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Essays on Macroeconomics and Finance Open Access

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This dissertation examines how macroeconomic conditions and policies affect financial markets. The first chapter studies how monetary policy changes the way real stock returns react to inflation. Empirical evidence from a broad set of advanced and emerging markets shows that monetary policy cyclicality, framework, and whether policy is constrained can partially explain the stock return-inflation dynamics. The second chapter explores the role of permanent shock to the trend output growth rate on stock return and inflation. In a theoretical Dynamic Stochastic General Equilibrium (DSGE) model, I illustrate that permanent and transitory productivity shocks generate distinct stock return-inflation correlations. The correlation between real stock return and inflation becomes more positive when the trend shock component in the business cycle is larger. This framework potentially offers a solution to the stock return-inflation difference puzzle across advanced and emerging markets. The third chapter investigates the determinants of financial dollarization in emerging market economies, a phenomenon that describes the large shares of foreign currencies in domestic residents' portfolios. This chapter places an emphasis on foreign exchange reserve management by central banks. Preliminary results from panel regressions confirm a positive and statistically significant association between lagged foreign exchange interventions and the private sector's foreign currency positions. In addition, past changes in foreign exchange reserves are positively associated with increases in financial dollarization. Panel data instrumental variable regressions are applied to establish a causal relationship between foreign exchange reserve movement and the private sector’s risk-taking behavior in financial dollarization. We find that a rise in foreign exchange reserve does not affect the share of foreign currency in the portfolios, but it increases the depth of financial dollarization in percent of GDP. These three chapters together demonstrate the importance of macroeconomic policies and business cycle characteristics in determining asset returns and portfolio allocations.

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