The thesis is aimed at investigating the implications of globalization for the conduct of monetary policy. By globalization we mean increased interdependence of national economies as reflected in greater and freer flow of goods, services, capital, and labour across national borders. In particular, our research addresses a number of important issues in the recent monetary policy and globalization debate. First, are global factors becoming important drivers of domestic inflation? Second, are global factors playing more powerful role on inflation dynamics in the sectors of an economy that are more open to trade? Third, has globalization made the job of Central Bankers more difficult? And finally, do the Central Bankers in the United States and the United Kingdom consider international factors too along with domestic factors while determining the short term interest rates? Inflation rates have been observed to be low across industrial countries since the early 1990s. The co-movements of inflation rates across countries are strikingly high. We model the co-movements of inflation rates by a global factor, regional factors and idiosyncratic component. In particular, we estimate a Dynamic Factor Model with Stochastic Volatility and find that the contribution of the global factor has increased over time in explaining the variance of inflation in OECD countries. The regional factor also gains importance in countries with strong intra-regional economic linkages potentially due to proliferation of regional trade agreements and common currency areas. In the European countries, the role of global and regional factor together dominates the country specific factor since the late 1990s. The volatility of inflation has substantially decreased over time and our modelling framework incorporates time varying volatility of inflation. We find strong positive and significant relationship between the international common factor and economic globalization. Consistent with inflation becoming a global phenomenon, co-movements of aggregate inflation between countries are observed to be high. We examine whether this is also the case for sectoral inflation, we model the co-movements in sectoral inflation as being associated with a global factor, a sector specific factor and an idiosyncratic error term. We find that the co-movements of inflation of tradable sectors are substantially greater than the co-movements in non-tradable sectors which implies that the greater co-movements of inflation can be attributed to increased trade global integration of product markets. To test this, we attempt to find empirical relationship between the estimated common factor in sectors and openness to trade measured as import penetration. A positive relationship is found between the estimated sector specific common factors and import penetration. Given our earlier chapters identify important global dimension to aggregate and sectoral inflation, does this matter for monetary policy? The implication of globalization for monetary policy in the United States and the United Kingdom are examined by estimating monetary policy reaction function for these advanced economies over the sample period 1985-2010. We also consider time variations in these reaction function by estimating over a sub-sample of 1992-2010 for the United Kingdom and the Greenspan-Bernanke Era for the United States. We estimate the policy reaction function with domestic and global inflation and output gaps and with the component of domestic inflation and output gap that is not related to global variations. The policy reaction function augmented with foreign variables such as real effective exchange rate and foreign interest rate is also estimated. We use measures of inflation based on GDP deflator, CPI and inflation expectations. We find that the Federal Reserve responds to global inflation only in the full sample and to global as well as the country specific inflation in the second sub-sample (Greenspan-Bernanke Era). This may imply strong commitment of the Federal Reserve to the goal of ``price stability'' during Greenspan-Bernanke Era. The Bank of England responds to global inflation along with the country specific inflation. The international factors such as the real effective exchange rate changes (depreciation) and foreign interest rates have significant and positive effect on policy rates.

The exchange rate is one of the most vital components in any economic and investment decision. With the increase in globalisation, there is a concomitant increase in the exchange rate risk in any global investment decision. This Ph.D. thesis examines asset pricing in the foreign exchange market in various dimensions, introduces new techniques for performance measurement and information flow, and attempts to explain the carry trade in the foreign exchange market. The economic significance of empirical exchange rates models in a portfolio-based framework was examined, using a thirty-year time series of five exchange rates. The forecast performances were evaluated in mean-variance and performance index (indices of acceptability) to compare the fundamental exchange rate models with a benchmark random walk model. The parameters were computed using advanced computational finance and econometric techniques. The performance measurements obtained from mean-variance by various models were compared using the Sharpe ratio. It was concluded that the structural model, although unable to beat the random walk model, did not perform worse than the forecasts obtained from the benchmark model. The results from the indices of acceptability evaluation indicate that one-month ahead forecasts obtained from the monetary model of the exchange rate performed better than the benchmark model. Furthermore, the information flow in the foreign exchange market was examined by evaluating the relationship between volatility and the customers' trading activity. An attempt was made to explain the relationship between volatility and customer order flows in a portfolio-based framework with unique aggregate and disaggregate customer order-flow data from the Union Bank of Switzerland (UBS). This was the largest private dataset used to-date in a study of the foreign exchange market. The relationship was found to be robust; that is, the order flow is one of the main sources for transmitting private information to the foreign exchange market. This relationship holds across all the currencies and in various volatility estimates. This study is the first in the foreign exchange market in the aforementioned setup, and robustly elucidates the cited relationship in the foreign exchange market. The results give significant support to information being asymmetric across classes of customers and that private information is transmitted to the foreign exchange market by the trading behaviour of informed customers. Moreover, the volatility patterns in the foreign exchange market are significantly and substantially affected by the customer order flows. The size of the trade impact on volatility in a portfolio-based approach was also examined and it was found that the large sales are more influential trades on volatility in the foreign exchange market. In addition, to study the subsequent volatility, there was an examination of two existing hypotheses; i.e., the liquidity-driven-trade-hypothesis (positive subsequent relationship), and the information-driven-trade-hypothesis (negative subsequent relationship.) Both phenomena were found to exist, depending on the economic condition of the market. Finally, an explanation was given for the existence and identification of the carry trade in the foreign exchange market. When an investor borrows from a low interest-rate currency and invests in a higher interest-rate currency, zero-investment portfolio, this trading strategy is called carry trade strategy. Again, a novel data set provided by the UBS was examined to establish a relationship between the ordering patterns of informed customers and the carry trade. The forward discount bias and the carry trade were studied using theories of microstructure finance and the consumption-based asset-pricing model in a portfolio-based framework. The microstructure approach is the standard model of Evans and Lyons (2002). It was found that the order flow significantly explained the excess return in the carry trade, implying that informed customers knew about the carry trade opportunities in the market and reorganised their portfolios in order to realise these gains. Volatility and customer order flows were also examined, using a GMM approach, as a global innovation factor, and it was found that both variables significantly explained the cross-section of carry returns in the foreign exchange market.

This research adds to the growing literature from recent years on innovation finance, innovation systems, and regional economic and innovation policy. Although the role of business has been seen as critical within the regional innovation system, the role of business financing intermediaries has received considerably less attention despite its recognised role as a central actor of the system. This research focuses on an innovation player that seems to have been neglected by scholars to date, namely the venture capital industry. The research examines the role of different types of venture capital, public and private, in fostering innovation at the regional level. In examining this relationship, this thesis empirically analyses the characteristics of 4117 investments deals made to 2359 companies, the innovation outputs of these businesses and the responses to a survey of 50 venture capital professionals. The contribution of this thesis is threefold: First, this thesis investigates whether and how the supply of private sector venture capital and supportive public interventions has changed the availability of venture capital at the regional level. It examines the combination of venture capital in the UK regions by providing a detailed analysis of the extent of venture capital public dependency in each UK region. It also elaborates on the potential implications of the public sectors’s domination in venture capital provision in several UK regions. The regional dimension of the analysis is of special interest as it is the first comprehensive analysis of the source of VC investments (public or private) for each UK region. From a regional perspective, the UK now appears to have two venture capital markets. In London, the South East and, to a lesser extent, the East of England, private sector investors dominate investment activity. This contrasts with the remainder of the UK where the venture capital market is underpinned by extensive public sector involvement. Second, this thesis also investigates the role of venture capital in innovation using patents as a proxy variable for business innovation. In this way, it contributes to the literature by analysing the relation between patenting practices of venture capital backed firms, paying particular attention to two aspects: first, the company’s acquisition of venture finance and progress through the venture capital journey and second, the relationship between patent practices and source of venture capital finance (public or private) in UK regions. The analysis shows a clear relationship between venture capital and patents. Companies with patents are more likely to secure follow up venture capital finance compared with companies without patents. The econometric analysis results also suggest that UK companies with moderate public venture capital support are positively associated with patents while companies with extensive public venture capital support are negatively associated with patents, compared to companies with solely private venture capital support. The final part of the thesis investigates whether the environment in which funds operate may explain observed differences in the ability of these funds to invest in companies with the potential to innovate. It does this by examining the ecology of interaction between venture capital and regional innovation systems. This is the first detailed empirical investigation of the relationship between different types of venture capital (private or public) and other players of the innovation system such as universities incubators, research institutes, and regional authorities. Three important findings emerge from this analysis. First, venture capital public dependence is strongly and significantly associated with higher volumes of interactions with the outside world. The more publicly dependent a fund is, the more it interacts with other players of the innovation system. Second, the role of proximity is still important within the VC industry. Venture capitalists from both the private and the public sector, are more likely to interact with their counterparts from the same region. Third, there is evidence to suggest that operators of publicly backed funds are lacking close connections with their counterparts from the private sectors. This may have implications for their ability to approach and attract private heavy weighted venture capital funds and limited partners that can provide follow on investments or raise further funding for the fund. Although publicly backed venture capitalists interact to a greater extent than the private counterparts, they experience less success (measured as financial performance of the fund or performance of their portfolio companies). It is widely acknowledged that interactions between venture capitalists and other players promotes tacit knowledge, but the results of this thesis suggests that interaction on its own is not enough to provoke success. Overall, the findings of this research suggests that the distinction between the two venture capital markets in the UK, publicly or privately driven, is not limited to the volume or type of venture capital activity but also relates to the ecology of interactions between venture capitalists and other players of the regional innovation system. Since publicly backed funds do not promote innovation to the same extent that private funds do when they invest alone, UK regions that are heavily dependent on public investments may not be able to receive the benefits of a functional venture capital industry. However, regions in which public venture capital funds work closely with private funds, demonstrate a relatively higher volume of venture capital backed companies with the potential to innovate. From a policy perspective, this finding suggests that from an innovation point of view, free public standing investments should be minimised while co-investments between publicly backed and private venture capital funds should be further encouraged.

This thesis investigates nominal frictions in price setting behaviour from both microe-conometric and macroeconometric perspectives. Chapter I and II use the unpublished retailer-level and producer-level microdata underlying CPI and PPI in the UK statisti-cal authority to study empirical price rigidity and price setting mechanisms. Based on the conventional frequency-based method, little rigidity is found since the implied price duration is less than half a year. However, this method is shown to significantly underestimate the true duration due to oversampling of short price spells. Alternative-ly, a trajectory-based cross-sectional approach is adopted, giving an unbiased and ro-bust estimate for average duration over 9 months (retailer price) and 15 months (pro-ducer price). That is to say, producer price has higher degree of rigidity than retailer price if cross-sectional approach is used. Both time-dependent and state-dependent features exist in price setting. In particular for retailer price, results also suggest con-spicuous heterogeneities in price rigidity across sectors and shop types, but weak dif-ference across regions and time. The overall hazard function of price change can be decomposed into a decreasing component from goods sectors and a 4-month cyclical component from services sectors. The empirical findings in the microdata not only contribute to the microdata literature on price setting behaviour, but also make possible the calibrations of macroeconomic DSGE model with heterogeneous price setting. Hence, based on the microdata find-ings in Chapter I and II, Chapter III uses Classical maximum likelihood and Bayesian inference to evaluate and estimate DSGE models with various price setting mecha-nisms. A vital problem with homogeneous price setting models is that they cannot generate enough persistence while keeping calibration of average price rigidity con-sistent with microdata evidence. In contrast, this ―persistence puzzle‖ is successfully resolved by heterogeneous price setting models, which greatly improve the dynamic performance of macroeconomic models.

The 2007-2008 global financial turmoil is the most severe crisis since the Great Depression. Starting with the sub-prime defaults in the United States, it quickly spills over into other markets leading to the collapses of many financial institutions, worldwide banks bailouts, downturns in asset prices and also to sovereign debt crises. The aim of this thesis is to empirically investigate the repercussions of this financial crisis on interbank market and sovereign risk. In Chapter one, we empirically explore the effect of bank lending relationships in the interbank market. We use data from the e-MID market that represents the only transparent electronic platform in Europe and the United States, unaffected by search costs and other actions. We show that stable relationships exist and that they play a significant role during the 2007-2008 financial crisis. Trading with preferred counterparts is associated with more favorable rates for both lenders and borrowers, and carries larger trading volumes. The results point to a peer monitoring role of relationship lending, which contributes, at a time of financial distress, to a smooth liquidity redistribution among banks. Relationship lending thus plays an important positive role for financial stability. Chapter two investigates the role of banks' network centrality in the interbank market on their funding rates. Specifically we analyze transaction data from the e-MID market, over the 2006-2009 period, which encompasses the global financial crisis. We show that interbank spreads are significantly affected by both local and global measures of connectedness. The effects of network centrality increased as the financial crisis evolved. Local measures show that having more links increases borrowing costs for borrowers and reduces premia for lenders. For global network centrality, borrowers receive a significant discount if they increase their intermediation activity and become more central, while lenders pay in general a premium (i.e. receive lower rates) for centrality. This provides evidence of the `too-interconnected-to-fail' hypothesis. Chapter three draws attention to the effect of monetary policies and international linkages on European countries sovereign risks. Using a Global VAR method that allows for interdependencies across individual variables within and across units, we model government bond credit default swaps (CDS) relative to Germany by domestic, global, monetary and weighted foreign variables, where weights are calculated based on the countries' fiscal positions. We find evidence of positive correlation between sovereign bond CDS and risk aversion for almost all countries in the eurozone. When the European Central Bank (ECB) increases the refinancing rate, we observe an increase in risk of sovereign bonds of all countries due to negative environment in Euro area. A decline in money aggregate (M3) leads to all countries becoming more fragile, hence increasing sovereign risk. The shocks that stem from monetary policy changes (i.e. an increase in ECB refinancing rate) causes a rise in sovereign risk due to sensitivity to crisis and uncertainty in Euro area. In contrast, monetary policies have an opposite impact on Greece due to its relative worse performance.

Ever since the United Nations declared 2005 the year of micro-credit and linked it to the Millennium Development Goals, and especially on poverty reduction, there has been a series of studies looking at factors affecting the flow of credit down the poverty line. This is of particular importance because in spite of the success of Microfinance Institutions such as the Grameen Bank in Bangladesh and BancoSol in Mexico, evidence shows that many Microfinance Institutions do not reach down the poverty line but tend to cluster at the top. Developing several hypotheses using the elements of the neo-institutional theory, this study looks at how geographic location affects how Microfinance Institutions target their clients and the moderating effect that their regional context has on other factors. This is analysed using an unbalanced panel of 6, 645 observations drawn from 443 MFI institutions in 81 countries divided into 5 regions for the time period 2000-2014. An ordered logit regression was run using the target markets as the ordinal dependable variables. Based on the arguments of the neo-institutional theory, this study builds on previous ones by using a larger sample size (and number of years) to examine how the regional context affects the relationship between institutional quality and the selective lending behaviour of MFIs in 81 developing countries. An ordered logit regression was carried out using an unbalanced panel of 6645 observations from 443 MFI institutions across six regions from 2000-2014 against a broad range of company, country, regional and global specific variables. The results indicate that the geographic locations affects how MFIs lend down the poverty line with MFIs in and those in Eastern Europe and Central America less likely to lend to down the poverty line. The study found that the regional context also plays a big role in how institutional factors affect MFI lending practises with certain factors being more relevant in some regions than in others. This study also makes a case for using target markets as a better measure for depth of outreach as opposed to the more popular loan sizes and identifies the role that rural population growth and mobile phone penetration play in increasing depth of outreach of microfinance.

This thesis has developed alternative approaches for inflation forecasting and analysed the inflation risk premium in the context of commodity futures and options markets. Chapter 1 proposes an approach to tackle the non-availability of exchange-traded inflation futures price data. The composition of the consumer price index enables us to recognise the commodities which correspond to the consumption goods in the CPI. By averaging the commodity futures prices in the same way as the CPI is composed, we construct a synthetic futures contract written on the consumer price index, i.e. a futures on the CPI proxy, based on which we derive a ‘point’ forecast of inflation rate. Chapter 2 analyses the term structures of futures on the CPI proxy using the Schwartz (1997) method. Inspired by the Schwartz (1997)’s framework, we develop a two-factor valuation model filtering the spot consumer price index and the instantaneous real interest rate. The Kalman filter is applied to estimate the two-factor valuation model parameters. The filtered spot consumer price index may help alleviate the publication lag in the U.S. CPI-U index. What’s more, the two-factor valuation model is capable of forecasting the downward trend in the U.S. CPI inflation rate during May 2014 to December 2014. Chapter 3 forecasts the inflation rate from the perspective of commodity futures option market. We construct a synthetic option contract written on the futures on the CPI proxy. Based on a synthetic option implied volatility surface, we derive an interval estimate for the one-year ahead expected inflation rate. Moreover, the fact that commodity futures option market data is high-frequency enables our method of inflation forecasting to theoretically capture the market expectation of price level evolution in the real time. Chapter 4 estimates the inflation risk premium using commodity market data. We derive a link between the inflation risk premium and the risk premium associated with the futures on the CPI proxy. The negative inflation risk premium estimates in our result are consistent with the recent inflation risk premium estimates in the macroeconomic inflation risk premium literature.

This thesis contains of four chapters. The first chapter presents the introduction and all other three chapters look at different aspects of monetary policy in an economy with financial frictions. The second chapter studies the conditions under which a modest financial shock can trigger a deep recession with a prolonged period of slow recovery. We suggest that two factors can generate such a profile. The first is that the economy has accumulated a moderately high level of private debt by the time the adverse shock occurs. The second factor is when monetary policy is restricted by the zero lower bound. When present, these factors can result in a sharp contraction in output followed by a slow recovery. Perhaps surprisingly, we use a standard DSGE model with financial frictions along the lines of Jermann and Quadrini (2012) to demonstrate this result and so do not need to rely on dysfunctional interbank markets. The third chapter studies international transmission of financial shocks between two economies under flexible exchange rate regime. We consider different degrees of financial integration and demonstrate that welfare is maximised for an intermediate value of degree of it. Under perfect risk sharing there is large volatility of output during the period of adjustment, while the deleveraging is performed faster. With greater restrictions on international financial flows, the deleveraging is substantially slowed down which leads to longer periods of adjustment and greater costs. We demonstrate that in such world the effect of one country's credit shock has very limited effect on another country. When monetary policymakers cooperate and choose interest rate optimally, the unaffected country can nearly eliminate all aftereffects of the shock to the other country. To some extent, limited financial integration prevents the spread of volatility across the border, however, unconstrained monetary policy is the key to these results. In the fourth chapter we use two-country model and assume that both countries are locked into a permanently fixed exchange rate regime within a currency union. We demonstrate that the centralised monetary policy alone is unable to stabilise the economy. National fiscal policies must be activated to counteract asymmetric shocks. We demonstrate, however, that the effectiveness of fiscal policy is limited. Even if it is chosen optimally, fiscal policy does not eliminate cyclical patterns in economic adjustment, which is welfare-reducing volatility of economic variables. This model reveals that shocks hitting one economy, result in sharp contraction of consumption in both countries.

Nominal exchange rate stability has long been considered as a policy choice for many oil-exporting economies, including the GCC countries. The main motives for such policy choices include the desire to import credibility to domestic currencies, stabilize oil revenues and in turn government revenues (given their role in fiscal budget of these oil-based economies) and to avoid Dutch disease, particularly for those countries which have been trying to promote their non-oil exports. Recently however, with respect to the GCC countries, the advantages of exchange rate stability/peg have been overshadowed by adverse domestic and global developments. The recent surge in the GCC countries’ inflation rates that coincided with depreciation of the currencies of these countries due to the depreciation of the US dollar, has led to increasing public pressure for an upward revaluation or even a de-peg from the US dollar to an exchange rate regime that will ensure higher price stability. Accordingly, this thesis was put forth to provide a scientific opinion of the viability of the existing US dollar peg in the GCC countries, by focusing on the link between changes in exchange rate and inflation. To this end, the study attempted to assess the risk to the domestic inflation rates of the GCC countries arising from fluctuations of the US dollar against the currencies of the major trading partners of these economies. Based on a thorough review of the relevant literature, some empirical estimations were carried out using some econometric methods, and it was discovered that the amount of pass-through or impact from changes in exchange rates to inflation rates in the GCC economies is incomplete and moderate, with an average of around 23% in the long-run. Furthermore, an average long-run pass-through of around 23% does not signify a high risk from fluctuations in the foreign exchange market for domestic prices in the GCC countries. In other words, the volatility of exchange rates of the currencies of the GCC countries does not necessitate the adjustment of the money supply in these economies. These findings lent further support to the relevancy of the existing fixed exchange rate regime for maintaining stable inflation in the economies of the GCC countries. The findings were also supported by the performance of the GCC economies over the past two decades, despite some periods of dollar fluctuations. A retrospective analysis indicates that on average, inflation has been stable in the region over the past two decades. The study provided evidence for the important role of the fiscal policies of the GCC countries in affecting the recent impact from exchange rate to inflation rate in these economies, which suggests that these policies form a key macroeconomic tool in these countries, particularly ii given the lost independence of the monetary policy under the existing pegged exchange rate regimes. Moreover, the study suggests lowering the influence of fiscal policies on the link between exchange rate and domestic prices, or inflation in general, in the GCC countries by pursuing gradual steps toward domestic development in the economy, particularly given the limited absorptive capacity of these economies due to the shortage in supply bottleneck. The study was also extended to identify the potential alternative exchange rate regime if the GCC changed their focus from inflation to other, evolving, national objectives like international competitiveness. Based on the existing literature and the optimum currency theory, the study suggests that the GCC countries should consider moving gradually from their current single peg toward a more flexible exchange rate in order to avoid abrupt change that would disturb the existing market credibility. As an initial step, the study recommends moving toward a basket peg of two currencies, namely the US dollar and the Euro, that account for a large share of the GCC economies’ international trade and non-trade financial transactions. Finally, the study also concluded that an upward revaluation as a remedy for the recent inflationary development is an unsatisfactory solution, particularly if the same set of circumstances continued into the future. If this was the case, then the process would have to be repeated again, thus triggering the possibility of speculation attack.

This thesis decomposes the UK market volatility into short- and long-run components using the EGARCH component model and examines the cross-sectional prices of the two components. The empirical results suggest that these two components are significantly priced in the cross-section and the negative risk premia are consistent with the existing literature. However, the ICAPM model in this paper using market excess return and two volatility components as state variables is inferior to the traditional three-factor model. Therefore, investor sentiment is augmented to the EGARCH component model to analyse the impacts of sentiment on market excess return and the components of market volatility. Bullish sentiment leads to higher market excess return while bearish sentiment leads to lower excess return. The sentiment-augmented EGARCH component model compares favourably to the original EGARCH component model which does not take investor sentiment into account. The sentiment-affected volatility components are significantly negatively priced in the cross-section. This paper explores the cross-sectional impacts of market sentiment on stock returns and reveals that the sensitivities of investor sentiment vary monotonically with certain firm characteristics in the cross-section. The analysis suggests that investor sentiments forecast the returns of portfolios that consist of buying stock with high values of a characteristic and selling stock with low values. A sentiment risk factor is constructed to capture the average return differences between stocks most exposed to sentiment and stocks least exposed to sentiment. The two-stage Fama-MacBeth procedure suggests that the sentiment risk factor is significantly priced in the cross-section.