Looking for Spot in the Presence of Futures
Krishna Ramaswamy (The Wharton School of The University of Pennsylvania, U.S.A.)
Patrick Waldron (Trinity College, University of Dublin, Republic of Ireland)

This paper deals with a novel problem of price search in a world where futures markets play an important role. In the absence of the futures market, customers are unable to tell whether a high spot quote reflects a fundamental change in market conditions or whether they have run into a high-pricing dealer. The optimal strategy of a customer carrying out a costly search among dealers for the best spot price (while also participating in a futures market) is shown to have a reservation price property, where the reservation price is a function of the current futures price. In equilibrium, dealers randomize their price quotes in a way that is consistent with searchers’ expectations, yielding a self-fulfilling expectations equilibrium. This solution is consistent with optimal dealer behavior.
*The authors thank Michael Brennan, Greg Connor, John Fingleton, Maureen O’Hara, Dean Foster, and seminar participants at the London Business School, the Stockholm School of Economics and University College, Dublin and at the AFFI & EEA for helpful comments.

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A Theory of Currency Board with Irrevocable Commitments
Alex W. H. Chan (The University of Hong Kong)
Nai-Fu Chen (University of California, Irvine, U.S.A.)

Currency boards are subject to runs if the foreign currency reserve is insufficient to back the convertible money supply. We construct a simple model and show how pre-specified optimal reserve commitments can avert currency board runs. If there exists asymmetric information on the government’s resolve, the government can also use commitments as a costly signal to induce a separating equilibrium. The model can be adapted to analyze other hard-fixed exchange rate systems such as dollarizations and monetary unions. We illustrate the implications of our model in terms of the recent success in Hong Kong and possible remedies for Argentina.
*This paper started as a joint project with Merton Miller and many of the ideas in this paper were developed with him in 1998 during the Asian Currency Crisis. The main theme of this paper was given in a speech by Miller in 1999 entitled ‘The Hong Kong Curerncy Board: Have they finally got it right?’ The current authorship of the paper reflects the request of his estate. We are grateful to Jeremy Berkowits, Leonard Cheng, Sudipto Dasgupta, Juha Tarkka, Chi-wa Yuen, Sheridan Titman (editor), participants of HKEA 2000 conference in Hong Kong, FEMES 2001 conference in Osaka, and workshop participants in the Bank of Finland, Hong Kong Monetary Authority, the Hong Kong University of Science and Technology, State Administration of Foreign Exchange (Beijing, China) and the Swedish School of Economics (Helsinki) for their Helpful comments, and the financial support from Hong Kong RGC earmarked research grant HKU7137/00H.

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The Effect of Short Sale Constraint Removal on Volatility in the Presence of Heterogeneous Beliefs
Alan Kraus (University of British Columbia, Canada)
Amir Rubin (Simon Fraser University, Canada)

We evaluate the effect of short sale constraint removal on a stock market. The intuition is derived from simple geometry. We show that the price curve as a function of the uncertain future payoff changes when investors are able to act on the belief that the price of the share is relatively high. In a very simple model we show that volatility can either increase or decrease, depending on the variability of news about final payoffs. As an empirical illustration, we consider data from the Israeli stock market. The data show that volatility increased following the initiation of index options, consistent with the fact that short sales were prohibited in Israel when index options were introduced.
*We want to thank Bejamin Croitoru (who discussed the paper at the 2002 EFA meeting in Berlin), Ron Giammorino, Lorenzo Garlappi, Bruce Grundy, Jacob Sagi, Sheridan Titman, and an anonymous referee. We gratefully acknowledge the research support of the Social Science and Humanities Research Council of Canada.

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The Behavior and Performance of Foreign Investors in Emerging Equity Markets: Evidence from Taiwan
Anchor Y. Lin (National Chung Hsing University, Taiwan)
Peggy E. Swanson (The University of Texas at Arlington, U.S.A.)

This study investigates trading behavior and investment performance of foreign investors in 60 large-size firms listed on the Taiwan Stock Exchange. Strong evidence is found that foreign investors employ momentum strategies of buying past winners and selling past losers and favor large-size, high book-to-market, and high-tech stocks, while no evidence is found that foreign investors herd on market consensus. Findings show that foreign investors are short-term superior performers but long-term inferior performers. The short-term superior performance appears to be driven partially by price momentum or winners portfolios rather than by risk taking. After controlling for firm size, share turnover, and industry, foreigners’ short-term performance in large-size, high-turnover, and high-tech stocks is better than it is in small-size, low-turnover, and non-high-tech stocks.

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