My thesis analyzes various types of uncertainties and their effects on financial fragility in the context of information asymmetries and bank-run models. When various generations of currency crisis are considered, it is observed that the financial system and fragilities associated with it plays a critical role in more recent crisis episodes. Therefore, focusing on the financial system can possibly lead to a better understanding of how and why these crises took place. The analysis presented here aims to provide some new insights about this topic. In the first chapter I tried to analyze how public borrowing can affect financial fragility when how a private bank finances its lending to the government is private information. I built a simple theoretical model where the government basically borrows from a commercial bank. The objective of the government is to realize borrowing at the lowest possible cost but at the same time it cares about the financial stability. The risk averse commercial bank, on the other hand, maximizes utility by allocating the financing of its lending among a safe and a risky loan where the amount it uses from the safe source considered to be a measure of financial stability. Moral hazard arises as the amount of safe loan used is not observable to the government. Under the assumption that the risk premium is decreasing in income, I show, when the government is not able push the rate down below a certain level, it can trade a rise in borrowing costs with some financial stability. In other words, although pushing the rate down is good both for borrowing costs and financial stability, under asymmetric information, it may be optimal to design a contract with a reward scheme and accept a higher cost for borrowing for a relatively more reliable financial system. This chapter contributes to the literature by identifying a potential moral hazard problem in the process of public borrowing and displays how it can lead to a higher than optimal level of financial fragility when the economic policy gets obsessed with lowering the borrowing costs. The analysis provided is also interesting as it displays an unusual case where the borrower rather than the lender faces issues resulting from asymmetric information. In the second chapter, a bank-run model used to analyze effects of uncertainty on financial fragility in terms of maturity mismatch. I use an extended version of the well-known Diamond & Dybvig model by introducing short term borrowing where the future cost of borrowing is unknown. This creates an additional source of maturity mismatch and the demand deposit contracts are now vulnerable to both depositor and lender panics. The key is when the borrowing and investment decisions are made the total cost of borrowing is unknown but the deposit contract can be written contingent on this cost. This creates different consumption paths for patient and impatient agents and they bear different degrees of interest rate risk. The characterization of the contract shows interest risk is mainly borne by early consumers particularly for higher roll over costs. In times of crisis the most liquid funds are the ones that are used first and hence consumers who need urgent liquidity suffers most. The main contribution of this part is that, it combines a bank run model with aggregate uncertainty with short-term borrowing. It also sheds some light on the dynamics of financial problems in developing countries. The last chapter analyzes risk sharing under private banking. Once again a version of Diamond & Dybvig framework is used. Instead of assuming a banking structure where consumers form a union to achieve optimal risk sharing, I consider a private bank that maximizes profits. I analyze the deposit contract under different assumptions about how the bank and the depositors consider the probability of a bank run. The original Diamond & Dybvig model, implicitly assumes the probability of a bank-run is sufficiently small to ensure participation. With a private bank, I allow partial participation and optimizing depositors automatically establish individual rationality. This leads to a supply of deposits (or demand for risk sharing function) which varies along with the payments offered in the contract. Therefore, the bank faces a trade-off between the rates it offer and the amount of deposits it can attract. This basically leads a new set of equilibrium contracts to come out which are not possible under standard risk sharing. Depending on the risk averseness of the consumers these alternative contracts produce different levels of financial fragility. This last chapter contributes to the literature by considering the possible risk sharing contracts under a profit maximizing monopolistic commercial bank. It also briefly discusses how this may effect financial fragility.

The current global financial crisis centres on the impact of banking sector openness on economies. The tradeoff of banking sector openness between the potential benefit (economic growth) and risk (economic volatility) sparks hot debates. This thesis addresses the question of whether there are sufficient economic reasons to support openness. Banking sector openness may directly and indirectly affect growth. Chapter II reinvestigates these direct and indirect links, using an advanced econometric technique (GMM dynamic panel estimators). The empirical results confirm the presence of direct and indirect links, and thus provide the backbone for countries planning to open their banking sector to international competition, especially developing countries. In Chapter III, we use parametric and non-parametric stochastic frontiers to measure banking sectors’ cost efficiencies, and then use panel data methodology to reinvestigate the empirical relationship between bank efficiency and banking sector openness. Our results suggest the world banking industry becomes increasingly efficient with greater openness. Chapter IV studies the relationship between macroeconomic volatility and banking sector openness. We address several questions: can high levels of volatility be explained by the opening of the banking sector? Are the effects of banking sector openness in developing and developed countries different in a crisis compared with normal times? What is the effect of mis-match between banking sector openness and financial development? We find that the positive relationship between banking sector openness and economic volatility originates from the mismatch between banking sector openness and financial markets development. Banking sector openness in itself eases crisis volatility. Chapter V presents the main conclusions.

The overall aim of the research presented in this thesis is threefold: To empirically examine monetary transmission to UK retail mortgage rates; to examine why fixed versus variable rate mortgage lending differs across EU-15 countries; and to build a DSGE model which can be used for analysing optimal monetary policy in economies with different proportions of fixed or variable rate mortgage contracts. Chapter 2 investigates the transmission from UK policy and a range of wholesale money market rates to retail mortgage rates using a single-equation error correction model (SEECM) framework, from 1995 to 2009. The results add to previous studies by showing that the UK retail banking sector is imperfectly competitive at the aggregate level. More specifically, discounted rates, and to a lesser extent fixed rates behave competitively, whilst standard variable rates do not, which can be interpreted as evidence of exploitation of inert borrower behaviour. A snap-shot of the relative levels of variable rate lending across EU-15 countries is taken in the next Chapter 3, illustrating general cross-country differences. Risk simulations show that economies more conducive to variable rate mortgages include those with relatively volatile, persistent, and low inflation; low and stable real interest rates; high real income growth; and low correlation between inflation and real interest rate shocks. Regressions show that macroeconomic histories may indeed be important determinants of variable rate mortgage prevalence. The final Chapter 4 integrates a quantity optimising banking sector that lends under either a fixed or variable rate, into a model with borrowing constrained households. This provides a framework that can be used to investigate relationships between the structure of debt contracts and monetary policy. In particular, the propagation of a productivity shock in the non-durable sector under Ramsey monetary policy is presented, and it is demonstrated that the introduction of overlapping debt contracts tempers the effect of the financial multiplier. An appropriate design of the composition of fixed versus variable rate debt contracts, both their length and interest rate composition, could therefore reduce the volatility of key economic variables, and so there are important policy implications.

The present enquiry concerns whether there is a bi-directional causal relationship between financial development and economic growth. It contributes to the century of debate revolving around the issue of whether the financial sector is 'supply-leading' or 'demandfollowing' that is first raised by Patrick (1966). A new theoretical. model is developed to study the bi-directional relationship of the finance-growth nexus. The model shows that the provision of liquidity in the banking system, by preventing premature liquidation of capital and improvement ofrisk sharing through inter-mediation, results in a larger capital accumulation in the economy. This justifies the existence and development of the financial sector in the economy. Financial development in tum can exert a positive effect on long-run economic growth through the interest-rate channel by increasing bank competition and by increasing the efficiency of financial intermediation. Economic growth in the real sector will generate more saving, thereby exerting a positive external effect on banking productivity and raising the wage rate for the bank. This will lead to a further financial development. The interaction will continue until the marginal. productivity oflabour becomes equal across the real sector and the financial sector. A maximum of 161 countries with a maximum time span ranging from 1965 to 2004is included in the cross-country empirical analysis using the Granger-Causality test with optimal lag-length selection criteria and the Simultaneous Equation Model Approach, to examine the bi-directional relationship. Results from the Granger-Causality test suggest that economies will shift from the demand-following pattern in the early stage of development to a .supply-leading pattern at the later stage of development, and thereby refutes the Patrick (1966) hypothesis that supply-leading pattern dominates in the early stage. Results from the Simultaneous Equation Model Approach suggest that the relationship for the finance-growth nexus is reciprocal and give rises to a cumulative process. Policies that foster financial development and economic growth, such as private property rights protection, trade liberalisation policy, removal of inflation tax, population control, investment in education, raising private investment and government public expenditure, will therefore exert a cumulative beneficial effect to the economy. Insufficient financial development might therefore be a reason for the emergence of poverty trap, and insufficient economic growth might lead to underdevelopment of financial system that prevents the economy from taking off.

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Beginning with Jensen(1968), the evaluation of the investment performance of managed funds has been a major topic in Finance. This has not been without controversy, especially how the risk of the fund is to be measured. Evaluating portfolio performance has been closely associated with tests of market efficiency. Practically all of the theoretical and empirical studies have been conducted in the USA. The evaluation of fund performance in the UK has been limited. This study seeks to examine a number of issues in performance measurement using a sample of UK unit trusts. The study is organised as follows. Chapter 1 presents an overview of the performance measurement literature. The chapter describes Grinblatt and Titman's(l989) framework which provides the theoretical underpinnings of the study. Chapter 2 reports the tests of the ex ante mean-variance efficiency of a number of benchmark portfolios which are used to evaluate performance. Chapter 3 examines the performance of a sample of UK unit trusts using the Jensen(1968) measure against a number of benchmark portfolios. The chapter also considers the empirical significance of the potential timing biases in the Jensen measure. Chapter 4 presents evidence of the selectivity and timing performance of the trusts. Chapter 5 investigates the factors which may affect trust performance. These include the investment objective, size, expense ratios of the trusts. The final chapter presents the conclusions of the study.

The mam purpose of this thesis focuses on the investigation of major financial volatility models including the relevant mean model used in the context of volatility estimation, and the development of a systematic nonlinear identification methodology for these problems. Financial volatility is one of the key aspects in financial economics and volatility modelling involves both the mean process modelling, and the volatility process modelling. Although many volatility models have been derived to approximate the volatility process, linear mean models are almost always used and to the best of our knowledge there is no application of fitting the mean process using a nonlinear model with selected structure. Based on the fact that nonlinearity has been observed in many financial market return data sets, the Non linear AutoRegression Moving Average with eXogenous input (NARMAX) modelling methodology with the term selection algorithm Orthogonal Forward Regression (OFR) is proposed to approximate the nonlinear mean process during volatility modelling. However, the assumption of a constant variance is usually violated in financial market return data. A new Weighted OFR algorithm is therefore proposed to correct for the impact of heteroskedastic noise on the term selection of the nonlinear mean model based on the assumption that the variance process is modelled by a Generalized AutoRegressive Conditional Heteroskedastic (GARCH) model. Because the weights to use are unknown, an iterative refined procedure is developed to learn the weights and to simultaneously improve the parameter estimates of both the mean and the volatility models. New validation methods are proposed to validate the nonlinear selected mean model and the volatility model. During the validation, the assumptions associated with the mean model are tested using a correlation method and the assumptions of the volatility model are tested using a Brock-Dechert-Scheinkrnan (80S) independent and identically distributed (i.i.d.) testing method. The prediction performance of the mean and volatility models is evaluated using a hold out Cross Validation (CV)method. A departure in the prediction of the volatility for the linear mean model, when using nonlinear simulated data, is successfully identified by the new validation methods and the nonlinear selected mean model passes the test. Another application of the NARAMX model, in the very new field of modelling mortality rate, is introduced. A quadratic polynomial mortality rate model selected by the OFR algorithm is developed based on the LifeMetrics male deaths and exposures data for England & Wales from the Office of National Statistics. Comparing the long term prediction of the new model with the Cairns-Blake-Dowd (CSO) statistical mortality rate model indicates the better prediction performance of the quadratic polynomial models. A back-testing method is applied to indicate the robustness of the selected NARMAX type mortality rate models. The term selection, parameter estimation, validation methods and new identification procedures proposed in this thesis open a new gateway to apply the NARMAX modelling technique in the financial area, and for mortality rate modelling to provide a new empirical practice of the NARMAX modelling method.

This thesis investigates ten markets: U.S., U.K., Hong Kong, Japan Singapore, Malaysia, South Korea, Thailand, Taiwan, and Indonesia over a sample period covering roughly from the 1970s to 2006, in order to investigate whether bubble behaviour is a major source of financial instability. Price movements have fundamental components and bubble components. An attempt to explain price behaviour therefore prompts two major questions: What are the fundamental drivers of stocks? What behaviour causes actual prices to deviate from their fundamental values? This thesis constructs fundamental movements in stock prices by utilising the present value model, which, in turn, involves two further issues. First, do investors expect the required rate of return to be time-varying? Second, which fundamental driver, dividends or earnings, is more efficient in tracing investor perceptions of expected cash flows? I address the former issue by building and testing two models which assume constant discount rate and time-varying discount rate respectively. The second issue we address by using dividends and earnings data as the fundamental factor. Revealed deviations from fundamental value are investigated by considering three types of bubble behaviour discussed in the extant literature: rational explosive bubbles; rational intrinsic bubbles; and irrational price dynamics. Such bubble processes are then compared with actual price movements to gauge which type of behaviour is more likely to track actual prices in the sample markets. With respect to whether the required rate of return is time-varying, two variants of the present value model are used to construct the fundamental values of the relevant market indices. Results demonstrate that the dynamic version of the present value model has superiority in tracking actual price movements when compared to a static version of the present value model. With regard to which series is more effective in tracing investor expected cash flows, the more broadly defined expected earnings, rather than cash dividends, drive stock prices in the developed markets of the U.S., U.K. and Japan, as well as the developing markets of Korea and Malaysia. Dividends have relatively more influence on the markets of Thailand, Taiwan and Indonesia, but neither the dividend discount nor earnings discount model can explain the time path of stock prices in Hong Kong and Singapore. In terms of the drivers of bubble phenomena, results suggest no rational explosive bubble exists in any of the markets in the sample.

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