all actively managed capital. Changes in the market benchmarks imply distinct and predictable changes to global and local stock betas. Exploring whether global or local beta changes best explain the cross-section of event returns reveals that stocks in developed markets are priced globally and not locally. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

Recent evidence shows that higher trader participation increases exchange rate volatility. To explore this linkage, we develop a dynamic model of endogenous entry of traders subject to heterogenous expectational errors. Entry of a marginal trader into the market has two effects: it increases the capacity of the market to absorb exogenous supply risk, and at the same time it adds noise and endogenous trading risk. The competitive entry equilibrium is characterized by excessive market entry and excessively volatile prices. A positive tax on entrants can decrease trader participation and volatility while increasing market efficiency. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

[Recent evidence shows that higher trader participation increases exchange rate volatility. To explore this linkage, we develop a dynamic model of endogenous entry of traders subject to heterogenous expectational errors. Entry of a marginal trader into the market has two effects: it increases the capacity of the market to absorb exogenous supply risk, and at the same time it adds noise and endogenous trading risk. The competitive entry equilibrium is characterized by excessive market entry and excessively volatile prices. A positive tax on entrants can decrease trader participation and volatility while increasing market efficiency.]

The electronic trading system Xetra of the German Security Exchange provides a unique data source on the equity trades of 756 professional traders located in 23 different cities and eight European countries. We explore informational asymmetries across the trader population: Traders located outside Germany in non‐German‐speaking cities show lower proprietary trading profit. Their underperformance is not only statistically significant, it is also of economically significant magnitude and occurs for the 11 largest German blue‐chip stocks. We also examine whether a trader location in Frankfurt as the financial center, or local proximity of the trader to the corporate headquarters of the traded stock, or affiliation with a large financial institution results in superior trading performance. The data provide no evidence for a financial center advantage or of increasing institutional scale economies in proprietary trading. However, we find evidence for an information advantage due to corporate headquarters proximity for high‐frequency (intraday) trading.

We test if issuers of asset- and mortgage-backed securities receive rating favors from agencies with which they maintain strong business relationships. Controlling for issuer fixed effects and a large set of credit risk determinants, we show that agencies publish better ratings for those issuers that provide them with more bilateral securitization business. Such rating favors are larger for very complex structured debt deals and for deals issued during the credit boom period. Our analysis is based on a new deal-level rating statistic that accounts for the full distribution of tranche ratings below the AAA cut-off point of a structured debt deal.

We develop an equilibrium model in which exchange rates, stock prices, and capital flows are jointly determined under incomplete foreign exchange (forex) risk trading. Incomplete hedging of forex risk, documented for U.S. global mutual funds, induces the following price and capital flow dynamics: Higher returns in the home equity market relative to the foreign equity market are associated with a home currency depreciation. Net equity flows into the foreign market are positively correlated with a foreign currency appreciation. The model predictions are strongly supported at daily, monthly, and quarterly frequencies for 17 OECD countries vis-à-vis the United States. Correlations are strongest after 1990 and for countries with higher equity market capitalization relative to GDP, suggesting that the observed exchange rate dynamics is indeed related to equity market development.

[Traditional portfolio balance theory derives a downward sloping currency demand function from limited international asset substitutability. Historically, this theory enjoyed little empirical support. We provide direct evidence by examining the exchange rate effect of a major redefinition of the MSCI Global Equity Index in 2001 and 2002. The index redefinition implied large changes in the representation of different countries in the MSCI Global Equity Index and therefore produced strong exogenous equity flows by index funds. Our event study reveals that countries with a relatively increasing equity representation experienced a relative currency appreciation upon announcement of the index change. Moreover, stock markets that are upweighted (downweighted) feature a higher (lower) permanent comovement of their currency with the basket of other MSCI currencies.]

The early stage of the 2007/2008 financial crisis was marked by large value losses for bank stocks. This article identifies the equity funds most affected by this valuation shock and examines its consequences for the nonfinancial stocks owned by the respective funds. We document three key empirical findings. First, ownership links to these distressed equity funds lead to large temporary underperformance of the most exposed nonfinancial stocks. Second, distressed equity funds make the better performing stocks in their portfolio the preferred liquidation choice. Third, stocks with higher overall fund ownership generally performed better throughout the crisis.