Felix Lopez-Iturriaga

Juan-Antonio Rodríguez

Félix J López-Iturriaga

Juan Antonio Rodríguez-Sanz

Capital structure and institutional setting: a decompositional and international analysis

Keywords: Capital structure, Corporate finance, Legal tradition, International analysis

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Introduction

The capital structure of firms has been the core of an academic debate for a long time.

This debate has run parallel with the research about the influence of the legal and institutional setting on firms' financial decisions. Laws, and specially investor protection, have been proved to have a great influence on the corporate system. In this sense, the analysis of the origins of the legal system can help to explain institutional factors such as corporate governance, the relative importance of capital markets and the development of some industries (La [START_REF] Porta | Investor protection and corporate governance[END_REF]. This paper is based on both fields and aims to analyse the capital structure of firms in the framework of the legal system of each country. It is a suggestive approach because, although most of the research focuses on developed countries [START_REF] Rajan | What do we know about capital structure? Some evidence from international data[END_REF], there are notable institutional differences between them which should be taken into account. This is the main contribution of our paper, as we aim to study the factors determining capital structure in an international framework. We do not simply wish to check the different financial leverage of the different countries or groups of financial systems; we are also interested in analysing different measures of capital structure in order to elucidate how the impact of the factors that have traditionally explained capital structure is conditioned by that legal and institutional framework.

Our results stress the significant differences in financial leverage between countries and between legal frameworks, and how those differences are not due to different factors but to their differential impact. More specifically, we find that the firms belonging to different financial systems show big differences in the level of debt and especially in the maturity structure of debt. In addition, we document the influence of law enforcement and the quality of accounting on firms' capital structure.

Our paper can be divided into four sections. Section 2 looks at the main literature on this topic and we introduce the theoretical background on which the empirical analysis is grounded. Section 3 presents the data, the definition of the variables to be used and the statistical methodology. In section 4, the results of the empirical estimation are reported and discussed. Section 5 includes the most relevant conclusions and some directions for future research. Capital structure has been one of the most controversial topics in finance and there are plenty of papers which have tried to identify its determining factors [START_REF] Barnea | Agency problems and financial contracting[END_REF][START_REF] Harris | The theory of capital structure[END_REF][START_REF] Colombo | Determinants of corporate capital structure: evidence from Hungarian firms[END_REF]. Although not exhaustively, the literature has pointed to some of these factors, such as firm size [START_REF] Marsh | The choice between equity and debt: an empirical study[END_REF][START_REF] Jalilvand | Corporate Behavior in Adjusting to Capital Structure and Dividend Targets: An Econometric Study[END_REF], firm performance [START_REF] Kester | Capital and ownership structure: a comparison of United States and Japanese manufacturing corporations[END_REF][START_REF] Titman | The determinants of capital structure choice[END_REF], collateral [START_REF] Bradley | On the existence of an optimal capital structure: Theory and evidence[END_REF][START_REF] Berger | Relationship lending and lines of credit in small firm finance[END_REF], growth opportunities [START_REF] Mcconnell | Equity ownership and the two faces of debt[END_REF], the ownership structure (Kim y Sorensen, 1986;Bergström y Rydqvist, 1990), debt tax shields [START_REF] Titman | The determinants of capital structure choice[END_REF] and assets structure [START_REF] Balakrishnan | Asset specificy, firm heterogeneity and capital structure[END_REF], etc.

In recent years, the literature has paid special attention to the influence of the legal and institutional framework on corporate finance. The financial decisions of firms are not isolated from the institutional characteristics. In fact, the legal and institutional setting creates a net of relations between firms and financial institutions. From this point of view, financial systems have traditionally been classified into two main groups, depending on the orientation or importance of financial intermediaries [START_REF] Allen | Stock markets and resource allocation[END_REF][START_REF] Allen | Comparing financial systems[END_REF].

There is a Continental or bank-oriented system in which banks play a prominent role as financial channels from the ultimate lenders to the ultimate borrowers. It is the dominating system in Japan and in most Continental European countries such as Germany, France, Italy, Spain, etc. There is also an Anglo-Saxon or market-oriented system (e.g., U.S.A., United Kingdom, etc.) in which banks are not so important and financial functions are directly performed by capital markets. Since both systems show big differences in the extent to which the banks are present in the core of the system, there will also be big differences in the capital structure of the firms (Rajan &[START_REF] Rajan | What do we know about capital structure? Some evidence from international data[END_REF]1998).

In spite of the wide support for this classification, the limitations of this criterion have been underlined in recent years [START_REF] Corbett | German investment financig: an international comparison[END_REF][START_REF] Porta | Investor protection and corporate governance[END_REF]. The banks vs. markets scheme relies on two differentiated levels of financial leverage, and Anglo-Saxon firms are usually less leveraged than their Continental counterparts [START_REF] Rutherford | An international perspective on the capital structure puzzle[END_REF][START_REF] Mayer | Financial systems, corporate finance, and economic development[END_REF]. Nevertheless, this assertion has been proved not to be completely exact, especially regarding some countries, such as Germany, which are supposed to belong to the bank oriented model [START_REF] Rajan | Debt, folklore, and cross-country differences in financial structure[END_REF]. This is why another classification scheme has arisen. Instead of grounding on the importance of markets and financial intermediaries, this new criterion is based on the legal origins of each country (La [START_REF] Porta | Legal determinants of external finance[END_REF]1998;[START_REF] Levine | The legal environment, banks, and long-run economic growth[END_REF][START_REF] Levine | Financial intermediation and growth: Causality and causes[END_REF].

Basically, countries are classified into two main groups: common law countries and civil law Legal origins determine the characteristics of each system. In fact, creditors' and shareholders' rights, law enforcement, the quality of accountancy, ownership concentration and per capita wealth are quite different, conditional upon investor protection. Investors have the best legal protection in common law countries and the worst in the French civil law countries. Similarly, law enforcement and the quality of accountancy are higher in the common law and in the Scandinavian civil law countries than in the others [START_REF] Porta | Legal determinants of external finance[END_REF].

Financial and institutional systems are relevant because investor protection has a positive effect on the development of capital markets (both equity and debt markets) and, consequently, it affects firms' financial strategy. For instance, weak investor protection implies a more concentrated ownership and control structure [START_REF] Himmelberg | Investor Protection, Ownership, and the Cost of Capital[END_REF], whereas good protection indirectly leads to the growth of production and productivity through a more efficient resources allocation [START_REF] Porta | Investor protection and corporate governance[END_REF]. Likewise, the development of the banking system is positively related to the protection of creditor rights [START_REF] Levine | The legal environment, banks, and long-run economic growth[END_REF] and economic development is enhanced by the institutional framework (i.e. institutional support and economic freedom) as found by [START_REF] Assane | Institutional framework and economic development: international evidence[END_REF].

Hence, the legal framework of each country -especially law enforcement and investor protection-has been proved to affect corporate finance [START_REF] Fabbri | The legal enforcement of credit contracts and the level of investment[END_REF]. For instance, [START_REF] Giannetti | Do better institutions mitigate agency problems? Evidence from corporate finance choices[END_REF] has shown how intangible assets -which could be the most difficult assets to fund-, are more easily funded when creditor rights are better protected and that a lower development of capital markets forces firms to use more debt. In addition, [START_REF] Storey | The role of legal status in influencing bank financing and new firm growth[END_REF] has proved that bank financing is affected by the legal status of the firm.

These two academic fields -namely, capital structure theory and the international comparison of financial systems-are the backbone of our paper since we aim to study the capital structure of an international sample of firms following a decompositional analysis.

According to [START_REF] Booth | Capital structures in developing countries[END_REF], our research is twofold: firstly, in a descriptive approach, we attempt to discover whether capital structure shows significant differences across countries and, secondly, we test whether the factors determining firms' financial decisions have a different influence depending on the legal and institutional framework.

Although the classification scheme according to the institutional environment does not necessary imply any prediction concerning financial leverage but about internal and external -4finance [START_REF] Porta | Legal determinants of external finance[END_REF], there is evidence of the different level of debt and, more specifically, of the different debt maturities across countries. Broadly speaking, firms in the civil law countries usually have more debt and shorter maturity of debt than their common law counterparts [START_REF] Demirgüc-Kunt | Institutions, financial markets, and firm debt maturity[END_REF][START_REF] Fan | An International Comparison of Capital Structure and Debt Maturity Choices[END_REF]. Consequently, we could hypothesize that our results are supposed to show higher financial leverage and shorter maturity of debt in civil-law countries relative to common law countries.

Data and methodology

Our data base set is Compustat. As is widely known, Compustat gathers financial information with high reliability from a large number of firms. Given the high number of countries (and the disparities among them in terms of accounting rules), we have centred on balance sheets and income statements from a sample of 10 countries throughout 1997-2002 (Table 1). These firms can be divided into three of the four above mentioned main institutional settings.

Our methodology follows two steps. The first step is broadly descriptive and aims both to compare the level of debt across countries or across legal systems and to test the existence of possible significant differences through the analysis of variance (hereinafter ANOVA). As stated by [START_REF] Rajan | What do we know about capital structure? Some evidence from international data[END_REF], both the level of financial leverage and its sensibility to the influencing factors can critically depend on the kind of measure of financial leverage. Therefore, we propose a set of different measures of capital structure and we decompose them into their basic components. The second methodological stage is mainly explanatory and aims to test the impact of some factors on capital structure. In this phase, we are interested in knowing to what extent the international differences can be explained by a different impact of these factors.

Our sample includes data from Austria and Germany as civil law countries with the German tradition, from Canada, the U.S.A. and the United Kingdom as common law countries, and from Italy, France, Spain, the Netherlands and Belgium as civil law countries with the French tradition. The final distribution by countries and corporate systems is reported in Table 1.

Insert Table 1 We use three main measures of capital structure as suggested by [START_REF] Rajan | What do we know about capital structure? Some evidence from international data[END_REF] and, especially, by [START_REF] Bevan | Capital structure and its determinants in the UK -A decompositional analysis[END_REF], so that we can compare our results with those of the above authors. The first measure is a general indicator of financial leverage and includes any kind of debt (both financial and commercial debt). We defined B1 as the ratio of financial debt (FD), i.e. costly debt, plus commercial debt (CD) to total assets at book value (TA).

TA CD FD + = 1 B
The second measures explicitly focuses on costly debt and excludes commercial debt. Consequently we define B2 as total financial debt to book total assets ratio.

TA FD = 2 B
The last variable is informative of the relation between debt and costly funds (both implicit and explicit cost). These costly funds are costly debt and equity. The main difference between this ratio and previous ones is the exclusion of commercial debt and some elements which are quite difficult to classify such as deferred taxes, minority interests, non-taxable reserves, etc1 .

) ( 3 BV FD FD B + =
Since an all-inclusive explanation of capital structure is beyond the scope of this paper and we simply aim to compare the basic issues of corporate finance across different legal and institutional frameworks, we limit our attention to four variables potentially driving the capital structure decisions of firms [START_REF] Rajan | What do we know about capital structure? Some evidence from international data[END_REF][START_REF] Bevan | Capital structure and its determinants in the UK -A decompositional analysis[END_REF][START_REF] Bhaduri | Determinants of capital structure choice: a study of the Indian corporate sector[END_REF]: growth opportunities, firm size, firm performance and assets tangibility.

Growth opportunities, according to [START_REF] Mcconnell | Equity ownership and the two faces of debt[END_REF] and [START_REF] Lasfer | Agency costs, taxes and debt: the UK evidence[END_REF], are proxied by MTB or the market-to-book ratio (book value of debt plus market equity value to book total assets ratio). The size of the firm is measured through the log of the firm's turnover and the performance of the firm is measured with the EBIDTA (earnings before interest, depreciation, taxes and amortizations) to total assets ratio. Assets tangibility is measured through the assets with a physical existence (PA) to total assets ratio. These definitions can be expressed as follows: The explanatory analysis is run through regression analysis with the panel data method. The model to be tested can be expressed as follows:

it i it it it it it TANG PROF LOGSALE MTB L + + + + + + = 4 3 2 1
In this equation, i sub-index stands for the individual and t sub-index for the time. i is the fixed-effects term which is firm specific and it is the random component which is supposed to introduce all the remaining factors potentially affecting capital structure. The fixed-effects term introduces firm specific factors which can be correlated with the set of independent variables and whose omission could bias the results of the estimation. This fixed effect or unobservable and constant heterogeneity can not only be identified, but also treated by panel data procedures [START_REF] Arellano | Panel data econometrics[END_REF][START_REF] Baltagi | Panel data : theory and applications[END_REF].

Panel data is basically a multivariate regression analysis along with the use of the Hausman test to detect the existence of these underlying individual effects and their correlation with the explanatory variables. When the Hausman test suggests the rejection of the null hypothesis of no correlation between the fixed effects term and the independent variables, the within-groups estimation provides consistent estimators. If the null hypothesis is not rejected, a random model or generalized least squares provides consistent and asymptotically efficient coefficients.

Nevertheless, there is a lot of literature suggesting the endogeneity of some righthand side variables, so we should control for this possible endogeneity [START_REF] Cho | Ownership structure, investment, and the corporate value: an empirical analysis[END_REF][START_REF] Demsetz | Ownership structure and corporate performance[END_REF]. There are a number of procedures to deal with this problem and we will stress the generalizad method of moments GMM [START_REF] Arellano | Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations[END_REF][START_REF] Mairesse | Estimating the productivity of research and development in French and US manufacturing firms: an exploration of simultaneity issues with GMM methods[END_REF]. The GMM is based on the use of instrumental variables according to the structure of available lagged variables which are supposed to be endogenous. By counting on more instruments than variables to be estimated, GMM provides more efficiently estimated coefficients. This is why, in our last stage, we report the results from the GMM estimation for MTB and PROF in order to test the robustness of our previous results.

Results

The first step is a test of possible significant differences for the measures of capital structure among different legal systems. Results are reported in Table 2 and, although they are perhaps too detailed, they show a common and persistent pattern for B1, B2 and B3 across legal systems: whereas firms in the French civil law countries are the most leveraged, their German civil law counterparts are the least prone to debt. Although these results hold for the three measures of financial leverage, they are inconsistent with our expectations, since civil law firms were hypothesized to have more debt than common law firms.

Consequently, new analyses are required to solve this conflict.

The next stage is an ANOVA to test the extent to which one can assert that different institutional and legal settings have different mean values of capital structure. ANOVA results, reported in Table 3, are quite significant and show that we can reject the equality of means across the three groups with a confidence level higher than 99%.

Insert Tables 2 and3 Nevertheless, this evidence requires a more detailed development with bilateral comparisons between pairs of systems as reported in Table 4. This table shows that, on average, the level of financial leverage is significantly different across groups of countries and corroborates the fact that firms from the French tradition of civil law countries are the most leveraged, whereas their German civil law counterparts are those with the least leverage. Consequently, the market vs. banks classification scheme seems to lose importance relative to the legal roots and the institutional development criterion for classifying countries and explaining financial decisions (La [START_REF] Porta | Investor protection and corporate governance[END_REF].

Insert Table 4

We should note that there are some discrepancies in capital structure (for instance, the ranking based on B2 vs. the ranking based on B1 and B3). In order to elucidate this issue, we decompose the total debt to total assets ratio (B1) as a function of the maturity structure [START_REF] Bevan | Capital structure and its determinants in the UK -A decompositional analysis[END_REF][START_REF] Ozkan | The determinants of corporate debt maturity: evidence from UK firms[END_REF]. So, we have defined LTDTA as the proportion of long term debt over total assets and STDTA as the proportion of short term debt over total assets. Even short term debt can be divided into suppliers or commercial debt (COMTA) and the other short term debt (OSTDTA) 2 .

2 All these measures have been scaled by total assets. Results exhibit big differences according to the institutional framework. Consistent with our expectations and with previous literature, while Anglo-Saxon firms are those with the highest long term debt ratio (19.4%), the German civil law firms are those with the lowest long term debt (9.6%). On the contrary, if we focus on the short term debt, we can see how French civil law firms are the most leveraged companies whereas Anglo-Saxon firms are the least ones. In turn, different kinds of debt seem to have an asymmetric role: common law firms appear to be more prone to long term debt whereas civil law firms tend to borrow to short term. Among the possible explanations to these results, we could cite that both the legal protection of investors and the quality of legal enforcement foster long term lending relations, as well as institutional investors and the activity in capital markets -more often in common law countries than in civil law ones.

Once we have checked the differences between legal systems in terms of capital structure, we can test whether the factors determining firms' financial choices are responsible for those differences. We have made capital structure depend on four of the factors which are most usually supposed to affect a firm's finance: growth opportunities (MTB), firm size (LNSALES), firm performance (EBITDA) and assets tangibility (TANG). The results of the regression analysis with the method of panel data are reported in Tables 5 and6. For each explanatory variable and for each measure of capital structure four estimations are provided.

The first one has been run over the entire sample while the second, the third and the fourth are estimated for the Anglo-Saxon, the French and the German tradition of civil law system respectively.

Insert Tables 5 and6 In general terms, the results reported in Table 5 show a common pattern for the four explanatory variables in all the legal systems and for all the measures of capital structure.

Although we do not aim to explain corporate finance decisions in each institutional framework but simply to show the common and the distinctive features, we should try to provide some justification for these results.

Growth opportunities and firm performance are proved to have a negative and significant relation with financial leverage, whereas the size of the firm and the assets tangibility is positively related. These results can be explained by the link between the size of the firm and the asymmetric information in capital markets [START_REF] Ojah | Determinants of corporate debt structure in a privately dominated debt market: a study of the Spanish capital market[END_REF]. Since large companies are usually better known in capital markets, there is less asymmetry between a firm's informed managers and investors, so that large firms can more easily borrow from capital markets. The negative relation between debt and firm performance has (Myers, 1977;[START_REF] Myers | Corporate financing and investment decisions when firms have information that investors do not have[END_REF]. Nevertheless, the effect of growth opportunities and assets tangibility requires further explanation.

As far as growth opportunities are concerned, their negative impact -when significantis noticeable and coherent with previous research [START_REF] Bevan | Capital structure and its determinants in the UK -A decompositional analysis[END_REF]. A more detailed analysis as a function of maturity structure confirms that firms with more growth opportunities rely on commercial debt because this kind of debt does not impose such constraining covenants as other types of credit [START_REF] Barclay | The capital structure puzzle: another look at the evidence[END_REF].

Table 5 also shows how assets tangibility is positively related to debt for all the measures of capital structure and in all the legal systems. This result can be explained on the basis of tangible assets as collateral: the more important the tangible assets are the more collateral the firm puts and, consequently, the lower the interest rate is. Notwithstanding, Table 6 shows remarkable differences conditional upon the kind of debt: whereas TANG is positively related to LTDTA, it is negatively related to STDTA. This means that long term debt is likely to fund long term assets (which can be put as collateral for long term debt) and short term debt will fund current assets.

To sum up, our results up to this point show: 1) Noticeable and quite consistent differences in the level of financial leverage across the firms from different legal systems; 2) Financial leverage is affected by the same factors which have traditionally been supposed to explain capital structure. But, if this is the case, one should question how the same factors could produce such large differences across the systems or, more precisely, across countries. This is why, in the subsequent analysis, we introduce two country specific characteristics which are related to the legal and institutional framework: law enforcement and the quality of accounting. Based on data from La [START_REF] Porta | Law and finance[END_REF], we have defined two dummy variables (DEL and DQA) that equal 1 if law enforcement or the quality of accounting is above the mean of the sample3 . These dummy variables have interacted with the four explanatory variables in order to test if they have differential effects conditioned by the law enforcement and the quality of accounting.

Results are displayed in Table 7. For the sake of simplicity, we will just comment on the most general and common features instead of a too detailed explanation of the results. The interacting variables are quite significant, so we can assert that growth opportunities, the size and performance of the firm, and the assets tangibility have a different effect depending on those two characteristics. Two results, nevertheless, deviate from this pattern: neither the interaction of MTB and the dummy of quality accounting nor the interaction of TANG and quality accounting seem to have a significant impact. Excluding these exceptions, Table 7 is interesting because it suggests that different levels of leverage are not per se a result of the legal environment, but that the legal setting creates the conditions so that those factors have a differential impact.

We have run some additional regressions in order to check the robustness of our results. Firstly, we have defined a dummy variable for each institutional setting. These dummies (DFC and DGC 4 ) have interacted with the four above-mentioned explanatory variables to test possible differential effects depending on the legal system. Results are shown in Table 8 and are consistent with previous ones: the four variables continue to be significant and, in addition, the interacting variables are also statistically significant, with the sole exception of MTB in some estimations. Since a very exhaustive explanation might obscure the general meaning of the regression, just a general comment can be suitable: the high significance of the interacting variables allows us to infer that the four determinants of capital structure have a differential influence in each legal system.

Another sensitivity analysis takes into account the possible endogeneity of the explanatory variables. As some authors have pointed out (Demsetz and Lehn, 1985;Jensen, 1986;[START_REF] Mcconnell | Equity ownership and the two faces of debt[END_REF], some firms' characteristics that we have assumed exogeneous could be affected by the firms' capital structure. Thus, we have replicated the previous regressions with the generalized method of moments (GMM) to control for the potential endogeneity of the explanatory variables (Table 9). Results basically remain the same as the previous ones with two small exceptions: PROF is no longer as significant as it was and MTB coefficients are inconsistent for some estimations. Notwithstanding, the Hansen test, which aims to control the overidentification restrictions -and, consequently, the validity of instruments-does not support the accuracy of the instruments. Additionally, the second order serial correlation would advise some caveat in analyzing GMM results because the weakness of the instruments reduces the efficiency of the estimations and increases the possible bias.

Concluding remarks

Recent research has shown the influence of the legal and institutional setting on firms' financial decisions. These decisions are no longer due just to firms' value enhancement strategies but are also affected by the legal framework in which firms operate. Our paper joins analyses of firms' capital structure in an international framework in order to test differences across countries or legal systems and to find common points in the factors potentially affecting capital structure.

We begin with a division of the countries according to the characteristics of the corporate system. The traditional bank-oriented vs. market-oriented classification scheme is no longer practical enough and we need to use more precise criteria based on the legal origin of institutions. In fact, as a first conclusion of our paper, we can assert that the global consideration of the bank oriented system is inexact since it includes a number of countries with fairly different corporate systems. When we decompose capital structure in a set of different measures, we find that the firms in the French tradition of civil law countries are more leveraged than their common law counterparts and we also find that the firms in the German tradition of civil law are the least leveraged ones. More important than the level of leverage, our analysis reveals a clear difference in debt maturity so that, the more the rights of investors are protected, the longer the term of the debt becomes.

Although the use of debt is different across legal systems, the factors traditionally thought as determinants of capital structure have much in common in different financial systems. Although the performance and the size of the firm, the assets tangibility and growth opportunities have a similar effect in the three scenarios, there are specific effects conditional on the legal systems. Consequently, our results suggest that the effect of the factors that have traditionally been considered determinants of capital structure depends on the legal and institutional setting and that these differential effects can explain international disparities in capital structure. Our research has also shown that the introduction of some variables concerning the legal protection of investors, such as the enforcement of the law and the quality of the financial information, can help to explain firms' financial choices. The whole number of observations is 18,003 for common law countries, 4,854 for the French tradition of civil law countries and 3,029 from the German tradition of the civil law countries. B1 and M1 are allitems including definitions of capital structure, B2 and M2 includes just costly debt and B3 and M3 are scaled by costly liabilities. LTDTA and STDTA stand for long term debt or short term debt to total assets respectively. COMTA stands for commercial debt to total assets ratio and OSTTA for other short term debt to total assets ratio. Estimated coefficients and (t-statistics). *** for a confidence level higher than 99%, ** for a confidence level higher than 95% and * for a confidence level higher than 90%. Hausman test follows a 2 distribution with so many degrees of freedom as estimated coefficients. Estimated coefficients and (t-statistics). *** for a confidence level higher than 99%, ** for a confidence level higher than 95% and * for a confidence level higher than 90%. Hausman test follows a 2 distribution with so many degrees of freedom as estimated coefficients. Estimated coefficients and (t-statistics). *** for a confidence level higher than 99%, ** for a confidence level higher than 95% and * for a confidence level higher than 90%. Hausman test follows a 2 distribution with so many degrees of freedom as estimated coefficients. Independent variables have interacted with a dummy of law enforcement (DEL) and with a dummy of the quality of accounting (DQA) Estimated coefficients and (t-statistics). *** for a confidence level higher than 99%, ** for a confidence level higher than 95% and * for a confidence level higher than 90%. Hausman test follows a 2 distribution with so many degrees of freedom as estimated coefficients. Independent variables have interacted with dummy variables of the French civil system (DFC) and the German civil system (DGC). Estimated coefficients and (t-statistics). *** for a confidence level higher than 99%, ** for a confidence level higher than 95% and * for a confidence level higher than 90%. Wald test is a test of joint significance for all the variables. Hansen test of overidentification restrictions allows controlling the validity of instruments and follows a 2 distribution with so many degrees of freedom as the difference between the number of instruments and the number of regressors. AR(1) and AR(2) are tests or first and second order serial correlation.

B1

  the law is made by judges in common law countries, legal scholars play a prominent role in civil law countries. Civil law countries can be further divided into three origins: the French, Scandinavian and German traditions.

  by previous research into the pecking order theory of capital structure

4

  Dummy for the French civil and the German civil countries.

Table 1 : Sample distribution across countries

 1

	Countries	Number of firms	Countries	Number of firms
	United States	2,827	Holland	185
	United Kingdom	675	Belgium	102
	Canada	464	Italy	209
	Total common law	4,066	France	564
	Germany	671	Spain	103
	Austria	92	Total French civil law	1,163
	Total German civil law	763	Total	5,992

Table 2 : Mean value of debt conditional upon the legal system

 2

Table 3 : Analysis of the variance depending on the legal system

 3

			Square mean	F-Test	p-value	Square mean	F-Test	p-value
	B1	Between-groups	11.585	336.06	0.000 LTDTA	17.048	673.608	0.000
		Within-groups	0.034			0.025
	B2	Between-groups	2.886	94.35	0.000 STDTA	30.462 2273.038	0.000
		Within-groups	0.030			0.013
	B3	Between-groups	5.376	93.90	0.000 COMTA	8.725 1288.853	0.000
		Within-groups	0.057			0.006
					OSTTA	8.238 1427.425	0.000
						0.005

Table 4 : Bilateral post-hoc tests

 4

								Comment [Y1]: Los comas no
								deberían de ser puntos. Quiero decir
								decimal (que es punto en inglés) y no mil
								(que es coma en inglés?
		System I System II	Difference	p-value		Difference	p-value
	B1	Anglo.	French	-0,061	0,000	LTDTA	0,062	0,000
			German	0,044	0,000		0,097	0,000
		French	German	0,105	0,000		0,035	0,000
	B2	Anglo.	French	0,005	0,055	STDTA	-0,124	0,000
			German	0,047	0,000		-0,053	0,000
		French	German	0,041	0,000		0,070	0,000
	B3	Anglo.	French	-0,050	0,000	COMTA	-0,066	0,000
			German	0,009	0,056		-0,003	0,052
		French	German	0,059	0,000		0,063	0,000
						OSTTA	-0,057	0,000
							-0,050	0,000
							0,006	0,000

Page 16 of 21 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

	Submitted Manuscript
	-16-
	F o r P e e r R e v i e w

Table 5 : Factors affecting capital structure.

 5

Table 6 : Factors determining capital structure.

 6

Table 7 : Factors determining capital structure with law enforcement and the quality of accounting

 7

Table 8 : Factors determining capital structure with dummy variables for institutional settings

 8

Table 9 : Factors determining capital structure (GMM estimation)

 9

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript

We have defined three measures of capital structure analogously to B1, B2 and B3 with market values instead of book values. Results are not reported for simplicity but are fully consistent.

The countries with the best law enforcement in our sample are Canada, The United States, Belgium, Holland and Austria, whereas the countries with the best quality of accounting are Canada, The United Kingdom, The United States, France, Holland and Spain. It is interesting to note that this classification differs from the civil vs. common law, so that the dummy variables do not measure the legal tradition but these two features of the legal and institutional setting.

Comment [Y2]:Otra vez puntos y comas?


Alvaro Aguiar

Manuel M F Martins
email: mmfmartins@fep.up.pt

Manuel M F Martins Cempre

Testing for Asymmetries in the Preferences of the Euro-Area Monetary Policymaker

Keywords: C32 -Time-Series Models Central Bank Preferences, Asymmetry, Euro Area, GMM, Optimal Control Central Bank Preferences, Asymmetry, Euro Area, Optimal Control, GMM. JEL classification: E52, E58, C32

published or not. The documents may come   L'archive ouverte pluridisciplinaire

Introduction 1

The purpose of this paper is to formally examine whether there is significant evidence of asymmetries in the revealed preferences of the Euro Area monetary policymaker.

Most of the empirical analysis of monetary policy preferences has modeled the preferences of the policymaker as a symmetric quadratic loss function. Within that framework, [START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF], following an approach similar to Favero and Rovellis' (2003) study of the US case, have found that the aggregate Euro Area data uncover the existence of a well-defined monetary policy regime of strict inflation targeting with interest rate smoothing during 1995:I-2002:IV.

However, the hypothesis that the coefficients of policymakers' loss functions may not be identical across different states of the macroeconomy is receiving a growing interest in the literature. On one hand, [START_REF] Cukierman | The Inflation Bias Result Revisited[END_REF][START_REF] Cukierman | Are Contemporary Central Banks Transparent about Economic Models and Objectives and What Difference Does It Make?[END_REF] has suggested that credible central banks may have a precautionary demand for expansions, i.e., would rather have a positive than a negative output gap given a particular inflation level. On the other hand, [START_REF] Goodhart | Central Bankers and Uncertainty[END_REF] has argued that central banks with a need to build credibility may have a precautionary demand for price stability, i.e., would rather have inflation below than above the target, everything else equal.

Although discrimination between symmetry and asymmetry would clearly improve the knowledge about the preferences of monetary policymakers, examples of formal loss-function asymmetry tests do not abound in the literature. Most studies have tested for asymmetries in policy reaction functions, which, as reduced forms, are uninformative about the (structural) parameters of the loss function; while others have tested loss function asymmetry proper, but in the context of static or purely forwardlooking macro structures, which are not data consistent.

In this paper we relax the assumption of a symmetric quadratic policymaker loss function, allowing and testing for different coefficients across cyclical states of the economy, in a framework that encompasses the standard symmetric case. The baseline model consists of an aggregate demand-aggregate supply (AD-AS) macroeconomic structure and an Euler equation for optimal discretionary policy. The three equations are jointly estimated by the generalized method of moments (GMM), using the relevant cross-equation restrictions and the pre-defined policy targets. Among the estimates, we focus on the varying parameters of the loss function in order to conduct formal tests of asymmetry.

The evidence is based on a sample beginning in 1995:I, a date that we -based on the record of European macroeconomic and monetary integration -assume as the beginning of a well-defined (although not formally until 1999:I) monetary policy regime in the aggregate Euro Area. The aggregate Euro Area data -quarterly 1995:I-2005:II -is mostly from the last update of the European Central Bank's Area Wide Model Database (AWM12up5) available since August 2004 2 . Regarding the output gap, we use a quasi-real-time output gap, in contrast with the ex-post measures often used in monetary policy analysis, as an attempt to approach the real-time data available to policymakers at the time of policy decisions.

The main result is that there is statistically significant evidence that the Euro Area monetary policymaker has had a precautionary demand for price stability during 1995-2005. This seems consistent with the fact that during the main part of this period a crucial task for the Euro-Area monetary policymaker -first a notional policymaker ahead of the EMU, throughout 1995-1998, andthen the European Central Bank (ECB) proper, starting in 1999 -has been to establish its (anti-inflationary) credibility.

The rest of the paper is outlined as follows: In section 2 we briefly review the literature and recent empirical results on asymmetries of monetary policy preferences; then, in section 3, we present our model and econometric strategy; section 4 describes the data and discusses the empirical results, and section 5 shows some sensitivity checks; finally, section 6 offers some concluding remarks.

The case for Asymmetric Monetary Policymaker's Preferences

In this section we review the recent literature and main empirical results on asymmetric loss functions, and present the specific motivations for testing this asymmetry regarding the Euro Area policymaker.

Conventionally, policymakers' preferences have been modeled with symmetric quadratic loss functions, in which the same weights are attached to equally sized positive and negative deviations of the goal variables from their targets. Motivations for this assumption include plausibility, analytical tractability and clearness of the results.

Yet, the hypothesis that the preferences of monetary policymakers may be asymmetric has received a lot of interest in two currents of the literature.

In the first current, [START_REF] Cukierman | The Inflation Bias Result Revisited[END_REF][START_REF] Cukierman | Are Contemporary Central Banks Transparent about Economic Models and Objectives and What Difference Does It Make?[END_REF] has argued that even though central bankers dislike deviations of inflation from the target as well as negative output gaps, for a given level of inflation they do not have interest in offsetting positive output gaps. 2 We thank Elvira Rosati, of the ECB, for providing this latest version of the AWMD. The claim is that the political establishment is sensitive to the social costs of recessions, and that in democratic societies even independent and accountable central banks are not completely insensitive to social and political pressures. This hypothesis has practical appeal in as much as it seems consistent with many insiders' descriptions of policy, such as Blinder's (1998, p. 19-20) much cited: "In most situations the CB will take far more political heat when it tightens preemptively to avoid higher inflation than when it easies preemptively to avoid higher unemployment". Moreover, it has the theoretical appeal of offering an explanation for the inflationary bias in the monetary policy of the 1960s and 1970s that does not hinge on the Kydland-Prescott/Barro-Gordon (KP/BG) assumption that policymakers target output above its natural level. In fact, a policymaker with a loss function featuring Cukierman's asymmetry would tackle the uncertainty of policymaking choosing rather to err on the side of ease than on the side of tightening, i.e., it would have a precautionary demand for expansions -see [START_REF] Gerlach | Recession Aversion, Output and the Kydland-Prescott Barro-Gordon Model[END_REF] for a formal analysis, and Ruge-Murcia (2003a) and [START_REF] Cukierman | The Inflation Bias Revisited: Theory and Some International Evidence[END_REF] for reduced-form tests of this hypothesis applied, respectively, to the US and 21 OECD countries.

In the second current of the literature, [START_REF] Goodhart | Central Bankers and Uncertainty[END_REF] has remarked that a policymaker trying to establish its credibility as an inflation fighter would react to uncertainty preferring negative rather than positive deviations from the inflation target.

In this case, the policymaker would have a precautionary demand for price stability, from which a deflationary bias would arise. This type of bias that had been mentioned before by [START_REF] Fischer | Modern Central Banking[END_REF] in the context of the creation of a new commitment to low inflation by developed countries during the 1980s. In such contexts of credibility buildup, the hypothesis of precautionary demand for price stability seems plausible, and could improve the quadratic functions as a description of the preferences of policymakers -see Ruge-Murcia (2003b) for an indirect test of this hypothesis for Sweden, Canada and the UK. [START_REF] Goodhart | Central Bankers and Uncertainty[END_REF] notes that, as inflation is typically a procyclical variable, this precautionary demand for price stability may offset Cukierman's precautionary demand for expansions.

Given these two conflicting hypothesis about the nature of the possible asymmetry in central banks' preferences, several researchers undertook the approach of testing for asymmetry encompassing both precautionary demands -for expansions and for price stability. Most of this research has focused on the estimation of non-linear policy reaction functions (for a variety of samples and with a variety of non-linear specifications) exploiting the well-known result that if an asymmetry in central bank preferences exists, then the optimal policy rule is non-linear -see [START_REF] Bec | Asymmetries in Monetary Policy Reaction Function: Evidence for US, French and German Central Banks[END_REF], [START_REF] Kim | Nonlinearity in the Fed's Monetary Policy Rule[END_REF], [START_REF] Cukierman | Do Central Banks have Precautionary Demands for Expansions and for Price Stability?[END_REF], [START_REF] Martin | Modelling Monetary Policy: Inflation Targeting in Practice[END_REF], [START_REF] Karagedikli | Do Inflation Targeting Central Banks Behave Asymmetrically? Evidence from Australia and New Zealand[END_REF][START_REF] Karagedikli | Do Inflation Targeting Central Banks Behave Asymmetrically? Evidence from Australia and New Zealand[END_REF][START_REF] Bruinshoofd | Nonlinear monetary policy in Europe: fact or myth?[END_REF][START_REF] Bruinshoofd | Nonlinear monetary policy in Europe: fact or myth?[END_REF].

However, evidence of non-linearity in policy reaction functions may be ultimately uninformative about the asymmetry of the policymaker's loss function. The reason is that policy reaction coefficients, as complex convolutions of the structural parameters, do not reveal the policymaker's preferences. Dealing with this issue requires the specification of a structural model of the economy so as to uncover the coefficients of the policymaker's loss function.

Examples of this structural approach are much more scarce, however, and seem limited to [START_REF] Dolado | Non-Linear Monetary Policy Rules: Some New Evidence for the US[END_REF] and [START_REF] Surico | Asymmetric Reaction Functions for the Euro Area[END_REF][START_REF] Surico | Inflation Targeting and Nonlinear Policy Rules: the Case of Asymmetric Preferences[END_REF]. [START_REF] Dolado | Non-Linear Monetary Policy Rules: Some New Evidence for the US[END_REF] have shown that an asymmetric loss function of the linex functional form and a macroeconomic structure of the Rudebusch-Svensson type (Rudebusch andSvensson, 1999, 2002) generate an optimal policy reaction function that includes the conditional variance of inflation in addition to the standard reaction function regressors. With this setup, they found evidence of precautionary demand for price stability in the US only after 1983. [START_REF] Surico | Asymmetric Reaction Functions for the Euro Area[END_REF][START_REF] Surico | Inflation Targeting and Nonlinear Policy Rules: the Case of Asymmetric Preferences[END_REF] shows that the analytical solution of the policymaker optimization problem with a loss function with linex forms in both inflation and the gap, under a forward-looking AD-AS structure, results in an interest rate rule that includes the square of the output gap and of inflation deviations from target, and devised tests on its coefficients that allow for inference on the loss function non-linearity. While [START_REF] Surico | Asymmetric Reaction Functions for the Euro Area[END_REF] finds that monthly Euro Area data for 1997:7-2002:10 reveals a precautionary demand for expansions, [START_REF] Surico | Inflation Targeting and Nonlinear Policy Rules: the Case of Asymmetric Preferences[END_REF] finds a precautionary demand for expansions in the US monetary policy before 1979 and no sign of any asymmetry thereafter.

Both these studies seem to have some drawbacks, however. [START_REF] Dolado | Non-Linear Monetary Policy Rules: Some New Evidence for the US[END_REF] have to restrict their policymaker loss function to a regime of strict inflation targeting and thus are not able to test for Cukierman's asymmetry. Moreover, their econometric strategy is not a truly simultaneous estimation of the macro system, as the conditional variance of inflation included in the optimal policy reaction function is generated in a first step prior to the rule estimation. In turn, [START_REF] Surico | Asymmetric Reaction Functions for the Euro Area[END_REF][START_REF] Surico | Inflation Targeting and Nonlinear Policy Rules: the Case of Asymmetric Preferences[END_REF] While the literature of formal analysis of central bank preferences' asymmetry, just briefly reviewed, exposes the need for methodological contributions, it also reveals that the Euro Area case has barely been studied to date -the only exception being [START_REF] Surico | Asymmetric Reaction Functions for the Euro Area[END_REF]. Yet, there are at least two compelling motivations for a study of the possible asymmetry in the preferences of the aggregate Euro Area monetary policymaker.

The first motivation is the ECB's own definition of price stability as "a year on year increase in the Harmonised Index of Consumer Prices for the Euro Area below 2 percent" (ECB, 2004, p.50), further clarified in the May 2003 statement that the ECB "aims to maintain inflation rates below but close to 2 percent over the medium term" (ECB, 2004, p. 51). This can be interpreted as an indication of asymmetric preferences, in the sense that 2 percent annual inflation is the ceiling consistent with price stability, with negative deviations from that limit preferred to positive deviations.

Second, the fact that the ECB has been created very recently may offer good substance for a case-study. In fact, the study of a new policymaker of a new monetary area is an exceptional opportunity to assess the plausibility of Goodhart's hypothesis that central banks engaged in the establishment of its credibility are prone to have a precautionary demand for price stability. From this point of view, [START_REF] Surico | Asymmetric Reaction Functions for the Euro Area[END_REF] evidence of a precautionary demand for expansions by the Euro Area policymaker between 1997 and 2002 is quite surprising.

We contribute to this literature with new evidence of the revealed preferences of the Euro-Area monetary policymaker. In view of the small-sample econometric difficulties in testing for varying policymaker's preference parameters with quarterly data starting in 1999, we stretch our sample back to 1995, thus adding a period of a notional Euro-Area policymaker ahead of the EMU (1995EMU ( -1998) ) to the period of actual ECB policymaking (1999)(2000)(2001)(2002)(2003)(2004)(2005). The extension of the estimation period back to 1995 is grounded on [START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF] analysis that within the time span between the EMU Treaty (1992) and the actual monetary union, the evidence points to a welldefined aggregate monetary policy regime since 1995. 3 Yet, in section 5 below we inspect the sensitivity of the results to deviations from this sample period, including a shorter sample closer to the formal ECB era. 3 In addition to reviewing the main European integration facts and the literature on the convergence of cycles in the EMU countries, [START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF] present econometric evidence of structural stability of an aggregate Euro-Area AS-AD system and of an aggregate policymaker's loss function coefficients since 1995. The evidence is extracted using a framework that allows for testing the relevant asymmetries in the central bank loss function, given a data-consistent macroeconomic structure. The basis is [START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF] GMM simultaneous estimation of an AS-AD macroeconomic structure with the policymaker's Euler equation, which is modified to allow for non-linearities in the Euler equation. Such non-linearities are clearly identified with asymmetries in the policymaker's loss function. In doing so, we are able to identify and, thus, retrieve the coefficients of the policymaker's preferences and of the macroeconomic structure (assumed to be linear). In addition to discriminating between precautionary demand for expansions and precautionary demand for price stability, the framework may also detect asymmetry in interest rate smoothing. This third type of asymmetry in preferences, although unexamined to date, is implicit in [START_REF] Goodhart | Why Do the Monetary Authorities Smooth Interest Rates?[END_REF] contention that because interest rate increases are normally seen as bad news while decreases are seen as good news, central bankers may tend to decrease rates smoothly and to increase them less frequently and in larger increments.

A framework for testing for asymmetries in the preferences of the monetary policymaker

This section presents the model and the econometric strategy for testing for asymmetries in the policymaker's preferences.

The model consists of an aggregate supply-aggregate demand (AS-AD) macroeconomic structure and a loss function describing the policy-maker's preferences.

In view of the generally recognized data-inconsistency of the dynamics of purely forward-looking specifications (documented by [START_REF] Estrella | Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational Expectations Models[END_REF], for example) and considering the difficulties in identifying and estimating hybrid specifications with a small sample, we assume a simple AS-AD system of the Rudebusch andSvensson (1999, 2002) class. Versions of this type of macroeconomic structure have been profusely used in recent studies of monetary policy, including, for European countries, [START_REF] Taylor | The Robustness and Efficiency of Monetary Policy Rules as Guidelines for Interest Rate setting by the European Central Bank[END_REF] and [START_REF] Dolado | Are Monetary Policy Reaction Functions Asymmetric? The Role of Nonlinearity in the Phillips Curve[END_REF]. According to Rudebusch and Svensson (2002, pp. 421-422), their dynamic backward-looking AS-AD model is motivated by its "…congruence with actual central bank models, and empirical fit to the data." and it "…also appears to roughly capture the views about the dynamics of the economy held by many monetary policymakers."

We adopt the following version of the Rudebusch-Svensson model identified empirically with Euro-Area data by [START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF]:

F o r P e e r R e v i e w + + + + + + = + + + + = . ) 1 ( ) ( 1 9 8 4 7 6 5 3 7 2 6 1 5 3 3 4 3 3 2 2 1 1 AS t t t t t t t t AD t t t t t t t I c y c c c c c c c i c y c y c y c y (1)
The first equation -the aggregate demand (AD) -links the output gap, y, to its past and to the real interest rate, i-. The second equation -the aggregate supply (AS)relates inflation, , to its lags, to the output gap, and to the lagged difference between imported and domestic inflation, I . The innovations [  ]

2 1 2 2 0 ) ( *) ( 2 1 + + + + = + + µ t t t t t i i i y E Min t (2) subject to system (1), t .
Asymmetry in the policymaker's preferences means that the structural weights , , and µ depend on the appropriate state of the economy. Restricting these functions to simple threshold (bilinear) models, the types of asymmetric preferences suggested in the literature may be written as follows, reflecting (i) [START_REF] Cukierman | The Inflation Bias Result Revisited[END_REF] precautionary demand for expansions, (ii) [START_REF] Goodhart | Central Bankers and Uncertainty[END_REF] precautionary demand for price stability and (iii) [START_REF] Goodhart | Why Do the Monetary Authorities Smooth Interest Rates?[END_REF] interest rate smoothing asymmetry:

[ ] [ ] 0 0 0 0 1 | 1 | < < + + + + × + × = t t t t y y y y [ ] [ ] * * * * 1 | 1 | < < + + + + × + × = t t t t [ ] [ ] 0 0 0 0 1 | 1 | < < + + + + × + × = µ µ µ t t t t i i i i (3) where [ ] .
1 is a Heaviside function that equals one if the argument-condition holds and zero otherwise. Under (3), the loss function turns into a threshold quadratic function in which the weights associated with the squared deviations of each goal-variable from its desired level are allowed to switch when each goal-variable is expected to be above or below its desired level. The modified policymaker's optimization problem is, then, , and interest rates are changed -at moment t -more (less) aggressively when the expected output gap -at moment t+ -is negative (positive), for the same size of deviation from zero. This specification encompasses the symmetric case, in which the weights , , and µ, are constant. In addition, it is flexible enough to allow for testing asymmetry of the loss function weights simultaneously or individually, thus permitting a clarification of the origin of the possible asymmetry. The choice of a bilinear model is aimed at keeping the loss function and the corresponding Euler equation as simple as possible; this seems reasonable in view of the limited data and of the lack of a-priori information about the functional form of the possible asymmetry. 4The Euler equation for this problem is the following expression describing the optimal path for the policy instrument, i¸as function of the expected values of the state variables of the economy, and y: Because of the persistence in the AS-AD system, the Euler equation has an infinite horizon, and thus cannot be used directly in empirical work. With this regard, we adopt the approach devised by [START_REF] Favero | Macroeconomic Stability and the Preferences of the Fed: A Formal Analysis, 1961-98[END_REF], and truncate expression (5) at 4 quarters ahead. This horizon seems realistic, in view of the ability of forecasting macroeconomic conditions by actual policymakers -see [START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF] for further discussions and sensitivity analysis. The specification proceeds with the expansion of the partial derivatives in (5) as functions of the relevant AS-AD coefficients in (1), in order to include the cross-equation restrictions that ensure that the minimization of the policymaker's loss function is subject to the constraints given by the structure of the economy. The resulting expression, supplemented with an innovation for estimation purposes, is Simultaneous estimation of the system of 3 equations composed of the AS-AD system (1) and the Euler equation ( 6), delivers the parameters describing the monetary policy regime and the AS-AD coefficients. Because expectations of future inflation, output gaps and interest rates are not available in the data, they are replaced by actual observations and, therefore, GMM are the appropriate estimators, assuming that the policymaker's expectations errors are not correlated with the information available at the time of expectations formation. As regards the instrument set to form the orthogonality conditions, we follow [START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF] and use the second, third and fourth lags of all the system's variables as instruments, and base inference in a heteroskedasticity and auto-correlation-consistent variance-covariance matrix. The inflation rate is 100 times the difference of the log of quarterly GDP deflator to the same quarter in the previous year. It could be argued that, to agree with the ECB's definition of price stability, the annualized inflation rate should be computed from the harmonized index of consumer prices (HICP), instead of our choice of the GDP deflator. But, because must relate closely to both the policy decisions and, in the AS equation, to the output gap, the growth of the GDP deflator is more adequate than the HICP. 5 In any case, the sample average of , 1.923 percent, is identical to the average of the analogous rate of growth of the HICP, and the volatility of HICP inflation is only slightly below that of . The nominal short-term interest rate is the quarterly average of the 3-month interest rate Euribor, in percentage points. The proxy for exogenous supply shocks is the lagged difference between imported and domestic inflation, with imported inflation computed as 100 times the annual difference of the log of the Area's imports deflator.

[ ] [ ] ( ) [ [ ] [ ] ( ) [ ] [ ] ( ) ] 2 1 0 0 0 0 2 0 0 0 0 2 * * * * 0 ) ( 1 | 1 | ) ( 1 | 1 | *) ( 1 | 1 | 2 1 + + < < + < < + < < = × + × + × + × + × + × + + + + + + + + + + + + µ µ t t i i i i t y
F o r P e e r R e v i e w 10 [ ] [ ] ( ) [ ] [ ] ( ) [ ] [ ] ( ) [ ] [ ] ( ) . 0 ) ( 1 | 1 | ) ( 1 | 1 | 1 | 1 | *) ( 1 | 1 | 1 0 0 0 0 1 0 0 0 0 0 0 0 0 0 * * * * 0 = × + × × + × + × + × + × + × + < < < < + + < < = + + < < = + + + + + + + + + + + + + + + + t t t i i i i t t i i i i t t t
[ ] [ ] ( ) ( ) [ ] [ ] ( ) ( ) [ ] [ ] ( ) [ ] [ ] ( ) ( ) [ ] [ ] ( ) [ ] [ ] ( ) . 0 ) ( 1 | 1 | ) ( 1 | 1 | 1 | 1 | 1 | 1 | *) ( 1 | 1 | *) ( 1 | 1 | 1 0 0 0 0 1 0 0 0
= + × + × × + × + × + × + × + × + + × + × + × + × + < < < < + < < + < < + <
The output gap, in percentage points, is the log difference between real GDP and a stochastic trend.

The output gap has been estimated by the authors from a univariate unobservable components model of log real output, specifically a local linear trend model augmented with an autoregressive cycle. As the maximum likelihood estimate of the variance of the innovation to the stochastic drift in the trend is biased towards zero, we employ Stock and Watson's (1998) procedure to obtain a median unbiased estimation of this variance, and then constrain the kalman filter estimation of the trend-cycle model accordingly. 6 The output gap time-series is not given by the end-of-sample kalman smoother, but rather the updated one-step-ahead forecasts given directly by the kalman filter (see [START_REF] Harvey | Forecasting, Structural Time Series Models and the Kalman Filter[END_REF]). This quasi real-time estimate, in comparison with the two-sided output gaps that have been used in the tests for asymmetry of policy preferences in previous literature, is conceptually closer to the information available to policymakers at the time of policy decisions. 7 The framework for testing loss function asymmetry requires a pre-defined inflation target, *. In view of the definition of price stability by the ECB, reviewed above, a value of 2 percent for * is a consensual choice; this target has also been used, in the related literature, by [START_REF] Dolado | Are Monetary Policy Reaction Functions Asymmetric? The Role of Nonlinearity in the Phillips Curve[END_REF] and by [START_REF] Surico | Asymmetric Reaction Functions for the Euro Area[END_REF].

Figure 1 shows, for the sample period, the data on the relevant arguments in the policymaker's loss function, together with the corresponding desired values, which are the threshold levels in the asymmetry tests -0 for y and i, and 2 for .

Table 1 summarizes the tests for each asymmetry -precautionary demand for expansions, precautionary demand for price stability and asymmetric interest rate smoothing -as well as the joint tests of these three type of asymmetries. In order to focus the analysis, we report only the loss function coefficients, and the corresponding 6 Notice that the output gap is estimated with the whole available time-series of real output, 1970:I-2005:II, even though only gaps for 1995:I-2005:II are used in the subsequent estimations in the paper. All data and replication files are available from the authors upon request, including the Gauss codes for computing the output gap. 7 Our concept of quasi-real time output gap differs slightly from [START_REF] Orphanides | The Unreliability of Output-Gap Estimates in Real Time[END_REF] homonym concept, in that even though the kalman filter's one-step-ahead forecasts of trend output are computed from past data of output only, the filter uses the estimates for the UC model hyper-parameters that have been estimated using the whole sample. Moreover, the evidence indicates that the output gap, y, is not a relevant argument in the Euro Area's policymaker loss function, as is statistically insignificant not only when some source of loss function asymmetry is allowed for, but also (results not reported) when the loss function is of the standard quadratic form.

When, in accordance with this evidence, regimes of strict inflation targeting are adopted -restricting =0 -there is evidence in favor of the hypothesis of precautionary demand for price stability. In fact, the hypothesis that are unchanged when the asymmetry regarding the objective of price stability is combined with interest rate smoothing asymmetry (last line of table 1), and the p-value of the test for the hypothesis of precautionary demand for price stability is still at 1 percent. Regarding interest rate smoothing itself, there is no evidence in favor of this type of asymmetry throughout the entire table 1, as the hypothesis that

0 0 | | < + + = µ µ t t i i
is never rejected at conventional significance levels.

In short, during 1995:I-2005:II the policy actions of the Euro Area monetary policymaker reveal a regime of strict inflation targeting with interest rate smoothing and a precautionary demand for price stability. 8 In contrast with [START_REF] Surico | Asymmetric Reaction Functions for the Euro Area[END_REF] inference of a precautionary demand for expansions, this revealed asymmetry is consistent with the ECB's definition of price stability and with the priority of credibility-building by a recently created monetary authority. 9 8 The asymmetry tests results have proven to be robust to a cross-check (not reported here) consisting of testing for asymmetry in each loss function coefficient using as threshold variable all possible alternative target-variables in the loss function. 9 The disparity between our results and Surico's -which is beyond the scope of this paper to scrutinizecould result from differences in the model as well as in data: [START_REF] Surico | Asymmetric Reaction Functions for the Euro Area[END_REF] uses a different sample and Table 2 presents complete estimates of the selected model, in the upper panel, together with those of the parallel model with standard quadratic policy preferences, in the lower panel. The case of flexible inflation targeting -not restricted to 0 -has not been selected because of the insignificance of found above (also found by [START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF], with an alternative measure of the output gap).

The 1.837 percent inflation target estimated in the symmetric model, with a 95 percent confidence interval of [1.75, 1.92], is consistent with the downward bias relative to 2 percent in the asymmetric preferences model. The results in the table also suggest that the asymmetry in the loss function does not influence the AS-AD coefficients, which are estimated with the expected signs, reasonable magnitudes and good precision, and are remarkably similar across the two specifications (symmetric and asymmetric) of policy-maker's preferences. The converse remains to be assessed -if different AS-AD specifications interfere with the asymmetry of the loss function. This is one of the sensitivity checks to be conducted next.

Sensitivity checks

This section reports some sensitivity exercises to which we have submitted the results, concerning (i) the beginning date of the sample; (ii) the truncation of the Euler equation;

(iii) exclusion of interest rate smoothing from the central bank's loss function; (iv) an alternative output gap; and (v) variants of the AS-AD structure.

Sensitivity to the date of emergence of the monetary policy regime

In view of the non-institutional basis for identification, by [START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF], of 1995:I as the beginning date of the Euro Area notional policy regime, we now check the sensitivity of the tests for asymmetry to changes in the start of the sample period.

Table 3 shows, for selected samples beginning at 1996:I, 1997:I and 1998:I, the results of the tests of the hypothesis of precautionary demand for price stability (results regarding the significance of the output gap, not reported for space conservation, are entirely consistent with those in Table 1). The check does not proceed after 1998:I due to the reduced number of observations. Yet, from the 30 observations in this last sample only the first 4 are pre-EMU quarters, so that the results may be considered an approximation to a test of asymmetric policy preferences in the EMU. Overall, the estimates of the weights attached by the policy-maker to positive and negative deviations of inflation from 2 percent are remarkably consistent with those obtained from the full sample, and the hypothesis of no precautionary demand for price stability can be rejected at standard confidence levels.

Sensitivity to truncation of Euler equation

Since the Euler equation used in estimation is a finite approximation to the infinite terms' equation ( 5), we now inspect the robustness of the asymmetry tests results to larger forecast horizons of the policy-maker.

Table 4 reports the results of the relevant tests -precautionary demand for price stability in strict inflation targeting regimes -for truncations at 5 and 6 quarters aheadi.e. =5, and =6 in equation ( 5). Even though policy-makers may possibly set interest rates reacting to output gaps and inflation forecasted up until more than one and a half years ahead, further extension of the Euler equation is problematic because of the number and nonlinear combinations of parameters involved [START_REF] Favero | Macroeconomic Stability and the Preferences of the Fed: A Formal Analysis, 1961-98[END_REF], which is particularly critical in the case of small samples.

Clearly, the table shows that the evidence in favour of a precautionary demand for price stability in the Euro Area, reported in table 1, is robust to expanding the policymaker's forecast horizon up to one and a half years. 10

Sensitivity to inflation targeting without interest rate smoothing

While the ex-ante inclusion of interest rate smoothing as a policy goal in the policymaker's loss function is standard in empirical studies, as it is needed for a suitable replication of the inertia observed in interest rates, it could be argued that this may be a result of the assumed macroeconomic structure rather than a policy objective by itself.

Hence, we now check whether the asymmetry tests results are sensitive to the exclusion of interest rate smoothing from the policymaker's loss function.

Table 5 reveals that under the restriction µ=0 there is still no evidence allowing for rejection of the null hypothesis of no precautionary demand for expansions, while, in contrast, the hypothesis of no precautionary demand for price stability is again rejected at standard confidence levels. Consistently with our previous results, the detection of asymmetric inflation preferences appears clearly in the regime of strict inflation targeting, which is favored by the data against the flexible inflation targeting regime. 10 Allowing also for asymmetry in the preferences regarding the output gap -results not reported for space conservation -does not change the statistical evidence in favour of a precautionary demand for price stability.

Sensitivity to an alternative measure of the Output Gap

As explained above, our output gap measure is the kalman filter estimate of a univariate structural time series model of log real output. We have labelled this gap a quasi-real time output gap, in the sense that it results from a one-sided univariate filter of real output (conditional on the whole sample estimates of the model hyper-parameters), and have argued that it may be closer to the actual information available to policy-makers when setting interest rates than the standard two-sided filters. We now check whether results would change substantially with a two-sided and perhaps more conventional measure of the output cycle -the deviation of log real output from its Hodrick-Prescott filter trend.

As Table 6 shows, the results are entirely consistent with the baseline results reported in Table 1. First, there is no evidence of asymmetry in the preferences for interest rate smoothing and no evidence of precautionary demand for expansions; second, there is evidence of precautionary demand for price stability at very low significance levels, irrespective of the restrictions that are imposed on the other arguments of the policy-maker's loss function. The estimates of the policy-maker's loss function weights on inflation rates above 2 percent range from 1.353 to 1.493 (weights on inflation rates below 2 percent range from 0.647 to 0.507), which is in line with the estimates of table 1.

Sensitivity to variants of the AS-AD structure

The aggregate demand-aggregate supply structure (1) has been identified empirically, with Euro Area data including a quasi-real time output gap, starting out from the Rudebusch andSvensson (1999, 2002) model of the US economy. Although rooted in this benchmark, system (1) deviates from it in two main features. First, in the AS equation, inflation is explained by contemporaneous rather than lagged output gap.

Second, in the AD equation, the output gap is explained by a third lag of the real interest rate, rather than a real rate computed as its average during the previous four quarters.

We now check if results of the asymmetry tests are robust to alternative lagstructures of the AD and AS equations. 11 Specifically, we vary the lag of the real 11 Our framework would also allow for a joint test of the hypothesis of asymmetry in the policy-maker's preferences and of nonlinearity in the aggregate-supply equation. However, succeeding in such an econometric task with GMM estimation requires far more data than is currently available for meaningful analysis of aggregate Euro-Area policy-making, and thus we defer such exercise for future research. Table 7 confirms that there is no evidence of asymmetry between interest rate increases and declines. In what regards deviations of output from its trend, there is also no statistical evidence of asymmetry, neither precautionary demand for expansions nor contractions.

The table shows that the estimates of the policy-maker's loss function weights on positive deviations of inflation from the target are always larger than the weights on negative deviations, consistently with the results in the baseline model. These weights range, respectively, from 1.322 to 1.718, and from 0.678 to 0.282. Across the eight alternative AS-AD systems, there is always 1-percent significant evidence of precautionary demand for price stability, so long as the loss function is specified as a strict inflation targeting regime. When the policy-maker's preferences are allowed to include directly an output stabilisation objective, the evidence of precautionary demand for price stability remains 10-percent significant in six out of the eight alternative systems, and in all cases the estimates of the inflation weights hardly change.

Concluding Remarks

This paper has tested for asymmetries in the preferences of the aggregate Euro Area monetary policymaker, looking at deviations from the standard quadratic loss function that have been suggested in recent literature -precautionary demand for expansions, precautionary demand for price stability, and interest rate smoothing asymmetry.

The results obtained reject flexible inflation targeting in favor of strict inflation targeting, which corroborates previous evidence that we have obtained under symmetry.

As to the specific purpose of this paper, there is evidence that the Euro-Area monetary policymaker has revealed a precautionary demand for price stability throughout 1995-2005, weighting deviations of inflation above 2 percent twice as much as deviations below 2 percent. This type of asymmetry is consistent with the ECB's definition of price stability and with the priority of credibility-building by a recently created monetary authority.

The evidence of precautionary demand for price stability has proved to be robust to several variations in the empirical framework. This type of asymmetry persists under

  zero expected value. The AS equation is a version of the well known Gordon's Phillips relation, the triangle model of inflation explaining price dynamics with three basic elements -expectations and inertia, demand pressure and supply shocks. Dynamic homogeneity is imposed on the coefficients on lagged inflation, as the data does not reject that hypothesis in unconstrained estimation, with the advantage of reducing the number of coefficients to estimate and of complying with the natural rate hypothesis. As argued in more detail in[START_REF] Aguiar | The Preferences of the Euro Area Monetary Policymaker[END_REF], this model implies a dynamic behavior of the economy and a transmission of monetary policy consistent with the evidence in several studies of the aggregate Euro Area.Following standard assumptions in the empirical literature of monetary policy, the policymaker's preferences are modeled as an inter-temporal loss functional in which, at each period, the loss function depends on the square of the deviations of inflation and the output gap from desired levels ( * and zero, respectively) as well as on the square of the change in the interest rate (reflecting interest rate smoothing). Future values are discounted at rate , and the weights , , and µ are nonnegative. Assuming a discretionary policy regime, for the sake of realism and estimation feasibility, the optimization problem solved by the central banker is a closed-loop system. At each period, given the observed state of the economy, the policymaker chooses the value for the policy control variable -the interest rate i -that minimizes the loss functional, subject to the dynamic structure of the economy,

  In order to cover the three types of asymmetry in the policymaker's preferences identified in the literature, estimation is carried out sequentially allowing each of the loss function weights , , and µ to vary with the state of the corresponding target variable, and then concludes with a joint test. Statistical inference is based on individual significance tests and Wald tests of the null hypothesis of no asymmetry. In agreement with standard practice in the literature, the weight is restricted to =1 when not asymmetric; likewise, when is allowed to be asymmetric, the sum : the case of the Euro AreaIn this section we first describe the data and, then, conduct the tests for asymmetry in the monetary policymaker's loss function and assess the results, including a comparison of the asymmetric preferences results with those of a standard quadratic central bank loss function. All data series are quarterly time-series for 1995:I-2005:II for the aggregate Euro Area. The source is the ECB, except for the output gap, which has been computed by the authors as described below. For 1995:I-2003:IV, the figures are those of the latest update of the ECB's Area Wide Model Database (AWM12up5, available since September 2004), while for 2004:I-2005:II consistent updates have been obtained from the latest ECB's monthly bulletin.

  even though these have been obtained in a joint GMM estimation of the AS-AD-Euler system, as discussed in section 3, above.The table shows no sign of precautionary demand for expansions, at conventional significance levels, irrespectively of modeling this type of asymmetry individually or jointly.

  634, mean that the monetary policymaker has weighted positive deviations of inflation from the target twice as much as negative deviations.

  periodicity(monthly data 1997:7-2002:10), a different computation of the output gap (two-sided Hodrick-Prescott-filter of industrial production) and a different structural macro model (purely forward-looking AS-AD model without any policy lags).

  the AD equation from one through four quarters, and the lag of the output gap from zero to one quarter, thus encompassing the whole range of lags of the Rudebusch-Svensson structure. Results are summed-up in table 7, including the[START_REF] Rudebusch | Policy Rules for Inflation Targeting[END_REF] US-economy specification in the last four lines.

  Hodrick-Prescott filter based) measure of the output gap, and under variants of the aggregate demand-aggregate supply structure of the Rudebusch-Svensson class, including the system specified by these authors for the US economy.Moreover, the evidence of precautionary demand for price stability holds out in samples beginning as late as 1998:I, which is very close to the EMU years. Yet, this evidence should be put to the test once enough new data allow for the estimation of strictly post-1999 monetary policy preferences with acceptable degrees of freedom.Future empirical research on the Euro Area case, when enough data on the Area policy regime and macro structure becomes available, should also test simultaneously for asymmetries in the policy-maker's preferences and for nonlinearity of the AS relation, and experiment with hybrid forward and backward-looking AS-AD equations to model the macro structure of the Area.

  Figure 1. Loss Function Variables Euro Area 1995:I-2005:II

Table 1 . Tests for Asymmetries in the Preferences of the Monetary Policymaker Euro Area 1995:I -2005:II

 1 The test statistics in the last three columns are Wald statistics for the indicated null hypothesis.

	Notes: -Joint estimation by GMM of system (1) and equation (6) with the appropriate restrictions, with * = 2 and = 0.975 (AS-AD coefficients not shown);
	-GMM estimation with one-step weighting matrix, fully iterated parameters, HAC variance-covariance matrix, Bartlett kernel, Andrews bandwidth;
	-Instruments: constant, t-i , y t-i , i t-i , I t-i , i=2, 3, 4;
	-

Table 2 . Macroeconomic Structure and Asymmetric vs Symmetric Policymaker's Preferences Euro Area 1995:I -2005:II

 2

	Notes: -Upper panel: joint estimation by GMM of system (1) and equation (6) with =0, µ constant,
	* = 2 and = 0.975; -Lower panel: joint estimation by GMM of system (1) and equation (6) with =0, and µ
	constant and = 0.975;
	-GMM estimation with one-step weighting matrix, fully iterated parameters, HAC variance-
	covariance matrix, Bartlett kernel, Andrews bandwidth;
	-Instruments: constant, t-i , y t-i , i t-i , I t-i , i=2, 3, 4;
	-P-values in parenthesis.

Table 3 . Sensitivity to Beginning Date of the Notional Monetary Policy Regime in the Euro Area

 3

	Notes: -Joint estimation by GMM of system (1) and equation (6) with the appropriate restrictions, with
	* = 2 and = 0.975 (AS-AD coefficients not shown);
	-GMM estimation with one-step weighting matrix, fully iterated parameters, HAC variance-
	covariance matrix, Bartlett kernel, Andrews bandwidth;
	-Instruments: constant, t-i , y t-i , i t-i , I t-i , i=2, 3, 4;
	-The test statistics in the last two columns are Wald statistics (and p-values) for the indicated null
	hypothesis.

Table 4 . Sensitivity to Longer Horizons in the Euler equation Euro Area 1995:I -2005:II

 4

			Parameter Estimates		Test Statistics
				(P-values)			(P-values)
		| 2	| < 2	µ	µ| i 0	µ| i < 0	| 2 = | <2	µ| i 0 = µ| i<0
	Asymmetry in Inflation
	Targeting
	=5	1.420	0.580	0.003			14.951
		(0.000)	(0.000)	(0.001)			(0.000)
	=6	1.512	0.488	0.001			7.508
		(0.000)	(0.010)	(0.105)			(0.006)
	Asymmetry in Inflation
	Targeting and in
	Interest Rate Smoothing
	=5	1.439	0.561		0.005	0.002	10.272	0.754
		(0.000)	(0.000)		(0.048)	(0.046)	(0.001)	(0.385)
	=6	1.512	0.488		0.002	0.001	5.166	0.158
		(0.000)	(0.030)		(0.463)	(0.522)	(0.023)	(0.692)

Notes: -See notes to table 3.

Page 27 of 29 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript F o r P e e r R e v i e w Table 5. Sensitivity to Policymakers' Loss Function without Interest Rate Smoothing Euro Area 1995:I -2005:II

		| 2	| < 2		| y < 0
	Asymmetry in Inflation	1.454	0.546
	Targeting	(0.000)	(0.000)
		1.292	0.708	-0.119		2.452
		(0.000)	(0.000)	(0.070)		(0.117)
	Asymmetry in Output Gap	1.0		-0.097	-0.201		0.927
	Targeting			(0.462)	(0.015)		(0.336)
				0.000	0.000
				(0.139)	(0.146)		(0.136)
	Asymmetry in Inflation	1.397	0.603	-0.216	-0.105	3.225
	and Output Gap	(0.000)	(0.006)	(0.174)	(0.075)	(0.073)	(0.421)
	Targeting

Notes: -See notes to table 3.

Table 6 . Sensitivity to Hodrick-Prescott filter Output Gap Euro Area 1995:I -2005:II

 6

	Page 29 of 29			Submitted Manuscript
				Parameter Estimates					Test Statistics
				(P-values)						(P-values)
		| 2	| < 2	| y 0	| y < 0	µ	µ| i 0	µ| i < 0	| 2 = | <2	| y 0 = | y<0	µ| i 0 = µ| i<0
	Asymmetry in Output Gap	1.0		0.005	-0.028	0.001				1.847
	Targeting			(0.426)	(0.199)	(0.000)				(0.174)
	Asymmetry in Inflation	1.430	0.570	-0.012		0.001			19.237
	Targeting	(0.000)	(0.000)	(0.211)		(0.000)			(0.000)
		1.463	0.537			0.001			24.862
		(0.000)	(0.000)			(0.002)			(0.000)
	Asymmetry in Interest	1.0		-0.007			0.001	0.001			0.205
	Rate Smoothing			(0.5073)			(0.3866)	(0.005)			(0.650)
		1.0					0.001	0.001			0.011
							(0.231)	(0.056)			(0.915)
	Joint asymmetries	1.353	0.647	-0.004	-0.015		0.002	0.001	5.180	0.829	2.181
		(0.000)	(0.000)	(0.540)	(0.242)		(0.004)	(0.006)	(0.023)	(0.363)	(0.140)
		1.493	0.507				0.002	0.001	27.260		2.022
		(0.000)	(0.000)				(0.013)	(0.024)	(0.000)		(0.155)

Notes: -See notes to table 3.

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

Table 7 . Sensitivity to alternative lags in AS-AD structure Euro Area 1995:I -2005:II Notes

 7 : -Joint estimation by GMM of the indicated AS-AD system and the corresponding Euler equation, with appropriate restrictions, for alternative Loss asymmetry tests, given * = 2 and = 0.975; -The parenthesis in the first column (AS-AD), indicate the lag of the explanatory variable, ie AD(2) means that the AD includes a second lag of the real interest rate, AS(1) means that the AS has a one-quarter lagged output gap; -The loss function specifications indicated in the second column correspond to tests of the following asymmetries: (i) asymmetry in inflation targeting; (ii) asymmetry in inflation targeting and in interest rate smoothing (iii) asymmetry in inflation targeting and in output gap targeting; (iv) asymmetry in inflation targeting, in output gap targeting and in interest rate smoothing; (i) and (ii) are regimes of strict inflation targeting with interest rate smoothing, while (iii) and (iv) are regimes of flexible inflation targeting with interest rate smoothing; -GMM estimation with one-step weighting matrix, fully iterated parameters, HAC variancecovariance matrix, Bartlett kernel, Andrews bandwidth; Instruments: constant,

t-i , y t-i , i t-i , I t-i i=2, 3, 4;

We thank Fabio Canova's comments and suggestions to an earlier version of this paper. The usual disclaimer applies.

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript

One functional form often used in the recent literature, the linex function -see[START_REF] Nobay | Optimal Discretionary Monetary Policy in a Model of Asymmetric Central Bank Preferences[END_REF] and Ruge-Murcia (2004) -behaves quite similarly to our threshold quadratic specification for realistic parameters, but results in a more complex Euler equation and could lead to empirical problems due to the limitations of the data sample.

This argument is, in fact, parallel to the reason that lies behind the standard use of a 3-month interest rate instead of a shorter money market rate, which would be closer to the actual policy instrument -the fact that i must, in this class of models, simultaneously play the role of policy instrument and connect closely to aggregate demand decisions.

* CEMPRE -Centro de Estudos Macroeconómicos e Previsão -is a research centre supported by the Fundação para a Ciência e a Tecnologia, Portugal, which is financed by European Union and Portuguese funds.