nep-ifn New Economics Papers
on International Finance
Issue of 2005‒04‒16
27 papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange Rate Volatilities and Time-varying Risk Premium in East Asia By Chae-Shick Chung; Doo Yong Yang
  2. Are Exchange Rates Really Random Walks? Some Evidence Robust to Parameter Instability By Barbara Rossi
  3. The Changing Role of the Yen/Dollar Exchange Rate for Japanese Monetary Policy By Gunther Schnabl; Christian Danne
  5. Budget and Current Account Deficits in SEACEN Countries: Evidence Based on the Panel Approach. By Ahmad Zubaidi Baharumshah; Evan Lau
  6. Exchange Rate Risk and Convergence to the Euro By Lucjan T Orlowski
  7. Beyond Balassa - Samuelson: Real Appreciation in Tradables in Transition Countries By Martin Cincibuch; Jiri Podpiera
  8. Estimation of the J-Curve in China By Jaleel Ahmad; Jing Yang
  9. "The Transmission Mechanism of Monetary Policy: A Critical Review" By Greg Hannsgen
  10. Indonesia in Crisis: A Macroeconomic Perspective By Tubagus Feridhanusetyawan; Mari Pangestu
  11. Order Flow and Exchange Rate Dynamics in Brazil By Otavio De Medeiros
  13. Consistency versus credibility: how do countries choose their exchange rate regime? By Fabrizio Carmignani; Emilio Colombo; Patrizio Tirelli
  14. Recent Developments in International Currency Derivatives Market: Implications for Poland By Lucjan T. Orlowski
  15. Exchange rate exposure of stock returns at firm level By Gamini Premaratne; Prabhath Jayasinghe
  16. Early Locking to the Euro: Some Estimates for the New EU Countries based on Equilibrium Exchange Rates By Martin Melecky
  17. Testing Twin Deficits Hypothesis: Using VARs and Variance Decomposition By Ahmad Zubaidi Baharumshah; Evan Lau; Ahmed M. Khalid
  18. Trade Balance Constraints and Optimal Regulation By Lucia Quesada; Omar Chisari
  20. Money Rules For The Eurozone Candidate Countries By Lucjan T Orlowski
  21. Monetary Convergence And Risk Premiums In The EU Candidate Countries By Lucjan T Orlowski
  22. Exchange Rate Fluctuations in the New Member States of the European Union By Zenon Kontolemis; Kevin Ross
  23. Components of the Czech Koruna Risk Premium in a Multiple-Dealer FX Market By Alexis Derviz
  24. Some Exchange Rates Are More Stable than Others; Short-Run Evidence from Transition Countries By Aleš Bulíř
  25. FOREX Microstructure, Invisible Price Determinants, and the Central Bank’s Understanding of Exchange Rate Formation By Alexis Derviz
  26. Optimum Currency Area Indices – How Close is the Czech Republic to the Eurozone? By Luboš Komárek; Zdeněk Čech; Roman Horváth
  27. Exchange Rates in the New EU Accession Countries: What Have We Learned from the Forerunners By Aleš Bulíř; Kateřina Šmídková

  1. By: Chae-Shick Chung (Korea Institute for International Economic Policy); Doo Yong Yang (Korea Institute for International Economic Policy)
    Abstract: This paper is to analyze characteristics of the foreign exchange market in four major East Asian countries (Korea, Thailand, Singapore and Japan) before and after the financial crisis to get implicatoins of it. Our focus is given on the relationship between exchange rate volatilities and risk premium on the selected countries. The crisis-hit countries in the region including Korean and Thailand show structural break during the Asian crisis in representing higher standard deviations on nominal exchange rates since 1997. However, it is argued that they returned to the previous rigid exchange movements due to a fear of floating. Nevertheless, it is believed that the exchange rate arrangements in crisis-hit countries differ from the previous psedo-dollar pegged system.
    Keywords: Exchange rate volatility, risk premium foreign exchange, market in East Asia, financial crisis, foreign exchange rate, Korea, Thailand, Singapore, Japan
    JEL: F31 G12
    Date: 2004–10
  2. By: Barbara Rossi (Duke University)
    Abstract: Many authors have documented that it is challenging to explain exchange rate fluctuations with macroeconomic fundamentals: a random walk forecasts future exchange rates better than existing macroeconomic models. This paper applies newly developed tests for nested model that are robust to the presence of parameter instability. The empirical evidence shows that for some countries we can reject the hypothesis that exchange rates are random walks. This raises the possibility that economic models were previously rejected not because the fundamentals are completely unrelated to exchange rate fluctuations, but because the relationship is unstable over time and, thus, difficult to capture by Granger Causality tests or by forecast comparisons. We also analyze forecasts that exploit the time variation in the parameters and find that, in some cases, they can improve over the random walk.
    Keywords: forecasting, exchange rates, parameter instability, random walks
    JEL: C52 C53 F3
    Date: 2005–03–19
  3. By: Gunther Schnabl (Tuebingen University); Christian Danne (Tuebingen University)
    Abstract: This paper studies the role of the yen/dollar exchange rate in the Bank of Japan’s monetary policy reaction function. In contrast to prior estimations of reaction functions based on the Taylor-rule, we allow for regime shifts by estimating rolling coefficients from January 1974 to March 1999. The results show a temporary impact of the exchange rate on monetary policy around 1978/79 and a persistently increasing impact of the yen/dollar exchange rate after 1986. The ris ing importance of the yen/dollar exchange rate for Japanese monetary policy is in line with increasing efforts to stabilize the yen/dollar exchange rate by foreign exchange intervention after March 1999, when the nominal interest rate reached the zero boundary.
    Keywords: Japan, Monetary Policy Reaction Function, Bank of Japan, Interest Rate Rules, Exchange Rates, Taylor Rule, GMM.
    JEL: E43 E52 E58 F41
    Date: 2005–03–04
  4. By: Jerome Henry (ECB); Jens Weidmann (Bundesbank)
    Abstract: We investigate the consequences of the 1992-1993 EMS crises, which resulted in the widening of the exchange rate bands, on the long-run linkages between the daily 1-month-Eurorates on German Mark, US-Dollar and French Franc. First, within a Gaussian VAR, both the US Eurorate and the French-German Eurorate differential are found stationary between December 1990 and December 1993. Second, using various GARCH models to account for heteroskedasticity show that Gaussian models can be misleading as to the interpretation of the linkages. Third, the estimated variance parameters are stable and the July 1993 episode is not linked to especially high a volatility. Finally, focusing on the French rate, we find asymmetry in the stochastic volatility, positive shocks being more persistent.
    Keywords: Interest rates, cointegration, heteroskedasticity, GARCH, EMS, Asymmetry in the ERM
    JEL: F3 F4
    Date: 2005–03–30
  5. By: Ahmad Zubaidi Baharumshah (UPM); Evan Lau (UNIMAS)
    Abstract: In this paper, the twin deficits hypothesis was examined using data of nine SEACEN countries. To compensate for the lack of time series observations, data was polled from the nine countries into one panel. The effects of interest rate and exchange rate in the causal chain between budget and current account deficits were stressed. At the empirical level, there is enough evidence to support the view that Asian budget deficit causes current account deficit directly as well as indirectly. From the policy perspective, the statistical analysis suggests that managing budget deficit offers scope for improvement in the current account deficit. However, this finding does not support the policy of manipulating the intermediate variables to reduce the twin deficits to a sustainable level since these variables appear to be endogenous in the system.
    Keywords: twin deficits
    JEL: F3 F4
    Date: 2005–04–01
  6. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This paper proposes a new monetary policy framework for effectively navigating the path to adopting the euro. The proposed policy is based on relative inflation forecast targeting and incorporates an ancillary target of declining exchange rate risk, which is suggested as a key criterion for evaluating the currency stability. A model linking exchange rate volatility to differentials over the euro zone in both inflation (target variable) and interest rate (instrument variable) is proposed. The model is empirically tested for the Czech Republic, Poland and Hungary, the selected new Member States of the EU that use direct inflation targeting to guide their monetary policies. The empirical methodology is based on the TARCH(p,q,r)-M model.
    Keywords: exchange rate risk, inflation targeting, monetary convergence, euro area, new EU Member States
    JEL: E42 E52 F36 P24
    Date: 2005–01–28
  7. By: Martin Cincibuch; Jiri Podpiera
    Abstract: Using the simple arbitrage model, we decompose real appreciation in tradables in three Central European countries between the pricing-to-market component (disparity) and the local relative price component (substitution ratio). Appreciation is only partially explained by local relative prices. The rest is absorbed by disparity, depending on the size of the no-arbitrage band. The observed disparity fluctuates in a wider band for differentiated products than for a commodity like goods.
    Keywords: Purchasing power parity, pricing-to-market, transition, real appreciation, exchange rates
    JEL: F12 F15
    Date: 2004–12
  8. By: Jaleel Ahmad (Economics, Massachusetts Institute of Technology, Montreal, Canada); Jing Yang (Economics, Concordia University, Ottawa, Canada)
    Abstract: This paper investigates whether a J-curve can be detected in the time series data on China's bilateral trade with the G-7 countries. It utilizes cointegration and causality tests to ascertain the long-run relatedness, and the short-run dynamics, between the real exchange rate, national income, and the trade balance. There is some evidence that a real depreciation eventually improves the trade balance with some countries. But there is no indication of a negative short-run response which characteristics the J-Curve.
    Date: 2004–03
  9. By: Greg Hannsgen
    Abstract: Recently, many economists have credited the late-1990s economic boom in the United States for the easy money policies of the Federal Reserve. On the other hand, observers have noted that very low interest rates have had very little positive effect on the chronically weak Japanese economy. Therefore, some theory of how money affects the economy when it is endogenous would be useful. This paper pursues several such explanations, including the effects of interest rate changes on (1) investment; (2) consumer spending; (3) the exchange rate; and (4) financial markets. The theories of such authors as Kalecki, Keynes, Minsky, and J. K. Galbraith are discussed and evaluated, with an emphasis on the role of cash flow. Some of these theories turn out to be stronger than others when subjected to tests of logic and empirical evidence.
    Date: 2004–10
  10. By: Tubagus Feridhanusetyawan (Department of Economics, Centre for Strategic and International Studies); Mari Pangestu (Department of Economics, Centre for Strategic and International Studies)
    Abstract: This paper presents an illustrative analysis of the crisis from a macroeconomic perspective, by focusing on the various economic adjustments both in the real and monetary sectors. It argues that the complex nature of the political and economic reform process has resulted in sub – optimal growth rates. The paper discusses, first, the evolution of the crisis. Then it provides an account of the developments in the real sector and growth in general. The authors then present monetary adjustments, including inflation, exchange rate, and other issues related to the banking and financial sectors. The fourth section discusses the balance of payment trends, by focusing more on the adjustments of exports and imports. This is followed by a discussion on debt issues and fiscal sustainability, while the last part concludes with the prospect of achieving macroeconomic stability.
    Keywords: Indonesia, crisis, macroeconomic adjustment
    Date: 2004–02
  11. By: Otavio De Medeiros (Universidade de Brasilia, Brazil)
    Abstract: The paper presents results of empirical tests with hybrid nominal exchange rate models for the Brazilian foreign exchange market, using macroeconomic and market microstructure variables. The basic model was originally proposed and tested in the German (DM/US$) and the Japanese (¥/US$) foreign exchange markets by Evans and Lyons (2002). We applied the model to the Brazilian foreign exchange market (R$/US$) and obtained significant and correctly signaled coefficients, but the regressions showed low R2s, suggesting the omission of relevant variable(s). The inclusion of an additional variable representing a country-risk premium results significant and increases R2. Estimation by GARCH further improves previous results obtained by OLS. The upshot indicates that the route proposed by Evans and Lyons is a promising explanation for the R$/US$ exchange rate, but it seems the model specification needs further improvement.
    Keywords: exchange rate, market microstructure, country risk, order flow, Brazil
    JEL: G
    Date: 2005–03–16
  12. By: Jian Wang (University of Wisconsin, Madison)
    Abstract: Engel and West (2004a) provide an explanation to reconcile the random walk behavior of exchange rate and linear present value asset pricing models. In this paper, we study the long horizon property of exchange rate under Engel-West explanation. It is found that the long horizon data can not significantly improve our chance of beating random walk. This result is consistent with recent empirical studies on the long horizon exchange rate. Under E-W explanation, the change of exchange rate can be more serially correlated in the long horizon data, but this change in most cases is only marginal. Depending on the persistence of change in fundamentals, two patterns may exist between the autocorrelation of exchange rate change and the time horizon. Both of these two patterns are found existing in the real data of exchange rates. These results support E-W explanation for exchange rate puzzle.
    Keywords: Foreign exchange rate, present-value models, exchange rate and fundamentals, random walk
    JEL: F31 F41 G12 G15
    Date: 2005–01–25
  13. By: Fabrizio Carmignani (United Nations Economic Commission for Europe); Emilio Colombo (University of Milan - Bicocca); Patrizio Tirelli (University of Milan - Bicocca)
    Abstract: The empirical distinction between de facto and de jure exchange rate regimes raises a number of interesting questions. Which factors may induce a de facto peg? Why do countries enforce a peg but do not announce it? Why do countries 'break their promises'? In this paper we show that a stable socio-political and an efficient political decision- making process are a necessary prerequisite for choosing a peg and sticking to it. Whenever a country is implementing a de facto peg the same factors signal that the peg is more likely to be announced. Finally these factors explain why regime choices are not reversed.
    Keywords: Exchange Rate regime Choice Exchange Rate Regime Classification Political Systems
    JEL: F3 F4
    Date: 2005–02–04
  14. By: Lucjan T. Orlowski (Sacred Heart University)
    Abstract: This paper examines currency derivatives that have emerged in international financial markets over the past two years, emphasizing the departures of spot exchange rate movements from the macroeconomic fundamentals among the “triad” currencies: the U.S. Dollar (USD), the German Mark (DM), and the Japanese Yen (YE). Sensitivity of exchange rates to key macroeconomic variables (differentials in interest rates, income and inflation) is tested for the “triad” currencies in two periods: 1991-1993 and 1994-1995. In the latter period, some considerable misalignments between forward rates and changes in spot exchange rates are observed. This is contrary to the historical evidence of the validity of the so-called “unbiased forward rate hypothesis” claiming that forward rates are the best predictor of adjustments of spot rates (Levich, 1976). It is argued that the recently observed failure of the relationship between forward rates and lagged spot rates has contributed to significant losses of investors and speculators in international currency derivative markets. The examination of these relationships and the recent empirical developments provides useful lessons for the transition economies of Central and Eastern Europe in their attempts to construct viable modern financial markets. This study limits the scope of recommendations for developing financial markets to the conditions of Poland. It assumes that currency-based derivative transactions may play a pivotal role in reducing systemic risk of external trade and financial contracts in the Polish economy presently undergoing considerable structural adjustments aimed at promoting export and net capital inflows. It further argues that an introduction of financial derivatives in Poland shall be preceded by a construction of sound underlying security markets. A stable currency accompanied by low inflation is necessary prerequisites for a successful functioning of currency-based derivatives.
    JEL: F31 P20
    Date: 2005–02–12
  15. By: Gamini Premaratne (NUS); Prabhath Jayasinghe (NUS)
    Abstract: The use of conventional augmented CAPM specification in estimating the exchange rate exposure may result in less reliable estimates for, at least, two reasons. First, it does not take into account a few important stylized facts associated with financial time series. Second, one cannot estimate the total impact of the exchange rate changes on stock returns as a single coefficient with it and for this reason it does not help us analyze the reinforcing or offsetting interactions between direct and indirect exchange rate exposure effects. In this paper, we suggest an orthogonalized GJR-GARCH-t version of augmented CAPM that simultaneously addresses the above issues. Our findings have important implications for hedging and investment decision making.
    Keywords: Exchange rate exposure, GARCH, t distribution, Asymmetric volatility
    JEL: F3 F23 F31 G15
    Date: 2005–03–11
  16. By: Martin Melecky
    Abstract: The ECB recommends to prospective euro-area members that they choose the central parities, for fixing their currencies against the euro, consistent with a broad range of economic indicators while taking account of the market rate as well. In this paper, we estimate a behavioral model of the real exchange rates for a group of the EU 5 countries, along with equilibrium real exchange rates. In addition, we propose a methodology for estimating an optimal timing for ERM II entry based on convergence properties of the equilibrium real exchange rate. We find that the estimated optimal timing for ERM II entry derived from the analysis of the equilibrium real exchange rate suggests that fixing the national currencies of the EU 5 countries in forthcoming years would not be in contradiction with the convergence properties of the real equilibrium exchange rate.
    Keywords: Equilibrium Exchange Rate, ERM II Entry, Time-Series Panel Data
    JEL: C52 C53 E58 E61 F31
    Date: 2005–03–29
  17. By: Ahmad Zubaidi Baharumshah (UPM); Evan Lau (UNIMAS); Ahmed M. Khalid (Bond University)
    Abstract: This paper examines the twin deficits hypothesis in Indonesia, Malaysia, the Philippines and Thailand (ASEAN-4 countries). The major findings of this paper are: (1) Long run relationships are detected between budget and current account deficits. (2) We found that the Keynesian reasoning fits well for Thailand since a unidirectional relationship exists which runs from budget deficit to current account deficit. For Indonesia the reverse causation (current account targeting) is detected while the empirical results indicate that a bidirectional pattern of causality exists for Malaysia and the Philippines. (3) We also found support for an indirect causal relationship that runs from budget deficit to higher interest rates, and higher interest rates lead to the appreciation of the exchange rate and this leads to the widening of current account deficit. (4) The results of the variance decompositions and impulse response functions suggest that the consequences of large budget and current account deficits become noticeable only over the long run.
    Keywords: Twin deficits, Cointegration, Variance Decomposition
    JEL: F3 F4
    Date: 2005–04–01
  18. By: Lucia Quesada (University of Wisconsin Madison); Omar Chisari (Universidad Argentina de la Empresa)
    Abstract: We investigate the interactions between optimal regulation and external credit constraints. When part of a regulated ¯rm is owned by foreign investors, a credit-constrained country who wants to send pro¯ts abroad has to generate enough surplus in the trade account in order to compensate capital out°ows. We show that the credit constraint translates into a constraint of maximum profits for the regulated firm. Overall e±ciency in the regulated sector is reduced to maintain incentive compatibility. A flexible exchange rate helps relaxing the credit constraint. E±ciency is higher than with a fixed exchange rate, but still lower than without credit constraints.
    Keywords: Optimal regulation, Credit constraints, International trade
    JEL: D82 F32 L51
    Date: 2005–04–06
  19. By: Nelson H. Barbosa-Filho (Institute of Economics, Federal University of Rio de Janeiro)
    Abstract: This paper presents the correlation between the annual fluctuations of the terms of trade of Brazil, Argentina, Uruguay and Paraguay. The period under analysis is 1980-2001 and the main findings are that the four countries have a high to moderate synchronization of their export prices, a moderate to low synchronization of their import prices, and a low synchronization of their terms of trade. The small positive correlation between the growth rates of the terms of trade of Brazil and Argentina (0.24) support exchange rate coordination between the two countries, provided that their bilateral real exchange rate is allowed to fluctuate temporarily to accommodate possible differences between the intensity of shocks across them. For instance, given an adverse shock to Brazil, both the Brazilian and Argentine real exchange rates against the rest of the world (domestic good per unit of foreign good) should increase to avoid a reduction, or smooth the variation, of their trade balances, but the Argentine currency should appreciate against the Brazilian currency in real terms because Argentina tends to be less affected by the shock. The observed correlations indicate that, through a joint and flexible managed float of their currencies, Argentina and Brazil may be able to share the benefits and costs of terms-of-trade shocks without imposing major macroeconomic disruptions on each other. In such an arrangement and also based on the observed correlations, Uruguay may either follow Argentina, when the terms-of-trade shock is more intense to Brazil, or do nothing, when the shock is more intense to Argentina. In contrast, Paraguay should follow Brazil, when the terms- of-trade shock is more intense to Argentina, or do nothing, when the shock is more intense to Brazil. Because of the low correlation between the terms-of-trade fluctuations of Brazil and Argentina, the best form of exchange-rate coordination for the near future seems to be a Mercosur version of the European Monetary System of 1979-98, that is, a wide interval of fluctuation for the regional currencies around a common and competitive real exchange rate against the rest of the world.
    Keywords: Mercosur, Trade, Exchange-Rate Coordination
    JEL: F1 F2
    Date: 2005–03–04
  20. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study proposes the adoption of money growth rules as indicator variables of monetary policies by the countries converging to a common currency system, in particular, by the eurozone candidate countries. The analytical framework assumes an inflation target as the ultimate policy goal. The converging countries act in essence as “takers” of the inflation target, which, in this case, is the eurozone’s inflation forecast. The study advances a forward-looking money growth model that might be applied to aid monetary convergence to the eurozone. However, feasibility of adopting money growth rules depends on stable relationships between money and target variables, which are low inflation and stable exchange rate. Long-run interactions between these variables are examined for Poland, Hungary and the Czech Republic by employing a Johansen cointegration test, along with short-run effects assessed with a vector error correction procedure.
    Keywords: common currency system, eurozone, monetary convergence, money growth rules, inflation targeting.
    JEL: E42 E52 F36 P24
    Date: 2005–01–28
  21. By: Lucjan T Orlowski (Sacred Heart University)
    Abstract: This study examines the link between various monetary policy regimes and the ability to manage inflation and exchange rate risk premiums in the EU candidate countries as they undergo monetary convergence to the eurozone. The underlying hypothesis is that a system of 'flexible inflation targeting' may be an optimal policy choice for managing these two categories of risk. A model of inflation and exchange rate risk premiums within the context of inflation targeting is proposed. Recent trends in these risk premiums in Hungary, the Czech Republic and Poland are tested by using the GARCH(1,1) methodology.
    Keywords: inflation risk premium, exchange rate risk premium, inflation targeting, monetary convergence, transition economies
    JEL: E32 E52 P33
    Date: 2005–01–31
  22. By: Zenon Kontolemis (International Monetary Fund); Kevin Ross (International Monetary Fund)
    Abstract: This paper assesses the role of exchange rates in moderating the impact of economic disturbances in the new member states of the European Union, and finds some evidence in favour of this proposition. Exchange rates are mostly driven by real (demand) shocks, whilst output by real supply shocks. Nominal shocks, which have no long-run impact on output, are nevertheless important in explaining exchange rate fluctuations implying that less exchange rate flexibility may indeed be warranted in the run- up to the adoption of the euro. We find that while interest rate shocks generally do not explain exchange rate fluctuations, credit shocks matter in certain cases and seem to have considerable impact on exchange rate developments (e.g., for Poland). The analysis also shows that based on the average responses of exchange rates to different shocks, the adoption of narrow bands inside ERM II may be risky.
    Keywords: Exchange rate fluctuations, transmission economies, ERM II, EMU, structural VAR
    JEL: E
    Date: 2005–04–08
  23. By: Alexis Derviz
    Abstract: The paper proposes a continuous time model of an FX market organized as a multiple dealership. The model reflects a number of salient features of the Czech koruna spot market. The dealers have costly access to the best available quotes. They interpret signals from the joint dealer-customer order flow and decide upon their own quotes and trades in the inter-dealer market. Each dealer uses the observed order flow to improve the subjective estimates of the relevant aggregate variables, which are the sources of uncertainty. One of the risk factors is the size of the cross-border dealer transactions in the FX market. These uncertainties have diffusion form and are dealt with according to the principles of portfolio optimization in continuous time. The model is used to explain the country, or risk, premium in the uncovered national return parity equation for the koruna/euro exchange rate. The two country premium terms that I identify in excess of the usual covariance term (a consequence of the “Jensen inequality effectâ€) are the dealer heterogeneity-induced inter-dealer market order flow component and the dealer Bayesian learning component. As a result, a “dealer-based total return parity†formula links the exchange rate to both the “fundamental†factors represented by the differential of the national asset returns, and the microstructural factors represented by heterogeneous dealer knowledge of the aggregate order flow and the fundamentals. Evidence on the cross-border order flow dependence of the Czech koruna risk premium, in accordance with the model prediction, is documented.
    Keywords: Bayesian learning, FX microstructure, optimizing dealer, uncovered parity.
    JEL: F31 G11 G29 D49 D82
    Date: 2003–06
  24. By: Aleš Bulíř
    Abstract: The paper investigates empirically the endogenous liquidity nexus of exchange rate determination on a sample of four transition economies. We find evidence in favor of the hypothesis of a nonlinear error correction process vis-a-vis longer-term trend deviations. The results suggest that early and successful exchange-rate market and financial-account liberalization pays off in terms of depth of the market and, hence, faster adjustment of national currencies to short-term shocks to the exchange rate.
    Keywords: Exchange rate, endogenous liquidity, error-correction mechanism, nonlinearity.
    JEL: F31 F33 C32
    Date: 2003–06
  25. By: Alexis Derviz
    Abstract: The paper investigates the transmission of macroeconomic factors into the price-setting behavior of a specific dealer in the FX market. This problem is viewed from the perspective of a central banker who observes the price evolution but does not make the market in the home currency. The central banker’s task is to explain the forex behavior in terms of conventional economic logic. The analysis is based on a model of a multiple dealer market under two organizations - direct inter-dealer and brokered. The model is constructed in such a way as to reflect the most prominent features of the market for the Czech koruna and, accordingly, to address some issues of key relevance to the Czech National Bank’s exchange rate policy. We show that the totality of the exchange rate-relevant fundamental factors influence the market maker’s behavior through a single sufficient statistic, his “marginal†valuation of foreign currency holdings. Under the two studied trading mechanisms, the marginal valuations across market participants determine the equilibrium exchange rate by means of different trade patterns. Specifically, the brokered market is inferior to the direct one in terms of welfare improvement through trade. It takes a higher inter-dealer trade volume in the brokered market to absorb a new price impulse. Therefore, the central banker would do best by monitoring the brokered segment (as the only partially transparent one available), but by conducting interventions in the direct segment, where the desired impact is easier to achieve.
    Keywords: forex microstructure, multiple dealership, order flow, pricing schedule.
    JEL: F31 G15 C72
    Date: 2003–06
  26. By: Luboš Komárek; Zdeněk Čech; Roman Horváth
    Abstract: In this paper we provide a survey of the optimum currency area theory, estimate the degree of the explanatory power of the optimum currency area criteria, and also calculate the optimum currency area index in the case of the Czech Republic. The results indicate that the traditional optimum currency area criteria to certain extent explain exchange rate variability. Our results may be interpreted as an attempt to assess the benefit-cost ratio of implementing a common currency for a pair of countries. Our results also suggest that from the point of view of the optimum currency area theory the costs of adopting the euro for the Czech Republic may be relatively low, at least in comparison with other EMU member countries. We conclude that if the European Monetary Union is sustainable, the accession of the Czech Republic should not change it.
    Keywords: Convergence, EU/eurozone, exchange rate, optimum currency area theory, transition.
    JEL: E58 E52 F42 F33
    Date: 2003–12
  27. By: Aleš Bulíř; Kateřina Šmídková
    Abstract: Estimation and simulation of sustainable real exchange rates in some of the new EU accession countries point to potential difficulties in sustaining the ERM2 regime if entered too soon and with weak policies. According to the estimates, the Czech, Hungarian, and Polish currencies were overvalued in 2003. Simulations, conditional on large-model macroeconomic projections, suggest that under current policies those currencies would be unlikely to stay within the ERM2 stability corridor during 2004-2010. In-sample simulations for Greece, Portugal, and Spain indicate both a much smaller misalignment of national currencies prior to ERM2, and a more stable path of real exchange rates over the medium term than can be expected for the new accession countries.
    Keywords: ERM2, Foreign direct investment, Sustainable real exchange rates.
    JEL: F31 F33 F36 F47
    Date: 2004–12

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