Financial market activity under capital controls: Lessons from extreme events
This post presents a recent article by Gkillas and Longin published in Economics Letters (2018). In this article we investigate the relation between extreme return and transaction volume under the restrictions on transactions. We use bivariate extreme value theory to model the tail dependence structure. We show that restrictions on transactions have an impact on the activity of market participants.
The market activity and, therefore, the behavior of market participants is measured by the transaction volume. The stylized fact assumes a positive correlation between returns and volumes. However, contradictory results are obtained considering extremely volatile periods.
Such periods in combination with a financial crisis of a domestic origin, like the Greek crisis, can lead to strict intervention policies such as capital controls. The sovereign debt crisis in Greece led to the use of a financial support rescue mechanism by the European Monetary Union and the International Monetary Fund early in 2010. The domestic authorities imposed several restrictions on transactions. The Athens Stock Exchange stopped trading for more than two months and then opened to a dramatic decline. Greece became one of the few cases of a Eurozone country implementing such austerity policies.
In our work, we show that these long-term restrictions can be avoided. To this end, we apply bivariate extreme value theory. We show that capital controls have a significant negative impact on the activity of market participants. Therefore, we propose an automatic intra-day circuit-breaker mechanism when the market moves downwards and exceeds a specific threshold, in order to avoid not only the panic selling but long-term distortions for closing of the market.
Gkillas K. and F. Longin (2018) “Financial market activity under capital controls: lessons from extreme events” Economics Letters, 171C, 10-13.
You can download this paper via the following link: https://authors.elsevier.com/c/1XLFobZedijjr