nep-ifn New Economics Papers
on International Finance
Issue of 2005‒01‒23
nine papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Meese-Rogoff Redux: Micro-Based Exchange Rate Forecasting By Martin D.D. Evans; Richard K. Lyons
  3. Exchange Rate Fundamentals and Order Flow (July 2004) By Martin D. D. Evans(Georgetown University and NBER) and Richard K. Lyons(U.C. Berkeley and NBER, Haas School of Business)
  4. A New Micro Model of Exchange Rate Dynamics (March 2004) By Martin D. D. Evans(Georgetown University and NBER) and Richard K. Lyons(U.C. Berkeley and NBER, Haas School of Business)
  5. How is Macro News Transmitted to Exchange Rates? (December 2003) By Martin D. D. Evans(Georgetown University and NBER) and Richard K. Lyons(U.C. Berkeley and NBER, Haas School of Business)
  6. What are the Origins of Foreign Exchange Movements? By Martin D. D. Evans(Georgetown University and NBER)
  7. Persistence and the Role of Exchange Rate and Interest Rate Inertia in Monetary Policy By 300
  8. Overcoming Fear of Floating: Exchange Rate Policies in Chile. By José De Gregorio; Andrea Tokman R.
  9. The Stock-Flow Approach to the Real Exchange Rate of CEE Transition Economies By Balazs Egert; Amina Lahreche-Revil; Kirsten Lommatzsch

  1. By: Martin D.D. Evans; Richard K. Lyons
    Abstract: This paper compares the true, ex-ante forecasting performance of a micro-based model against both a standard macro model and a random walk. In contrast to existing literature, which is focused on longer horizon forecasting, we examine forecasting over horizons from one day to one month (the one-month horizon being where micro and macro analysis begin to overlap). Over our 3-year forecasting sample, we find that the micro-based model consistently out-performs both the random walk and the macro model. Micro-based forecasts account for almost 16 per cent of the sample variance in monthly spot rate changes. These results provide a level of empirical validation as yet unattained by other models. Our result that the micro-based model out-performs the macro model does not imply that macro fundamentals will never explain exchange rates. Quite the contrary, our findings are in fact consistent with the view that the principal driver of exchange rates is standard macro fundamentals. In Evans and Lyons (2004b)we report firm evidence that the non-public information that we exploit here for forecasting exchange rates is also useful for forecasting macro fundamentals themselves.
    JEL: F3 F4 G1
    Date: 2005–01
  2. By: Somnath Chatterjee
    Abstract: This paper examines the causal relationship between euro and sterling swap spreads during the period January, 1999 to March, 2003. The absence of any correlation between changes in the two swap spreads would indicate that credit risk factors are country-specific. But euro swap spreads showed some correlation with the interest rate differentials between the two markets. Both spreads follow a GARCH process but sterling swap spreads reacted more intensely to market movements and were more volatile than their euro counterparts. There was evidence of mild volatility transmission from the sterling swap spreads to the euro swap spreads but the causality was one sided.
  3. By: Martin D. D. Evans(Georgetown University and NBER) and Richard K. Lyons(U.C. Berkeley and NBER, Haas School of Business) (Department of Economics, Georgetown University)
    Abstract: This paper addresses the striking ability of transaction flows to explain exchange rate movements. Specifically, we examine whether this arises because transaction flows convey incremental information about fundamentals. If so, then these flows should affect price upon their realization and observation by price setters (marketmakers). Our model is a simple general equilibrium model of information aggregation that provides---in a setting of incomplete markets---a utility-based present-value representation for exchange rates. The model produces testable implications for the relationships between realized transaction flows, current and future exchange rate returns, and future fundamentals (e.g., money supplies). We then bring these implications to the data, making use of a new dataset covering over six years of transactions (which permits estimation at the monthly frequency). We find strong contemporanous effects of transaction flows on exchange rates, corroborating past findings. More importantly, we present four key findings that are both new to the literature and supportive of our model: (1) transaction flows forecast (Granger cause) future macroeconomic variables such as money growth, output growth, and inflation, (2) transaction flows forecast future exchange rates changes, and do so more effectively than forward discounts, (3) the future exchange rate components that current flows forecast are primarily the future non-flow-driven components, and (4) though flows convey new information about future fundamentals, much of this information is still not impounded in the exchange rate 9 months later. The slow pace of learning implies that abstracting from information aggregation---as is standard in exchange rate economics---is not innocuous. Classification-JEL Codes:F3, F4, G1
    Keywords: Exchange Rate Dynamics, Microstructure, Order Flow.
  4. By: Martin D. D. Evans(Georgetown University and NBER) and Richard K. Lyons(U.C. Berkeley and NBER, Haas School of Business) (Department of Economics, Georgetown University)
    Abstract: We address the puzzle of what determines exchange rates by examining information aggregation in a dynamic general equilibrium (DGE) setting. Unlike other DGE macro models, which enrich either preference structures or production structures, our model enriches the information structure. The model departs from microstructure-style modeling by identifying real activities where dispersed information originates, as well as the technology by which information is subsequently aggregated and impounded. Results relevant to the determination puzzle include: (1) persistent gaps between exchange rates and fundamentals, (2) excess volatility relative to fundamentals, (3) exchange rate movements without macro news, (4) little or no exchange rate movement when macro news occurs, and (5) a structural rationale for why transaction flows perform well in accounting for monthly exchange rate changes, whereas macro variables perform poorly. Classification-JEL Codes:
    Keywords: Exchange Rates, Dispersed Information, General Equilibrium, Microstructure.
  5. By: Martin D. D. Evans(Georgetown University and NBER) and Richard K. Lyons(U.C. Berkeley and NBER, Haas School of Business) (Department of Economics, Georgetown University)
    Abstract: This paper tests whether macroeconomic news is transmitted to exchange rates via the transactions process and if so, what share occurs via transactions versus the traditional direct channel. We identify the link between order flow and macro news using a heteroskedasticity-based approach, a la Rigobon and Sack (2002). In both daily and intra-daily data, order flow varies considerably with macro news flow. At least half of the effect of macro news on exchange rates is transmitted via order flow. Classification-JEL Codes:
  6. By: Martin D. D. Evans(Georgetown University and NBER) (Department of Economics, Georgetown University)
    Abstract: This paper uses a new transactions data set on the inter bank foreign exchange market to examine the origins of spot exchange rate movements. The data provide a comprehensive picture of trading activity and allow me to examine the contribution of public news to spot rate dynamics over hours, days, and weeks. Contrary the presumption of macroeconomic exchange rates models, I find that public news only accounts for a fraction of exchange rate volatility over the whole frequency spectrum. In particular, I estimate that less that 50\% of the variance of spot rate changes at very high frequencies is attributable to public news. At daily and weekly frequencies, changes in the spot rate understate the effects of public news by 20 to 40 percent because the cumulative effects of independent public and private news exert offsetting effects. These findings suggest one reason for the poor performance of macroeconomic exchange rate models; namely their exclusive focus on public Classification-JEL Codes:
  7. By: 300
    Abstract: In a general equilibrium model, this paper investigates the importance of the exchange rate and the interpretation of the observed inertia in the policy interest rate. We derive an optimizing macroeconomic model that features habit formation in the consumer's utility function and uses a hybrid New Keynesian Phillips curve with inflation inertia. As a consequence, aggregate demand and supply shocks will have a persistent effect on output and inflation. In this framework, we assess the performance of simple, and perhaps non-optimal, interest rate rules under different degrees of habit formation and inflation persistence. We conclude that a policy rule that responds to expected inflation, as well as to output and the exchange rate, is able to reduce output and inflation volatility in the face of aggregate demand and foreign inflation shocks. This result must be interpreted with caution, because, as is found in other studies, i) the reduction in volatility is marginal and ii) the Taylor-type policy rule assessed here may be a restrictive one and, as mentioned before, non-optimal. On the other hand, the gains from adopting an inertial interest rate rule are directly related to the degree of inflation persistence in the model. In particular, when the degree of inflation persistence is high, an inertial policy rule attenuates the impacts that supply shocks have on inflation and the interest rate.
    Date: 2004–12
  8. By: José De Gregorio; Andrea Tokman R.
    Abstract: The paper reviews the exchange rate management experience in Chile, with particular emphasis on the floating exchange rate regime and its two forex intervention episodes. It presents evidence on Chile’s favorable conditions to face exchange rate shocks: a well-developed financial sector, that offers hedging opportunities taken up by the corporate sector to decrease its vulnerability through balance sheet effects; and a low and decreasing level of passthrough from the exchange rate to prices. These elements contribute to diminish the costs of the floating exchange rate regime, reducing its implied financial and price instability threat, and therefore avoiding fear of floating. Moreover, it provides enough credibility to the current exchange rate system, reinforcing the commitment to making interventions a rare event.
    Date: 2004–12
  9. By: Balazs Egert; Amina Lahreche-Revil; Kirsten Lommatzsch
    Abstract: This paper investigates the determinants of equilibrium real exchange rates for the new EU member states and candidate countries, relying on an asset model inspired by Aglietta et al. (1998) and Alberola et al. (1999, 2002). The impact of productivity gains on both the Balassa-Samuelson effect and the behaviour of the tradable real exchange rate is especially assessed. Subdividing the panel into sub-panels, we show that the B-S effect is a common feature to all economies, but that the tradable price-based real appreciation is a distinct feature of transition and emerging economies. We also show that in transition countries, a decrease in net foreign assets leads to an appreciation of the real exchange rate, instead of the depreciation predicted by theory. Comparing in-sample and out-of-sample estimates (in terms of the country coverage) of equilibrium exchange rates shows that these measures can yield different results, and could therefore be considered as complementary tools in judging misalignments.
    Keywords: real equilibrium exchange rate; EU enlargement; Balassa-Samuelson effect; productivity; net foreign assets; out-of sample panel
    JEL: C15 E31 F31 O11 P17
    Date: 2004–11

This nep-ifn issue is ©2005 by Yi-Nung Yang. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.