Globalization, Gating, and Risk Finance

An in-depth guide to global and risk finance based on financial models and data-based issues that confront global financial managers.

Globalization, Gating, and Risk Finance offers perspectives on global risk finance in a world with economies in transition. Developed from lectures and research projects investigating the consequences of globalization and strategic approaches to fundamental economics and finance, it provides an approach based on financial models and data; it includes many case-study problems. The book departs from the traditional macroeconomic and financial approaches to global and strategic risk finance, where economic power and geopolitical issues are intermingled to create complex and forward-looking financial systems.

Chapter coverage includes: Globalization: Economies in Collision; Data, Measurements, and Global Finance; Global Finance: Utility, Financial Consumption, and Asset Pricing; Macroeconomics, Foreign Exchange, and Global Finance; Foreign Exchange Models and Prices; Asia: Financial Environment and Risks; Financial Currency Pricing, Swaps, Derivatives, and Complete Markets; Credit Risk and International Debt; Globalization and Trade: A Changing World; and Compliance and Financial Regulation.

• Provides a framework for global financial and inclusive models, some of which are not commonly covered in other books.
• Considers risk management, utility, and utility-based multi-agent financial theories.
• Presents a theoretical framework to assist with a variety of problems ranging from derivatives and FX pricing to bond default to trade and strategic regulation.
• Provides detailed explanations and mathematical proofs to aid the readers’ understanding.

Globalization, Gating, and Risk Finance is appropriate as a text for graduate students of global finance, general finance, financial engineering, and international economics, and for practitioners.

Motivation xviii

About the Authors xxv

1 Globalization: Economies in Collision 1

Motivation 1

1.1 Introduction 1

1.2 Trend and Challenges in Global Finance 5

1.3 Global Finance and Trade in the Media and News 12

1.4 Global Risks 15

1.5 Global Finance and Swaps and Financial Products 18

1.6 Currencies and Liquidity 20

1.7 Foreign Exchange Regime and Markets, Global Payment, and Reserve Currency 23

1.8 Trade Incentives and Repressions 33

1.9 Historical Evolution 36

1.10 Archaic and Modern Globalization: A Time Path 40

1.11 Discussions on Global Issues 44

References 46

2 Data, Measurements, and Global Finance 51

Motivation 51

2.1 Data and Models 51

2.2 Global Finance, Data Reduction, and Statistical Measurements 61

2.3 Volatility and Implied Models Estimates 76

2.4 Stochastic Models 86

2.5 Multivariate Probability Models 91

2.6 Statistical Data Reduction 100

2.7 Complexity: The Global Risk Finance Scourge 102

2.8 Discussion 103

References 104

3 Global Finance: Utility, Financial Consumption, and Asset Pricing 110

Motivation 110

3.1 Introduction: Financial Models and Pricing 110

3.2 Review: Elements of Utility and Risk 116

3.3 The Utility of Consumption and its Price 119

3.4 The Capital Assets Pricing Model 123

3.5 Review of Elements of Arrow–Debreu and Q Pricing 131

3.6 The Multiperiod Consumption-Based Capital Asset Pricing Model 142

3.7 Thought Experiments 154

References 155

4 Macroeconomics, Foreign Exchange, and Global Finance 157

Motivation 157

4.1 Introduction 157

4.2 Fundamental Macroeconomic Models 158

4.3 Balance of Payments Accounts 165

4.4 The Mundell and Fleming Model: IS–LM–BOP Model 171

4.5 Macroeconomic Factors Reshaping Global Outlook 178

4.6 Conclusion 190

References 191

5 Foreign Exchange Models and Prices 195

Motivation 195

5.1 Introduction 195

5.2 Macroeconomic Models of Foreign Exchange Rates 196

5.3 Exchange Rates and Purchasing Power Parity 198

5.4 Foreign Exchange Rates and Interest Rates: The Assets Approach 204

5.5 Demand and Supply of Money and Exchange Rates: Monetary Approach 207

5.6 Extensions of the Models 212

5.7 Conclusions 221

Appendix 5.A: Suggested Empirical Work for Econometric and Statistical Analysis 222

References 223

6 Asia: Financial Environment and Risks 226

Motivation 226

6.1 Introduction 226

6.2 Driving Engines of Economic Growth in Asia 228

6.3 Financial Sector Development in Asia 235

6.4 Risks of Investing in Asia 245

6.5 Financial Development in China 251

6.6 Finance in Japan 260

6.7 Conclusion 265

References 266

7 Financial Currency Pricing, Swaps, Derivatives, and Complete Markets 269

Motivation 269

7.1 Introduction 269

7.2 Pricing Consumption Price Index and Foreign Exchange in Complete Financial Markets 272

7.3 A Generalized Consumption Price Index Foreign Exchange Pricing Model 276

7.4 Relative and Foreign Exchange Basket Price Tracking 278

7.5 Options Pricing: Applications and Examples 292

7.6 Spread and Two-Factor Options 296

7.7 Optional Trading Strategies 300

7.8 The Greeks and Financial Risk Management 303

8 Credit Risk and International Debt 315

Motivation 315

8.1 Introduction 315

8.2 Growth of Debt and Debt Dependency 317

8.3 Foreign Exchange is a Credit Bestowed to a Sovereign Entity 321

8.4 Credit and Global Risks 323

8.5 Credit Risk, Credit Derivatives, and Credit Default Swaps 330

8.6 Swaps 332

8.7 Credit Default Swaps and Securitized Volatility 338

8.8 Pricing Credit Risk 340

8.9 Debt, The Merton Model, and Default 347

References 355

9 Globalization and Trade: A Changing World 358

Motivation 358

9.1 Introduction 358

9.2 Tracking Trade and Globalization 368

9.3 Strategic Trade and Gating 375

9.4 A Multicountry Financial Consumption Utility 378

9.5 The Demand Sector and its Supply 388

9.6 Conclusions 390

References 391

10 Compliance and Financial Regulation 395

Motivation 395

10.1 Introduction 395

10.2 Regulation Risks 403

10.3 Regulation, Technology, and Compliance 405

10.4 Statistical and Compliance Risks 407

10.5 A Multivariate Bernoulli Compliance and Audits 415

10.6 Regulation and Compliance Games 418

10.7 Satisficing Games and Regulation–Compliance 421

10.8 Conclusion 423

Appendix 10.A: Games, Risk and Uncertainty 423

Appendix 10.B: Concepts of Games and Risk 424

References 428

Index 000

UNURJARGAL NYAMBUU is a Professor of Economics in the Department of Social Science, New York City College of Technology (NYCCT), The City University of New York (CUNY), Brooklyn, NY.

CHARLES S. TAPIERO is the Topfer Chair Distinguished Professor of Financial Engineering and Technology Management, Department of Finance and Risk Engineering, Tandon School of Engineering, New York University (NYU), Brooklyn, NY.

An in-depth guide to global and risk finance based on financial models and data-based issues that confront global financial managers.

Globalization, Gating, and Risk Finance offers perspectives on global risk finance in a world with economies in transition. Developed from lectures and research projects investigating the consequences of globalization and strategic approaches to fundamental economics and finance, it provides an approach based on financial models and data; supported by many case-study problems. The book departs from the traditional macroeconomic and financial approaches to global and strategic risk finance, where economic power and geopolitical issues are intermingled to create complex and forward-looking financial systems.

Chapter coverage includes: Globalization: Economies in Collision; Data, Measurements, and Global Finance; Global Finance: Utility, Financial Consumption, and Asset Pricing; Macroeconomics, Foreign Exchange, and Global Finance; Foreign Exchange Models and Prices; Asia: Financial Environment and Risks; Financial Currency Pricing, Swaps, Derivatives, and Complete Markets; Credit Risk and International Debt; Globalization and Trade: A Changing World; and Compliance and Financial Regulation.

• Provides a framework for global financial and inclusive models, some of which are not commonly covered in other books
• Considers risk management, utility, and utility-based multi-agent financial theories
• Presents a theoretical framework to assist with a variety of problems ranging from derivatives and FX pricing to bond default to trade and strategic regulation
• Provides detailed explanations and mathematical proofs to aid the readers' understanding

Globalization, Gating, and Risk Finance is appropriate as a text for practitioners and graduate students of global finance, general finance, financial engineering, and international economics. As we enter the third millennium, information technology—by crushing the cost of communications—is accelerating the globalization of manufacturing, commerce, and especially finance thereby morphing national financial markets into one huge, efficient global marketplace for capital. Indeed, the relentless rise of the digital cyber-economy is weakening the grip of the nation-state as government policies are subjected to a continuing referendum by financial markets. And yet diehard sovereigns are holding firmly to their prerogatives of having a national currency, a national regulatory framework, and a national tax code of their own and much more. Nyambuu and Tapiero’s Globalization, Gating, and Risk Finance is a powerful recast of core international pricing models in a world of gated/segmented capital markets. It redefined risks and opportunities in a world of incomplete financial globalization, and is a must read for savvy financiers and their apprentices in their everlasting quest of exploitable capital market abnormalities and imperfections.

Laurent Jacque, Walter B. Wriston Professor of International Finance & Banking, The Fletcher School (Tufts University)

This book represents a major contribution to our understanding of the key issues currently facing the world economy and global financial markets. It can be highly recommended as a stand-alone textbook in international finance. It can also serve as an essential reference for both academics and practitioners interested in going beyond the standard approaches that assume market integration. This book is unique in providing both a lucid and rigorous exposure of the complexities of risk that pervade our world, where globalization is giving way to increased nationalism and protectionism.

Lorne N. Switzer, Professor of Finance and the Van Berkom Endowed Chair in Small Cap Equities, John Molson School of Business (JMSB) at Concordia University, Montreal, Canada