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Globalization, Gating, and Risk Finance


Unurjargal Nyambuu

New York City College of Technology The City University of New York




Charles S. Tapiero

Tandon School of Engineering New York University


















Dedicated to our parents: Nyambuu Khand, Selenge Tserenvanchig, and Violette Budestchu Tapiero

Chapters' Outline

The book is organized as follows.

Chapter 1, Globalization: Economies in Collision, provides a broad overview by introducing a selected number of problems motivating interest in global risk finance. This chapter provides a summary of foreign exchange (FX) markets, exchange rate regimes, and the evolution of reserve currencies from a macroeconomic perspective. We discuss the emergence of the Chinese yuan as a global exchange currency, its usage in global trade, and its inclusion in the International Monetary Fund’s basket of foreign currencies. Further discussion of the yuan is relegated to subsequent chapters. Chapter 1 further outlines the history of globalization and presents a list of special issues for further discussion.

Chapter 2, Data, Measurements, and Global Finance, provides a review of standard statistical measurement approaches commonly used in economics and finance. We discuss national accounts, big data and model‐less finance, technology and financial data, and data management. Particular attention is given to multivariate data and its treatment. For example, an introduction to data reduction and statistical measurement, principle component analysis, data modeling, copulas, implied volatility, autoregressive moving average, and related multivariate probability models are presented as an approach to the modeling and the study of global financial data. Autoregressive conditional heteroscedasticity (ARCH) and its extensions (generalized ARCH (GARCH), threshold GARCH, and GARCH‐in‐mean) are suggested for the measurement of FX volatility. This chapter assumes that the reader is already familiar with basic statistical techniques and seeks only to learn their relevance for practical problems. For the further study of data analytics and statistics, an extensive list of references is given.

Chapter 3, Global Finance: Utility, Financial Consumption, and Asset Pricing, outlines microeconomic and financial approaches to financial and asset pricing models and their extensions to a multi‐country and multi‐currency world. We develop the theoretical underpinnings underlying the Arrow–Debreu theory for complete market as well as the utility theory and its consumption capital asset pricing model (CCAPM). These theories are applied to valuation pricing in competing and a multi‐agent framework. To do so, we introduce an approach based on the financial commitments to consumption. We then apply this framework to both standard and multi‐country financial pricing and investment problems. This is shown to be far more representative of global finance based on competing agents. Examples for pricing foreign bonds, investments in securities, debt management, and currency wars are also outlined. CCAPM, in its multi‐agent form, is shown to be particularly useful in pricing debt, financial leverage, inequality, swaps, and other aspects of global finance. Our tentative analyses are essentially essays which express the complexity of the pricing of financial products across national boundaries. Throughout the chapter, we introduce pricing and valuation models that are consistent with fundamental approaches, yet seek their marginal expansion to problems recurrent in global finance. The chapter’s intent is to provide a relatively simple approach to some theoretical issues that occur in both conventional and multi‐agent applications of global finance models.

Chapter 4, Macroeconomics, Foreign Exchange, and Global Finance. Global finance and international macroeconomics are intimately related to one another, yet they differ by the time scale of their statistics and by their concern with economic and financial global policies. This chapter presents several fundamental macroeconomic FX rate models required to provide a broader appreciation of global finance as well as to better predict sovereign state policies based mostly on macroeconomic statistics and political and geopolitical factors. We refer to the closed economy model introduced by Keynes and study its extension to an open economy by the Mundell–Fleming model. In this context, the implications of monetary and fiscal policies under the IS–LM–balance of payments model are discussed, describing the relationship between the goods and money markets and the balance of payments. Also, an equilibrium exchange rate determined by the demand and supply of currency is described, with further discussion on major factors affecting the exchange rate. Interactions between expenditures by the private sector, government, and transactions with foreign economies are highlighted. Their evolution underlies the relationships between cross‐border trade, capital, and job flows. We discuss the importance of balance of payments in global finance and its implications. The sustainability of external debt, trends in foreign direct investment, and capital flows are highlighted. This chapter discusses recent trends in macroeconomic policies and exchange rate movements that shape global finance. At the same time, it highlights practical policy concerns and predictable scenarios concordant with macroeconomic finance. In addition, we analyze a correlation between globalization and income inequality and present the existing literature.

Chapter 5, Foreign Exchange Models and Prices, assesses FX rate pricing based on different models for FX. Purchasing power parity is explained using an application of the law of one price (concurrent to the no‐arbitrage principle in finance) and empirical findings for its validity. Furthermore, FX rates and interest rates are studied based on covered interest arbitrage and uncovered interest parity (UIP). Monetary and asset‐based approaches to FX rate determinations are presented along with the UIP model. We cover the Balassa–Samuelson model, the Dornbusch overshooting model, and the present‐value models, all of which are outlined as extensions together with empirical evidence. A list of works for econometric and statistical analysis is suggested.

Chapter 6, Asia: Financial Environment and Risks, provides an overview of Asia’s financial and economic development, emphasizing engines of growth and implications for the global economy and finance. Included is discussion of Asia’s increasing international trade and its regional interdependence, FX rate issues, and foreign investment. We analyze the financial environment in Asia with an emphasis on the banking sector, bond market, and stock market development, and use different approaches to assess the financial and investment risks that Asia’s financial industry is facing. Based on currency data, we discuss FX risks. We also consider regional systematic risk based on local stock exchange data. In addition to the study of Eastern and South‐Eastern Asia, a detailed discussion on China and Japan is presented. In the case of China, while stressing the importance and achievements of the banking sector, we analyze the problem of shadow banking and look at challenges in equity markets, and corporate debt in particular. Econometric and statistical analyses for selected problems are provided.

Chapter 7, Financial Currency Pricing, Swaps, Derivatives, and Complete Markets, provides analysis of pricing the consumer price index and the FX‐based securities in complete financial markets using modeling as well as empirical approaches. We present both relative and martingale‐based FX models with an emphasis on risks and approaches found in US currency indices, global index reversion, the Ricatti FX model, and basket‐based price reversion. We introduce a partial generalization by considering multivariate stochastic models and outline mean‐reverting volatility‐based models. Given the extensive use of options in finance, we assess their use only through some simple examples pertaining to FX options, cross‐national boundary investments, and so on. The currency option pricing models and their applications are presented with further examples using spreads and other options (with references directing the reader to the extremely rich family of optional models). Furthermore, we look at option‐based trading strategies, emphasizing protective puts, foreign trading, the covered call, and others. Finally, this chapter presents the, so‐called, Greek analysis, which measures the sensitivity of option prices to parameters defining the price (e.g., interest rates, volatility). Although, in a global and heterogeneous economic world, “assumed complete markets” may in fact be incomplete, we note that the complete market framework may also be used to price specific and tailor‐made financial products adapted to the needs of international financial transactions. To this purpose, we have also introduced swaps and some of their applications. More detailed developments and applications of swaps, accounting for a substantial part of foreign transactions, are introduced in Chapter 8, where loan‐debt contracts are also defined as swaps.

Chapter 8, Credit Risk and International Debt, presents the growth of debt and debt dependency, highlighting both credit and global risks. This chapter analyzes country‐specific risks, FX risks, credit trading, sovereign bond risks, as well as credit derivatives. In this context, different swaps (e.g., currency swaps, swaptions, credit default swaps, and securitized volatility) are defined and explained. This is important because, under assumptions of complete markets, option‐based products (e.g., swaptions) are used extensively in global financial exchanges. We present credit and default risk pricing based on reduced‐form models. Under this framework, bond prices are defined by the financial market in which they are traded. Then, we consider foreign bonds issued in a foreign currency as a pointer to the risk of bonds compounded by FX risk and extend this idea through the use of martingales. The utility approach is used to price and manage international credit risk and its option‐based derivatives. Finally, this chapter describes the Merton debt model and its relationship to FX markets; it provides an example of the market pricing of both debt and credit risk and outlines Merton’s continuous‐time model for debt and options.

Chapter 9, Globalization and Trade: A Changing World, provides an overview of the evolution of trade based on conventional approaches, as well as its financial and gating aspects. We highlight the importance of trade in globalization and discuss its contributions to the changing world by analyzing its risks and other related issues; for example, inversion, outsourcing, risk externalities, strategic trade and gating, and trade barriers. This chapter reviews trade models based on Ricardo’s theory and the implications of trade models for FX rates in a Cournot game. We introduce a strategic global and financial pricing approach to heterogeneous (and competing) agents (financial agents or countries) based on dependent utilities as well as competing suppliers. Therefore, our multi‐country financial consumption approach is presented starting with a one‐period utility consumption demand model integrated with a supply problem including imports and exports between two parties. Extensions to a Cournot multi‐period financial consumption model accounting for both current and future consumption are, for brevity, considered in research papers we refer to. Owing to their complexity, the problems defined are relatively simple, providing a guideline for the development of a far more complex trade model that can be analyzed using simulation techniques. In this context, this chapter outlines our belief that essential issues underlying globalization (for the “rich” Western world, in particular) are their relationships between local consumption prices and strategic (game) problems fueled by cheap imports, the creation/loss of jobs, foreign dependence and the pursuit of short‐ and long‐term political and geopolitical agendas.

Chapter 10, Compliance and Financial Regulation. Given the complex, growing, multi‐headed, and multi‐country financial and economic regulatory environment, this chapter is focused on compliance risks. A current trend, initiated by the USA, to regulate and tax globally will most likely lead to retaliatory actions by other countries. These retaliatory actions assume many forms; for example, creating competing markets where US laws cannot be enforced, a move away from the US dollar as the main exchange currency, stealthy finance seeking to elude controls, and so on. These and other new elements in global finance are having an impact which may be difficult to ascertain. Justice Stephen Breyer, in his book The Court of the World: American Law and the New Global Realities, raised some fundamental issues confronting the US legal framework and the future of democracy. One specific question he raised is, “Does foreign law have a place in interpreting the American Constitution?” Such a question is most relevant to almost all aspects of sovereign states’ exchanges and relationships and, as a result, the world of global business and finance. On the one hand, legal isolationism would entail a USA divorced from the world; on the other hand, globalization renders foreign laws and international affairs simply unavoidable. From a practical viewpoint, regulated finance, both domestic and global, is confronted with an application of laws and asks “How do we comply?” and “Can we comply in a multi‐polar world, with sovereign states and regulators pursuing multiple agendas?” These are complex questions that this chapter avoids. Instead, we introduce some of the issues and problems; we provide a partial view that emphasizes compliance in light of regulatory risks and their controls. We also point to the increased complexity of regulatory risks and compliance in a global, gated, and strategic finance. A number of quantitative and statistical compliance models are introduced based both on statistical and (random payoff) game constructs, raising a greater awareness of regulation and compliance risks and the consequences of these risks.

Although this book spans a wide breadth of problems, it is far from being exhaustive. The number of books and research papers that relate to the themes of study and featured in important international economics and financial journals, as well as those found in mathematical and quantitative finance and engineering books, is much larger. Our contribution seeks to create a greater awareness to the transformation of finance in an era confronting globalization and its gating and introduce their effects to financial pricing, trade, and compliance. In addition, we hope to provide the reader rational guidelines to economic and financial modeling in a global environment.


This book has profited from contributions from both authors' previous publications in academic journals and in books published by John Wiley & Sons, Springer, Elsevier, and others. In addition, we have referred, wherever we could, to our and others' many academic and professional publications that have addressed global finance from multiple perspectives. We apologize to those we missed and did not refer to. Throughout our research, we have benefitted from discussions with a number of students, academic researchers and practitioners. There may be too many to list, but among the many we thank Alain Bensoussan, Lucas Bernard, Dan Goroff, Ben Golub, Laurent Jacque, Konstantin Kogan, Peter Lewis, George Papanicolaou, Lorne Switzer, Pierre Vallois and three additional Tapieros: Daniel, Dafna and Oren, who are all immersed in real and global finance. Finally, Prof. Tapiero’s involvement was supported by the endowment of the Topfer Chair and by the Sloan Foundation (for its support for the Regulation Chapter 10). To all we acknowledge our gratitude.