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Advanced Spectral Techniques in Econometric Modelling of Macro-Financial Linkages in the Euro area

Final Report Summary - ASPECT (Advanced Spectral Techniques in Econometric Modelling of Macro-Financial Linkages in the Euro area)

ASpecT is a multidisciplinary project that investigates dynamic macroeconomic and financial causal linkages, reveals new market stylized facts, analyzes EU Economies’ (de)synchronization and develops new forecasting models for the Euro Area. Integration proceeded smoothly in the Eurozone due to the introduction of Euro, until the global financial crisis. However, the EU debt crisis served as a catalyst towards the revision of institutional regulations for monetary and fiscal consolidation.

Business cycles have always attracted considerable attention by policymakers, practitioners and politicians for monitoring current economic conditions and predicting future trends. The stylized facts of business cycles and the idiosyncratic features of financial markets required rigorous investigation of the complex co-movements and fluctuations amongst macro-financial variables that may lead to an optimal selection of leading indicators for economic activity.

ASpecT introduces advanced econometric methods such as spectral, time-series and Bayesian techniques that are utilized to detect the latent complex dynamics of economic markets, whilst putting emphasis on the Eurozone. The results are used to investigate the impact of long- and short-term shocks on EU and international economies and explore the predictability of markets via Multiscale Spectral Analysis (MSA) and Dynamic Stochastic General Equilibrium (DSGE) modeling.

Advanced MSA which allowed for simultaneous analysis in the time and frequency domain is utilized to detect the latent complex dynamics of global markets and particularly of the Eurozone. ASpecT aimed at quantifying the domestic/international interdependencies of business cycle divergence in the Euro area. Furthermore, the project developed new DSGE and time-varying econometric models to account for inherent nonlinearities of the economy in particular of the Euro area and comparatively evaluated the predictability of large-scale micro-founded DSGE models vs. conventional statistical tools utilized so far.

Beyond state-of-the-art research outcomes include the development of i) novel multiscale decomposition methods for the analysis and forecasting of economic and financial markets, ii) a spectral time-scale nonlinear causality testing approach, iii) the investigation of contagion, decoupling and the spillover effects of the US financial crisis to the Euro area, Asian counties and the BRICS, iv) the detection of co-movement, long-run relationships and short-run dynamics of EU macro-fundamentals and business cycles vis-à-vis international financial markets and v) the introduction of new approaches for time-varying parameter and DSGE models with the incorporation of the banking sector and financial frictions. Additionally, new findings emerged for asset forecastability and heterogeneous behaviour in financial markets. ASpecT explored the pattern of information diffusion in global markets that might explain inefficiency and market volatility. It was also shown that market interdependencies could have important implications for optimal asset allocation and portfolio diversification.

The socio-economic impact and wider societal implications of the project could be summarized in i) the created breakthrough of state-of-the-art which increased the awareness of the academic community on novel formal methods of analysis in economics, ii) the integration of datasets of economic indicators that would be of interest to international organizations and iii) the increased cooperation within EU universities and policy makers. Indeed, the network of collaborations the Scientist-in-Charge has developed enhances the dissemination channels to spread the results of the project widely throughout Europe.

ASpecT aims at increasing the awareness of the general public and policy makers on the existence and usefulness of formal methods of analysis and evaluation in the economic sciences through the diffusion of project results. The proposed modelling can be valuable after the global and EU crises as well as under the spectrum of new economic developments in emerging markets.

Moreover, the project took fully into consideration some of the main topics in the Lisbon meeting such as the need to “improve the European Research Area (ERA)”. It incorporates the basic steps given in the Lisbon strategy, “networking research together with the coordination and benchmarking of national research and promoting mobility” and “ensure the Community patent as a tool for rewarding innovation”. Based on the feedback and externalities that emerged among the Scientist-in-Charge and the developed academic team, comparative research was carried out that lead to policy implications. The network of collaborations enhanced the dissemination channels, thus the results of the project were widely diffused throughout Europe.

Via the Career Integration Grant the Scientist-in-Charge succeeded in gaining competencies to improve the prospects of reinforcing and advancing his academic status in the Host. The obtained experience as well as the complementary skills acquired, combined with the achieved academic publications have already enhanced his potential of reinforcing his current academic career perspective. He built a strong scientific network within the host institution as well as in other EU and international universities. In addition, he improved his knowledge on modern econometric techniques, which is one of the areas of his professional and academic expertise. The CIG Grant provided an ideal chance to build a long-term personal career development plan.

ASpecT results are bound to provide new insights for policy making and crisis management in the Euro area, as well as influence the greater predictability of EU markets. Importantly and policy-wise, the project results were useful in the direction of inaugurating a more permanent mechanism of crisis management within the Euro area beyond the European Financial Stability Facility (EFSF). The impact of the findings of ASpecT will be crucial to identify, predict and regulate EU financial markets and economies.