Discussion Paper

No. 2017-6 | February 13, 2017
Financial frictions and regime switching: the role of collateral asset in emerging stock market


This paper examines empirically the nonlinear business cycle dynamics due to the presence of financial frictions. Using a threshold vector auto regression, the authors estimate the behavior of interest rate shocks in which a regime change occurs if the two respective threshold variables namely asset price and exchange rate cross their critical threshold value. The authors find evidence that non linearity is strongly directed by regime-dependency; in fact the results suggest that output growth response is bigger when the economy is initially an appreciation regime.
In addition, the empirical findings prove the presence of asymmetric responses to interest rate shocks however this reaction is recognized via asset price ”debt-deflation mechanism” rather than shocks stemming from ”exchange rate depreciation spirals”. The results also show that a response to large shocks to interest rate shows disproportionate effects compared with responses to small shocks.

JEL Classification:

E51, E32, C20, C63


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Cite As

Haithem Awijen and Sami Hammami (2017). Financial frictions and regime switching: the role of collateral asset in emerging stock market. Economics Discussion Papers, No 2017-6, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2017-6

Comments and Questions

Anonymous - Referee Report 1
February 14, 2017 - 10:12

In this paper the authors use threshold VARs to study the asymmetric effects of monetary policy. They empirically investigate to what extent shocks to interest rates induce endogenous regime-switching behavior and how nonlinearities materialize by studying asymmetries (shocks of different directions) and disproportionality (shocks of different magnitude).

Is the ...[more]

... contribution of the paper potentially significant?
Although research of this type has been done in the past, its contribution potentially lies in its empirical value for the country explored. Unfortunately, the authors do not provide us with enough detail, or motivation, to see this potential contribution. For example, they do not even give information on the country they are investigating, its monetary policy or exchange rate regime. If the focus moves to the specific monetary system they are exploring, potentially there is contribution, but this calls for further empirical work.

Is the analysis correct?
It is hard to say, as we do not get much information on the variables used or mechanisms that exist in the unknown country explored. It seems that the TVAR and the Hansen test are fairly done, but the GIRFs look puzzling. There is no mention of confidence intervals for GIRFs (nowhere in the whole manuscript) but still from the figures it appears that they have constructed them. The question is how, as this is not trivial. Also, when interpreting results, the authors do not take into account the significance of impulse responses, while from the figures it seems that these are not always statistically significant.

Main strengths
Potentially, this paper could contribute to the debate on monetary policy in the country explored and provide important insights into the regime-switching behavior of economic variables.

Main weaknesses
The paper is poorly written. Not just in terms of language, but the structure and clarity as well. From the introduction it is not clear what was done. The literature review spans over too many different topics which hardly relate to the specific topic explored in the paper. The paper therefore lacks focus and clarity. Sometimes the authors are sloppy as they do not describe the data, the country, they do not give any descriptive statistics, and they do not even mention confidence intervals. Regarding the latter, from the figures it seems they have constructed confidence intervals but they do not say how or even what those lines represent.

Haithem Awijen and Sami Hammami - Reply to Referee Report 1
February 23, 2017 - 15:54

See attached file

Anonymous - Referee Report 2
March 20, 2017 - 12:22

See attached file

Haithem Awijen and Sami Hammami - Reply to Referee Report 2
March 29, 2017 - 16:48

See attached file