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Economic Review

Economic Review
C O N T E N T S
Third Quarter 2001/Volume 86, Number 3

Economic Review articles are posted on the Web as they become available. Page numbers in the PDF file posted here may not reflect the page numbers of the printed version.

These files are in PDF format, which requires Adobe Acrobat Software (links off-site)

PRESIDENT
JACK GUYNN

SENIOR VICE PRESIDENT AND
DIRECTOR OF RESEARCH

ROBERT A. EISENBEIS

RESEARCH DEPARTMENT
THOMAS J. CUNNINGHAM
Vice President and
Associate Director of Research

GERALD P. DWYER JR.
Vice President, Financial

JOHN C. ROBERTSON
Assistant Vice President, Regional

ELLIS W. TALLMAN
Assistant Vice President, Macropolicy

PUBLIC AFFAIRS
BOBBIE H. MCCRACKIN
Vice President

LYNN H. FOLEY
Editor

NANCY PEVEY
Managing Editor

CAROLE L. STARKEY,
PETER HAMILTON, AND JILL DIBLE
Designers

LYNNE ANSERVITZ
Marketing and Circulation

CHARLOTTE WESSELS
Administrative Assistance

The Economic Review of the Federal Reserve Bank of Atlanta, published quarterly, presents analysis of economic and financial topics relevant to Federal Reserve policy. In a format accessible to the nonspecialist, the publication reflects the work of the Research Department. It is edited, designed, produced, and distributed through the Public Affairs Department.

Views expressed in the Economic Review are not necessarily those of this Bank or of the Federal Reserve System.

Material may be reprinted or abstracted if the Review and author are credited. Please provide the Bank's Public Affairs Department with a copy of any publication containing reprinted material.

Free subscriptions and limited additional copies are available from the Public Affairs Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470 (404/498-8020). Internet: http://www.frbatlanta.org. Change-of-address notices and subscription cancellations should be sent directly to the Public Affairs Department. Please include the current mailing label as well as any new information.

ISSN 0732-1813

The Performance of Open-End International Mutual Funds
Paula A. Tkac

The 1990s witnessed tremendous growth in the assets of international mutual funds. This growth is likely to continue as more investors seek the diversification benefits of foreign assets, which have relatively low correlations with domestic stock portfolios. Investors may also be attracted to international funds in the popular belief that such funds can earn abnormally high returns because of the relative inefficiency of these markets. But there is little evidence that this notion is valid.

This article sets the stage for investigating whether exploitable foreign market inefficiencies exist by studying the performance of a large sample of international open-end mutual funds during the 1990s. The analysis sorts funds into thirty-two categories and then applies four commonly used performance measures to characterize the funds' return distributions.

The results show that a large percentage of well-diversified international funds outperform their passive benchmarks in a statistically significant manner, but regional and country funds do not. In addition, emerging markets funds exhibit volatilities that are generally higher than those of developed market funds but do not exhibit significantly higher average or abnormal returns.

These findings indicate that the attractiveness of emerging markets investment should be revisited in more detail. The author suggests that the next step is to formulate data tests that can disentangle competing models of international capital markets and thus identify the underlying factors driving the results.


The Beige Book: Timely Information on the Regional Economy
Donna K. Ginther and Madeline Zavodny

In making monetary policy, the Federal Open Market Committee (FOMC) relies in part on the Beige Book, a report on regional economic conditions released publicly about two weeks before each FOMC meeting. The Beige Book summarizes economic conditions in each of the twelve Federal Reserve districts and provides an overview of national conditions based on the regional reports.

The Reserve Banks gather information for their regional summaries from a variety of sources, including telephone and written surveys, local news reports, and reports on current and expected economic conditions from the Reserve Banks' boards of directors. Some critics consider this type of anecdotal information too subjective to be of much value. However, recent research applying quantitative methods to Beige Book information shows that the reports provide a useful indicator of national and regional economic activity.

This article evaluates the relationship between the Sixth District (Atlanta) Beige Book and regional and state per capita employment, real personal income, and real gross state product growth. The analysis also compares the Atlanta Beige Book to next-quarter estimates of economic activity and examines whether it contains information about regional economic activity in addition to that contained in the national Beige Book summary. The authors find that, despite the Beige Book?s anecdotal nature, the report provides timely, reliable information when actual data are not yet available, giving policymakers an early indication of the direction of the economy that helps them make informed decisions.


Equity Home Bias: Can Information Cost Explain the Puzzle?

Most stock market investors believe that the ideal equity portfolio should be well diversified to lower overall portfolio risk. International financial markets offer a means for diversification, but most investors do not exploit this risk-sharing opportunity and instead hold large shares of their portfolios in domestic stocks—a tendency called home bias.

To measure how severe home bias is, the author introduces a method of quantifying it. A simple asset allocation model is used to determine the shadow cost of foreign investment—that is, the perceived annual cost of foreign equity necessary to create a bias away from perfect international risk sharing and toward domestic equity. The model shows that in most industrialized nations the shadow costs would have to be unrealistically high to account for home bias. In the United States the home bias is almost 150 basis points per year, by far the lowest among all industrialized nations.

The article then discusses a popular explanation for home bias: information cost. This theory argues that investors face lower costs for gathering information on their domestic assets than on foreign assets and are therefore biased toward holding domestic equity. While this explanation is intuitive, the author demonstrates, using both a naive model and a rational expectations model, that the theory is unable to account for observed patterns of home bias. The author thus concludes that home bias is still a puzzle.


Monetary Policy Alternatives for Latin America
Myriam Quispe-Agnoli

During the 1990s, many Latin American countries began to address their problems with recession, inflation, and unemployment through dramatic economic reforms and monetary policy strategies that included exchange rate pegs, monetary aggregate targeting, or inflation targeting. Inflation targeting, in particular, had begun to lower inflation rates and to stabilize or increase real economic growth in countries such as New Zealand, Canada, and the United Kingdom. But has inflation targeting proved as successful for Latin American economies?

This article describes the recent history of monetary policy in Latin America, focusing on the strategies implemented by Argentina, Panama, Ecuador, El Salvador, Mexico, Peru, Chile, Colombia, and Brazil. For the most part their policies were successful: the inflation rate was lower in the 1990s than during the previous decade while average real economic growth more than doubled. But financial crises in recent years have highlighted the region's continuing vulnerability to international capital market volatility and other external and domestic shocks.

The author believes that the Latin American experience suggests some lessons about various policies' relative costs and benefits and the importance of the underlying economic and political environment in determining the ultimate success of alternative monetary policy regimes. She concludes that fiscal discipline, policy credibility, and the role of the exchange rate are critical factors that must be addressed to ensure the sustainability of economic policy.