Archive for July 11th, 2007

IPOs in Gulf Countries

July 11, 2007

This paper on performance of IPOs in Gulf Countries is simply too good to ignore. The abstract says:

This paper documents the phenomenon of underpricing initial public offerings (IPOs) for 47 firms that went public between 2001 and 2006 in the equity markets of the six Gulf Cooperation Council (GCC) countries. The average initial abnormal returns of 290 percent exceed those found in the existing literature for both developed and emerging markets IPOs. Although the IPOs’ returns over the one-year horizon beat the market index benchmark, they present negative abnormal returns once initial returns are excluded, which is consistent with findings in other industrial and emerging markets. The empirical models reject the hypothesis that the IPOs’ performance is driven by the common independent variables employed in the literature. On the contrary, in the case of the GCC, country- and industry-specific characteristics, in addition to the timing of the offers, play key roles in explaining the abnormal returns of IPOs. This paper’s empirical findings support the hypothesis that investors initially tend to be over-optimistic about the performance of IPOs, but grow more pessimistic over time.

So, all the returns are made on the listing day. Infact if listing day returns are excluded the returns are negative in a range of -23% to -50% vis-a-vis the benchmark portfolio. ¬†So, invest in IPO and sell on Day one seems to be the strategy in case you are looking at markets in the gulf ūüôā


Impact of dollar depreciation on US trade deficit

July 11, 2007

Currently, one of the most important developments we see is depreciation of the dollar. It has been a major source of concern for Indian exporters and India’s Balance of Payments.

The positive aspect of dollar depreciation is that it would lead to reduction of US trade deficit which is about USD 600 billion as of now. In one of the papers by Martin Feldstein which I covered here, Feldstein had argued that for trade deficit to reduce, either USD should depreciate or savings should increase. He had also said that it would be better if USD depreciates first.

Now, we see dollar depreciating (as there is no sign of savings improving, we see Feldstein’s wishlist coming true) so ideally theory would say US exports would increase and imports decrease and trade deficit will reduce. Right? Not really.

In this analysis by New York Fed Economists (Linda Goldberg and Eleanor Wiske Dillon), they say the reduction in deficit is going to be very little. They give 3 reasons:

1.  Extensive use of USD in invoicing imports: Despite adoption of Euro, USD dominates foreign trade invoicing. Euro dominates European countries trade invoices but Asian nations, Australia etc still use USD extensively. They have a table (Table2), which summarises the currency invoicing pattern.  The authors explain:

When foreign producers invoice their exports to the United States in dollars, the price of these goods remains fixed in the buyer’s currency if the dollar depreciates against other currencies. The exchange rate movements affect only the foreign producers’ profits and will not increase the dollar price paid by U.S. importers. After a time, of course, foreign producers may choose to adjust their prices in response to the exchange rate change. But evidence suggests that exporters set prices in dollars well in advance of the delivery of their goods and change those prices only periodically.

2. Market share concerns of foreign exporters: The authors say US is a big and a very competitive market for exporters and in case of dollar depreciation, they would reduce their margins rather than pass on the costs to the consumers. Moreover, Imports are a smaller component in the consumption basket (compared to other countries) and in case of any price increases, the US consumer would shift to domestic producers.

3. Sizable distribution costs: The above two are factors when goods comes to the border. The high distribution costs in US (The authors cite a paper which shows US has higher than average distribution costs across most consumption goods) further insulate the impact of depreciating dollar.

So,¬†USD depreciation would lead to little impact on imports but¬†the effect on¬†exports would be¬†higher. This is also reflected by looking at trade elasticities i.e. impact on US exports or imports¬†given dollar’s value¬†changes by 1%. The authors cite a study which says:

Using data from the 1960s to the mid-1990s, they estimate that demand for U.S. exports reacts more than proportionally to changes in export prices, rising 1.5 percent for every 1 percent drop in export prices. U.S. demand for imports, however, reacts less than proportionally to price changes, rising only 0.3 percent for a 1 percent drop in import prices. While this asymmetry is present in the trade elasticities of most other G7 countries, it is most pronounced for the United States.

They combine all this and project asking if USD depreciates by 10% what would happen?


United States Foreign Markets
Change in home currency price
of bilateral imports
+4 -7
Change in bilateral demand
for imports
-1 +10

The first row shows the effects on price and the second row shows the effects on demand. So, a 10 percent dollar depreciation has following effects:

  • lowers the prices of U.S. exports by 7%
  • raises the prices of US imports by at most a 4%
  • foreign demand for U.S. exports would rise 10¬†%
  • U.S. demand for imports from abroad would decrease only 1% in the six quarters after the depreciation. (Note that the decline in import demand may be overestimated because we omit the distribution services that further cushion the effects of the depreciation on the prices ultimately paid by consumers.)

In nutshell, US exporters gain and as prices of imports in US hardly increases,¬†the imported items would continue to be purchased and hence the impact on deficit would not be as much as expected. As prices of US imports don’t rise, the foreign exporters bear much of the fallouts of depreciation.

They summarise the paper as:

Even a marked rise in exports, however, is by itself unlikely to erase the U.S. trade deficit. In 2006, that deficit stood at $759 billion. If imports and terms of trade remained constant, exports would have to grow 52 percent to single-handedly close this gap. Either import demand will have to become more responsive to exchange rate movements or adjustment will have to take place through other developments that would affect demand. These other developments might include increases in U.S. public or private saving (with related declines in U.S. consumption of all goods) or a rise in global demand driven by economic growth abroad or increased market access for U.S. exporters.

Revisiting Feldstein paper, it seems only way to get out of this deficit is increase savings.

I am sure there would be papers ahead countering/ supporting the above view as it looks quite a contradictory statement to make and against the popular held (and shared) beliefs.

Excellent stuff.

Assorted Links

July 11, 2007

1. Economists have been wondering for quite some time why US unemployment data is so strong (i.e. employment is still high) despite some data showing signs of cooling off. A nice summary is given at Econbrowser.

Now, WSJ Blog points¬†out to a new report from Deutsche Bank economists which says that large number of illegal Hispanic workers (500,000!) have been laid off and they are not included in the unemployment data. If they are then unemployment rate would be around 5% higher than 4.5%. ( I can’t find the report though)

2. Ben Bernanke has given a speech on Inflation yesterday at NBER. Would try and summarise the speech later.   

3. ET reports that corporates would now show how many reserved category (SC/ST) employees it has on payroll. Is this inclusion?

4. Finally we have an official index to track housing prices. It is developed by National Housing Bank and is called NHB Residex.  This is a welcome development. However, it is not yet available at the NHB website.

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