nep-ifn New Economics Papers
on International Finance
Issue of 2005‒05‒14
twelve papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange Rates and FOMC Days By Michael Melvin
  2. Price Discovery in International Equity Trading By Michael Melvin; Joachim Grammig; Christian Schlag
  3. Pass-Through of Exchange Rate Changes and Macroeconomic Shocks to Domestic Inflation in East Asian Countries By Takatoshi Ito; Yuri N. Sasaki; Kiyotaka Sato
  4. Testing for Neglected Nonlinearity in Long Memory Models By Richard T. Baillie; George Kapetanios
  6. 'Once-in-a-Generation' Yen Volatility in 1998: Fundamentals, Intervention, and Order Flow By Jun Cai; Yan-Leung Cheung; Raymond Lee; Michael Melvin
  7. Currency Futures and Currency Crises By Andreas Röthig
  10. Common Currencies and FDI Flows By Stefano Schiavo
  11. The Contractionary Short-Run Effects of a Devaluation in Developing Countries: Some Neglected Nuances By Arslan Razmi
  12. Hellenic Export Prices and European Monetary Integration, 1970- 1995. By Theodoros V. Stamatopoulos

  1. By: Michael Melvin (W. P. Carey School of Business Department of Economics)
    Abstract: FOMC meeting days provide a natural laboratory for exploring the effects of policy uncertainty and learning on exchange rate determination. Intradaily mark/dollar exchange rates are employed for 10 FOMC meetings. The meetings examined are the first 10 following the February 1994 change in policy where the meeting outcome is announced after meetings end. The following hypotheses motivated by the market microstructure literature are examined: 1) strategic behavior by informed traders should result in position-taking prior to meeting end and the revelation of policy and 2) bid-ask spreads should widen due to adverse selection potential as the probability of quoting to an informed trader increases. A markov-switching model is used to estimate the time of informed position-taking. The data suggest that on most days, there is a switch to the informed-trading state during the time of the meeting, well before the end of the meeting. An extensive search of public news indicates that the informed trading cannot be explained as the response to public information. An ordered probit model of the bid-ask spread is estimated as a function of the probability of being in the informed trading state. The estimation results indicate that the greater the probability of being in the informed trading state, the wider spreads. This is consistent with dealers protecting against adverse selection in quoting. The evidence indicates that meeting outcomes are generally anticipated during the meeting. In this sense, the realization of the meeting outcome is often not news.
  2. By: Michael Melvin (W. P. Carey School of Business Department of Economics); Joachim Grammig (Universite' Catholique de Louvain); Christian Schlag (University of Frankfurt)
    Abstract: This study addresses two questions: where does price discovery occur for internationally-traded firms and how do international stock prices adjust to an exchange rate shock? These questions are answered by analyzing quotes originating in New York and Frankfurt for three large German firms, DaimlerChrysler, Deutsche Telekom, and SAP, during overlapping trading hours. A high-frequency sample of quotes from both locations along with the dollar/euro exchange rate yields evidence of one cointegrating relation among the 3 variables. Vector error correction models are estimated for each firm and the associated vector moving average representations are utilized to infer the share of price discovery coming from the exchange rate, New York, and Frankfurt quotes. The evidence suggests a structure of the international equity market that has the home-market largely determining the random walk component of the international value of a firm along with an independent role for exchange rate shocks to affect prices in the U.S. markets. However, there is a significant information share for New York in the case of DaimlerChrysler and an even bigger role for New York with respect to SAP. Following a shock to the exchange rate, we find that almost all of the adjustment comes through the New York price.
  3. By: Takatoshi Ito; Yuri N. Sasaki; Kiyotaka Sato
    Abstract: We examine the pass-through effects of exchange rate changes on the domestic prices among the East Asian countries using the conventional pass-through equation and a VAR analysis. First, dynamics of pass-through from the exchange rate to import prices and consumer prices is analyzed using the conventional model of pass-through based on the micro-foundations of the exporter's pricing behavior. Both the short-run and long-run elasticities of the exchange rate pass-through are estimated. Second, a vector autoregression (VAR) technique is applied to the pass-through analysis. A Choleski decomposition is used to identify structural shocks and to examine the pass-through of each shock to domestic price inflation by the impulse response function and variance decomposition analyses. Both the conventional analysis and VAR analysis show that while the degree of exchange rate pass-through to import prices is quite high in the crisis-hit countries, the pass-through to CPI is generally low, with a notable exception of Indonesia. The VAR analysis shows that the size of the pass-through of monetary shocks is even larger in Indonesia. Thus, it was Indonesia's accommodative monetary policy as well as the high degree of the CPI responsiveness to exchange rates that contributed to high domestic price inflation, resulting in the loss of its export competitiveness, even when the currency depreciated sharply in nominal terms in 1997-98.
    Date: 2005–05
  4. By: Richard T. Baillie (Queen Mary, University of London); George Kapetanios (Queen Mary, University of London)
    Abstract: This paper constructs tests for the presence of nonlinearity of unknown form in addition to a fractionally integrated, long memory component in a time series process. The tests are based on artificial neural network structures and do not restrict the parametric form of the nonlinearity. The tests only require a consistent estimate of the long memory parameter. Some theoretical results for the new tests are obtained and detailed simulation evidence is also presented on the power of the tests. The new methodology is then applied to a wide variety of economic and financial time series.
    Keywords: Long memory, Non-linearity, Artificial neural networks, Realized volatility, Absolute returns, Real exchange rates, Unemployment.
    JEL: C22 C12 F31
    Date: 2005–04
  5. By: Hernán Rincón; Edgar Caicedo; Norberto Rodríguez
    Abstract: Colombian monthly data covering the period from 1995:01 to 2002:11 and ECM, fixed and time-varying parameters and Kalman filter techniques are used in this paper to quantify the exchange rate pass-through effects on import prices within a sample of manufactured imports. Also, whether the foreign exchange and inflation regimes affect the degree of pass-through is evaluated. The analytical framework used was a mark-up model. The main finding is that the long-run pass-through elasticities for the industries in the sample are stable and go from 0.1 to 0.8 and the short-run ones are unstable and go from 0.1 to 0.7, supporting mark-up hypotheses, in contrast to the hypotheses of perfect market competition and complete pass-through. The findings also show evidence of the variability and different degrees of pass-trough among manufacturing sectors, which confirm the importance of using dynamic models and disaggregate data for an analysis of the pass-through. Both, the hypothesis that under a floating regime there is a low degree of pass-through and the hypothesis that a low inflation environment has the same result are not supported.
    Keywords: Pass-through effects;
    JEL: F31
    Date: 2005–03–31
  6. By: Jun Cai (City University of Hong Kong); Yan-Leung Cheung (City University of Hong Kong); Raymond Lee (City University of Hong Kong); Michael Melvin (W. P. Carey School of Business Department of Economics)
    Abstract: The yen provided foreign exchange market participants with 'once-in-a-generation' volatility movements in 1998. For instance, after many months of uneven yen depreciation a remarkable period of yen appreciation was experienced where, in one two-day period, the U.S. dollar dropped in value by 20 yen, market-makers were refusing to quote yen/dollar prices for more than $1 million, and funds with short yen positions incurred massive losses. Not since the early 1970s has the yen-dollar exchange rate experienced such shifts. Analysts claimed that the yen reversal was due to order flow driven by changing tastes for risk and hedge-fund herding on unwinding yen ‘carry trade’ positions rather than any fundamentals related to the yen. In this paper, we examine the high-frequency evidence on the yen/dollar exchange rate in 1998 and provide a detailed characterization of the return volatility. Evidence of shifting fundamentals is provided by a comprehensive list of macroeconomic announcements from both the U.S. and Japan. While macroeconomic announcements and intervention are found to have significant effects on volatility, our results lead to the conclusion that order flow played a more important role than news regarding fundamentals. Evidence regarding the independent effect of order flow was provided by spot, forward, and futures positions of major market participants. These position changes are found to be significant determinants of volatility. Since such portfolio shifts are revealed to the market through trading, the results are consistent with order flow playing a significant role in the revelation of private information and the associated exchange rate shifts.
    JEL: F31 G14 G15 C22
  7. By: Andreas Röthig (Institut für Volkswirtschaftslehre (Department of Economics), Technische Universität Darmstadt (Darmstadt University of Technology))
    Abstract: Since financial derivatives are key instruments for risk taking as well as risk reduction, it is only straightforward to examine their role in currency crises. This paper addresses this issue by investigating the impact of currency futures trading on the underlying exchange rates. After a discussion of trading mechanisms and trader types, the linkage between futures trading activity and spot market turbulence is modelled using a VAR-GARCH approach for the exchange rates of Australia, Canada, Japan, Korea and Switzerland in terms of the US dollar. The empirical results indicate that there is a positive relationship between currency futures trading activity and spot volatility. Moreover, in the case of four out of the total of five currencies discussed in this paper, futures trading activity adds significantly to spot volatility.
    Keywords: Currency crises; Exchange rate volatility; Currency futures trading activity; VAR-GARCH estimation.
    JEL: C13 C32 F31 G15
    Date: 2004–05
  8. By: Alejandro Reveiz
    Abstract: The set of objectives in reserves management are normally predefined and include: protecting the economy against potential external shocks on the current account or on capital flows; invest the reserves minimizing the potential of a loss and ensuring the availability of international liquidity when necessary. Whereas the adoption of a floating exchange rate in theory reduces the need for reserves to protect against external shocks, in the context of free capital movements it will be a function of the efficiency of international markets. In practical terms, Reserves Management is a process with a high effective complexity. The manager is confronted with the randomness of markets – including its own through the impact on the Reserves of Central Bank intervention – and the regularities that arise from its guidelines (i.e. credit and market risk, as well as liquidity policies) and the foreign exchange intervention mechanisms. Recently, given the increase in the size of the foreign reserves in recent decades for some central banks, as a result and in response to globalization and more volatility on currency flows, portfolio foreign investment and other related factors as contagion effects, the pressure to generate long-term returns has increased. However, the goal of increased returns is subdued to the security and liquidity objectives in international reserves management. As a result, the process of asset allocation and the construction of an efficient set of investment guidelines, as well as a risk policy, must be framed by a liquidity policy and, generally, to an asymmetric exposure to risk where capital loses are to be avoided in specific time horizons; i.e. a fiscal year.
    Date: 2004–05–30
  9. By: Leonardo Villar; Ricardo Ffrench-Davis
    Abstract: In 1995, when contagion from the tequila crisis was spreading in Latin America, both Chile and Colombia were exempt from contagion and presented high rates of economic growth. Several analysts attribute this positive performance to the fact that both had undertaken prudential measures to avoid excessive exposure to short term capital flows and pressures towards excessive real exchange rate appreciation: Both countries were using a reserve requirement on short term foreign indebtedness, crawling-bands, and other instruments for reducing domestic vulnerability to capital flows. The parallelism between Chile and Colombia continued after the Asian crisis. In this period, despite the fact that short-term liabilities represented only a small share of foreign debt in both countries, vulnerability to the international financial crisis was high. In both, real interest rates rose sharply in 1998 and GDP growth was negative in 1999. The similarities between Chile and Colombia, however, do not go much farther. During the 1990s, GDP growth rates were very high in Chile while in Colombia they were below historical standards. Chile had fiscal surpluses and high private savings, while in Colombia there was a rapidly increasing fiscal deficit and falling domestic savings. This paper presents a comparative analysis of the macroeconomic policies of Chile and Colombia during the 1990s, in particular the exchange rate regimes, the capital account regulations, and the gestation and management of financial crises.. _______________ Paper prepared for the Project on Management of Volatility, Financial Globalization and Growth in Emerging Economies, coordinated by ECLAC with the support of the Ford Foundation. **Ffrench-Davis is Principal Regional Adviser of ECLAC and Professor of Economics of Universidad de Chile. Villar is Co-Director at the Board of Directors of Banco de la República of Colombia and Professor of Economics of Universidad de los Andes. The authors appreciate the valuable comments and suggestions of Guillermo Le Fort, Carlos Quenan and other participants at two ECLAC Seminars in Santiago and at a technical meeting of G-24 in Geneva. Opinions expressed herein are exclusively of the authors and not of the institutions in which they work
    Date: 2004–07–30
  10. By: Stefano Schiavo
    Abstract: The paper investigates the impact of EMU on foreign direct investment flows. Using the option value approach to investment decisions, it is possible to show how exchange rate uncertainty hinders cross-border investment flows. By permanently fixing bilateral exchange rates, a currency union can then be expected to spur international investment. Results from a gravity model on a sample of OECD countries confirm the hypothesis that currency unions have a positive impact on FDI; moreover, adopting the same currency appears to do more than merely eliminating exchange rate volatility. These findings closely resemble those recently obtained in the trade literature.
    Keywords: EMU, Currency Union, FDI, Uncertainty, Investment.
  11. By: Arslan Razmi (University of Massachusetts Amherst)
    Abstract: This paper extends the framework developed by Krugman and Taylor (1978) to take into account nuances related to the evolving structure of international trade. In particular, the increasing presence of transnational production chains and differential pricing behavior of de- veloping country exports destined for industrial and developing countries are accommodated. Individual country and panel data pass-through estimates are then provided to justify the va- lidity of the latter extension. The theoretical likelihood of contractionary short-run effects of nominal devaluations is shown to be positively related to the proportion of a country's exports destined for other developing countries. The policy implications emerging from the extended framework underline the need to take into account these nuances of international trade while designing exchange rate policies. JEL Categories: F12, F14, F23, F41
    Keywords: Nominal devaluations, differential pass-through elasticities, contractionary deval- uations, income effects, transnational corporations.
    Date: 2005–05
  12. By: Theodoros V. Stamatopoulos (TEI of Crete & University of Piraeus, Greece. C.E.F.I. Universite d'Aix Marseille II)
    Abstract: We aim to explain the variability of the Hellenic Export Index Unit Value, during the period 1970-1995. The Hellenic index of unit labour cost, an effective index of unit value of European competitors’ exports and the effective exchange rate of the Greek Drachma (GRD) are used as explanatory variables, suggested by the literature and much more by the consequences of the Hellenic accession into the EEC. We found evidence with regards to the sample’s split in the accession’s year 1981 and the equilibrium relationship between Hellenic export prices and exchange rate of GRD during the second subperiod. In addition, in spite of the small size of the Hellenic economy we detected the Greek exporters’ discreet pricing policy, for the first sub-period, this was possible due to the diversification of their destination markets and for the second, the sliding rate policy of the Bank of Greece. The latter policy combined with the European competitors’ pricing policy re-established their margins, with at the most a year lag, whenever the Hellenic labour cost was increased.
    Keywords: Decomposition Approach; Export Prices Equations; Discreet Pricing Policy; Inconsistent triad; European Monetary Integration; Integration and Co-integration Analysis.
    JEL: F3 F4
    Date: 2005–05–12

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