nep-ifn New Economics Papers
on International Finance
Issue of 2005‒06‒14
eighteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Non-linear dynamics in output, real exchange rates and real money balances: Norway, 1830-2003 By Q. Farooq Akram; Øyvind Eitrheim; Lucio Sarno
  2. Foreign exchange rates don't follow a random walk By Hui Guo; Robert Savickas
  3. Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues By Égert, Balázs; Halpern, László; MacDonald, Ronald
  4. Large Devaluations and the Real Exchange Rate By Burstein, Ariel Thomas; Eichenbaum, Martin; Rebelo, Sérgio
  5. Explaining the Early Years of the Euro Exchange Rate: an episode of learning about a new central bank By Manuel Gomez; Michael Melvin
  6. Equilibrium Exchange Rates in Central and Eastern Europe: A Meta-Regression Analysis By Égert, Balázs; Halpern, László
  7. The US Current Account and the Dollar By Blanchard, Olivier; Giavazzi, Francesco; Sa, Filipa
  8. Forecasting the Spot Exchange Rate with the Term Structure of Forward Premia: Multivariate Threshold Cointegration By van Tol, Michel R; Wolff, Christian C
  9. FORECASTING EXCHANGE RATE :A Uni-variate out of sample Approach By Mahesh Kumar Tambi
  10. Exchange rate overshooting and the costs of floating By Michele Cavallo; Kate Kisselev; Fabrizio Perri; Nouriel Roubini
  11. The commodity currency puzzle By Hilde C. Bjørnland and Håvard Hungnes
  12. Macroeconomic Order Flows: Explaining Equity and Exchange Rate Returns By Dunne, Peter; Hau, Harald; Moore, Michael
  13. Do Demand Curves for Currencies Slope Down? Evidence from the MSCI Global Index Change By Hau, Harald; Massa, Massimo; Peress, Joël
  14. International Financial Adjustment By Gourinchas, Pierre-Olivier; Rey, Hélène
  15. Real Exchange Rate Overshooting RBC Style By Meenagh, David; Minford, Patrick; Nowell, Eric; Sofat, Prakriti
  16. The Common-Trend and Transitory Dynamics in Real Exchange Rate Fluctuations By Michael Bergman; Yin-Wong Cheung; Kon S. Lai
  17. Capital Inflows, Policy Responses, and Their Ill Consequences: Thailand, Malaysia, and Indonesia in the Decade Before the Crises By Clara Garcia
  18. Exchange Rate Regimes: Latin American Economic Analysis before the Depression By Kenneth P. Jameson

  1. By: Q. Farooq Akram (Norges Bank); Øyvind Eitrheim (Norges Bank); Lucio Sarno (Norges Bank)
    Abstract: We characterise the behaviour of Norwegian output, the real exchange rate and real money balances over a period of almost two centuries. The empirical analysis is based on a new annual data set that has recently been compiled and covers the period 1830{2003. We apply multivariate linear and smooth transition regression models proposed by Terasvirta (1998) to capture broad trends, and take into account non-linear features of the time series. We particularly investigate and characterise the form of the relationship between output and monetary policy variables. It appears that allowance for statedependent behaviour and response to shocks increases the explanatory powers of the models and helps bring forward new aspects of the dynamic behaviour of output, the real exchange rate and real money balances.
    Keywords: Business cycles, real exchange rates, money demand, non-linear modelling, smooth transition regressions.
    JEL: C51 E32 E41 F31
    Date: 2005–06–09
  2. By: Hui Guo; Robert Savickas
    Abstract: The paper documents a new empirical result that a high level of aggregate U.S. idiosyncratic stock return volatility is usually associated with a future appreciation in U.S. dollars. The relation is highly significant for most foreign currencies. For example, idiosyncratic volatility accounts for over 20 percent variations of the subsequent change in the Deutsche mark/U.S. dollar rate in the non-overlapping semi-annual data and its improvements over the random walk model in the out-of-sample forecast are statistically significant. We find the similar result*a positive and significant relation between a country*s aggregate idiosyncratic volatility and the future U.S. dollar price of its currency*in France, Germany, and Japan. Moreover, the U.S. default premium provides additional information about future exchange rates. Given that idiosyncratic volatility and the default premium are strong predictors of fundamentals, our results are consistent with monetary models of foreign exchange rates.
    Keywords: Foreign exchange ; International finance
    Date: 2005
  3. By: Égert, Balázs; Halpern, László; MacDonald, Ronald
    Abstract: In this Paper we present an overview of a number of issues relating to the equilibrium exchange rates of the new EU member states from Central and Eastern Europe. In particular, we present a critical overview of the various methods available for calculating equilibrium exchange rates and discuss how useful they are likely to be for the new member states. We then consider some methodological issues, relating to the implementation of an equilibrium exchange rate model for new member states, such as the speed with which equilibrium exchange rates change and issues of implementation. Finally, we present an overview of the various extant measures of equilibrium that have been calculated for the new member states.
    Keywords: Balassa-Samuelson effect; equilibrium exchange rate; Purchasing Power Parity; tradable prices; transition economies
    JEL: C15 E31 F31 O11 P17
    Date: 2004–12
  4. By: Burstein, Ariel Thomas; Eichenbaum, Martin; Rebelo, Sérgio
    Abstract: In this Paper we argue that the primary force behind the large drop in real exchange rates that occurs after large devaluations is the slow adjustment in the price of non-tradable goods and services. Our empirical analysis uses data from five large devaluation episodes: Argentina (2001), Brazil (1999), Korea (1997), Mexico (1994), and Thailand (1997). We conduct a detailed analysis of the Argentina case using disaggregated CPI data, data from our own survey of prices in Buenos Aires, and scanner data from supermarkets. We assess the robustness of our findings by studying large real-exchange-rate appreciations, medium devaluations, and small exchange-rate movements.
    JEL: F31
    Date: 2004–12
  5. By: Manuel Gomez (No affiliation); Michael Melvin (W. P. Carey School of Business Department of Economics)
    Abstract: Many observers were surprised by the depreciation of the euro after its launch in 1999. Handicapped by a short sample, explanations tended to appeal to anecdotes and lessons learned from the experiences of other currencies. Now sample sizes are just becoming large enough to permit reasonable empirical analyses. This paper begins with a theoretical model of pre- and post-euro foreign exchange trading that generates three possible causes of euro depreciation: a reduction in hedging opportunities due to the elimination of the legacy currencies, asymmetric information due to some traders having superior information regarding shocks to the euro exchange rate, and policy uncertainty on the part of the ECB. One empirical implication of the model is that higher transaction costs associated with the euro than the German mark may have contributed to euro depreciation. However, empirical evidence on percentage spreads tends to reject the hypothesis that percentage spreads were larger on the euro than the mark for all but the first few months. This seems like an unlikely candidate to explain euro depreciation over the prolonged period observed. Reviewing evidence on market dynamics around ECB, Bundesbank, and Federal Reserve meetings, there is no evidence suggesting that the market is "front running" in a different manner than the other central banks. However, we do find empirical support for the euro exchange rate to be affected by learning. By focusing on euro-area inflation as the key fundamental, the model is structured toward the dynamics of learning about ECB policy with regard to inflation. While a stated target inflation rate of 2 percent existed, it may be that market participants had to be convinced that the ECB would, indeed, generate low and stable inflation. The theory motivates an empirical model of Bayesian updating related to market participants learning about the underlying inflation process under the ECB regime. With a prior distribution drawn from the pre-euro EMS experience and updating based upon the realized experience each month following the introduction of the euro, the evidence suggests that it was not until the fall of 2000 that the market assessed a greater than 50 percent probability that the inflation process had changed to a new regime. From this point on, trend depreciation of the euro ends and further increases in the probability of the new inflation process are associated with euro appreciation.
  6. By: Égert, Balázs; Halpern, László
    Abstract: This Paper sets out to analyse the ever-growing literature on equilibrium exchange rates in the new EU member states of Central and Eastern Europe in a quantitative manner using meta-regression analysis. We study the extent to which the estimated real misalignments reported in the literature depend on the underlying theoretical approach (Balassa-Samuelson effect, Behavioural Equilibrium Exchange Rate, Fundamental Equilibrium Exchange Rate) and on other characteristics of the individual studies. We also seek to explore whether we can gain more insight from the literature regarding what determines the size and, perhaps more importantly, the sign of the estimated coefficient of the productivity variable and of two other variables commonly included in real exchange rate determination equations, notably net foreign assets and openness.
    Keywords: Balassa-Samuelson effect; equilibrium exchange rate; meta-analysis
    JEL: C15 E31 F31 O11 P17
    Date: 2005–01
  7. By: Blanchard, Olivier; Giavazzi, Francesco; Sa, Filipa
    Abstract: There are two main forces behind the large US current account deficits. First, an increase in the US demand for foreign goods. Second, an increase in the foreign demand for US assets. Both forces have contributed to steadily increasing current account deficits since the mid-1990s. This increase has been accompanied by a real dollar appreciation until late 2001, and a real depreciation since. The depreciation has accelerated recently, raising the questions of whether and how much more is to come, and if so, against which currencies, the euro, the yen, or the renminbi. Our purpose in this paper is to explore these issues. Our theoretical contribution is to develop a simple portfolio model of exchange rate and current account determination, and to use it to interpret the past and explore alternative scenarios for the future. Our practical conclusions are that substantially more depreciation is to come, surely against the yen and the renminbi, and probably against the euro.
    Keywords: current account; dollar exchange rate; portfolio models
    JEL: E30 F21 F32 F41
    Date: 2005–02
  8. By: van Tol, Michel R; Wolff, Christian C
    Abstract: In this paper we develop a multivariate threshold vector error correction model of spot and forward exchange rates that allows for different forms of equilibrium reversion in each of the cointegrating residual series. By introducing the notion of an indicator matrix to differentiate between the various regimes in the set of nonlinear processes we provide a convenient framework for estimation by OLS. Empirically, out-of sample forecasting exercises demonstrate its superiority over a linear VECM, while being unable to out-predict a (driftless) random walk model. As such we provide empirical evidence against the findings of Clarida and Taylor (1997).
    Keywords: foreign exchange; multivariate threshold cointegration; TAR models
    JEL: C51 C53 F31
    Date: 2005–03
  9. By: Mahesh Kumar Tambi (IIMT, Hyderabad-India)
    Abstract: In this paper we tried to build univariate model to forecast exchange rate of Indian Rupee in terms of different currencies like SDR, USD, GBP, Euro and JPY. Paper uses Box-Jenkins Methodology of building ARIMA model. Sample data for the paper was taken from March 1992 to June 2004, out of which data till December 2002 were used to build the model while remaining data points were used to do out of sample forecasting and check the forecasting ability of the model. All the data were collected from Indiastat database. Result of the paper shows that ARIMA models provides a better forecasting of exchange rates than simple auto- regressive models or moving average models. We were able to build model for all the currencies, except USD, which shows the relative efficiency of the USD currency market.
    Keywords: Exchange rate forecasting, univariate analysis, ARIMA, Box- Jenkins methodology, out of sample approach
    JEL: F3 F4
    Date: 2005–06–08
  10. By: Michele Cavallo; Kate Kisselev; Fabrizio Perri; Nouriel Roubini
    Abstract: Currency crises are usually associated with large nominal and real depreciations. In some countries depreciations are perceived to be very costly (“fear of floating”). In this paper we try to understand the reasons behind this fear. We first look at episodes of currency crises in the 1990s and establish that countries entering a crisis with high levels of foreign debt tend to experience large real exchange rate overshooting (devaluation in excess of the long-run equilibrium level) and large output contractions. We then develop a model of a small open economy that helps to explain this evidence. The key element of the model is the presence of a margin constraint on the domestic country. Real devaluations, by reducing the value of domestic assets relative to international liabilities, make countries with high foreign debt more likely to hit the constraint. When countries hit the constraint they are forced to sell domestic assets, and this causes a further devaluation of the currency (overshooting) and a reduction of their stock prices (overreaction). This fire sale can have a significant negative wealth effect. The model highlights a key tradeoff when considering fixed versus flexible exchange rate regimes; a fixed exchange regime can, by avoiding exchange rate overshooting, mitigate the negative wealth effect but at the cost of additional distortions and output drops in the short run. There are plausible parameter values under which fixed exchange rates dominate flexible exchange rates from a welfare perspective.
    Keywords: Foreign exchange rates ; Financial crises
    Date: 2005
  11. By: Hilde C. Bjørnland and Håvard Hungnes (Statistics Norway)
    Abstract: This paper addresses the purchasing power parity (PPP) puzzle for commodity currencies. A substantial part of the literature on commodity currencies has found that, despite controlling for the effect of commodity prices, PPP does not hold in the long run. We show that once we also control for the effect of the interest rate differential in the real exchange rate relationship, the discrepancies from PPP are fully accounted for. The analysis is applied to the real exchange rate behaviour in Norway, which has a primary commodity (oil) that constitutes the majority of its exports. We show that with the interest rate differential included in the long run real exchange rate relationship, the real oil price plays a minor role. Adjustment to equilibrium (half-lives) is also substantially reduced, taking no more than one year on average. Hence, contrary to earlier findings on commodity currencies, we have effectively removed the PPP puzzle.
    Keywords: Exchange rate; commodity currencies; real oil price; purchasing power parity; uncovered interest parity.
    JEL: C32 F31
    Date: 2005–05
  12. By: Dunne, Peter; Hau, Harald; Moore, Michael
    Abstract: Macroeconomic models of equity returns perform poorly. The proportion of daily index returns that these models explain is essentially zero. Instead of relying on macroeconomic determinants, our model includes a concept from microstructure order flow. Order flow is the proximate determinant of price in all microstructure models. We explain aggregate equity returns as well as exchange rates in a model with heterogenous beliefs. Belief changes are shown to be observable through order flow. To test the model we construct daily aggregate order flow data from all equity trades in the U.S. and France from 1999 to 2003. Almost 60% of the daily returns in the S&P100 index are explained jointly by exchange rate returns and macroeconomic order flows.
    Keywords: equities; exchange rates; international macroeconomics; microstructure
    JEL: F30 F31 G10 G15
    Date: 2004–12
  13. By: Hau, Harald; Massa, Massimo; Peress, Joël
    Abstract: Do exchange rates react to exogenous capital movements? We explore this issue based on the redefinition of the MSCI international equity indices announced on 10 December 2000 and implemented in two steps on 30 November 2001 and 31 May 2002. The index changes implied major changes in the representation of different countries in the MSCI world index. Our event study shows a strong announcement effect in which countries with a decreasing equity representation vis-a-vis the US depreciated against the dollar. Around the two implementation dates, we find further systematic, but opposite, exchange rate effects, which can be interpreted as a result of excessive speculation on the first implementation date and insufficient speculation on the second date.
    Keywords: event study; exchange rates; Global Equity Index Funds; Limits of Arbitrage
    JEL: F31 G12 G24
    Date: 2005–01
  14. By: Gourinchas, Pierre-Olivier; Rey, Hélène
    Abstract: The Paper proposes a unified framework to study the dynamics of net foreign assets and exchange rate movements. We show that deteriorations in a country’s net exports or net foreign asset position have to be matched either by future net export growth (trade adjustment channel) or by future increases in the returns of the net foreign asset portfolio (hitherto unexplored financial adjustment channel). Using a newly constructed data set on US gross foreign positions, we find that stabilizing valuation effects contribute as much as 31% of the external adjustment. Our theory also has asset-pricing implications. Deviations from trend of the ratio of net exports to net foreign assets predict net foreign asset portfolio returns one quarter to two years ahead and net exports at longer horizons. The exchange rate affects the trade balance and the valuation of net foreign assets. It is forecastable in and out of sample at one quarter and beyond. A one standard deviation decrease of the ratio of net exports to net foreign assets predicts an annualized 4% depreciation of the exchange rate over the next quarter.
    Keywords: exchange rates; external adjustment; MeeseRogoff; net foreign assets; valuation
    JEL: F31 F32
    Date: 2005–02
  15. By: Meenagh, David; Minford, Patrick; Nowell, Eric; Sofat, Prakriti
    Abstract: This paper establishes the ability of a Real Business Cycle model to account for real exchange rate (RXR) behaviour, using UK experience as empirical focus. We show that a productivity burst simulation is capable of explaining the appreciation of RXR and its cyclical pattern observed in the data. We then test if our model is consistent with the facts. We bootstrap our model to generate pseudo RXR series and check if the ARIMA parameters estimated for the data lie within 95% confidence limits implied by our model. We find that RXR behaviour is explicable within an RBC framework.
    Keywords: productivity; real business cycle; real exchange rate
    JEL: E32 F31 F41
    Date: 2005–04
  16. By: Michael Bergman (Institute of Economics, University of Copenhagen); Yin-Wong Cheung (University of California, Santa Cruz); Kon S. Lai (California State University, Los Angeles)
    Abstract: This study explores the sources of real exchange rate fluctuations under the current float. Using a cointegration model of the real exchange rate, the innovations are decomposed into transitory and common-trend components. Both transitory and common-trend innovations are found to explain an appreciable portion of real exchange rate fluctuations, albeit their relative importance can vary across major currencies. Further analysis suggests that common-trend innovations are attribut- able to both productivity and monetary changes, albeit transitory innovations are linked primarily to monetary changes. The empirical results are largely consistent with an open-economy macroeconomic model.
    Keywords: real exchange rate; common trend; productivity shock; monetary shock
    JEL: F31 F41
    Date: 2005–05
  17. By: Clara Garcia
    Abstract: Capital inflows, especially when volatile, denominated in foreign currencies and not properly hedged against exchange rate risks, may pose macroeconomic and financial problems in the recipient economy. In this paper we analyze the mechanisms through which those problems arise; and we assess the policies that national authorities may resort to in order to prevent them, under the assumption that capital inflows are the result of previous stabilization and liberalization packages. Also, we study the use and effectiveness of policy responses to capital inflows in Thailand, Malaysia, and Indonesia in the years prior to the 1997-98 financial crises. We conclude that policies that reinforce the stabilization and adjustment trends of the 1980s are more likely to be (at least partially) ineffective or even counterproductive, whereas the measures that depart from those trends appear to have a higher potential for effectiveness but face obstacles to implementation.
    Date: 2004
  18. By: Kenneth P. Jameson
    Abstract: The early twentieth century role of U.S. “money doctors” in establishing Latin American exchange rate regimes and monetary institutions is relatively well known. For example, the work of Edwin Kemmerer in the Andes has been extensively documented. Not so well-known is the work of Latin American economists on these same issues. This paper examines a number of cases where the Latin American analysts were active players and participants in analyzing the exchange rate and monetary issues and in formulating domestic policy to address them. The role of Latin American economists in a variety of international monetary conferences and commissions from 1903-1922 is investigated. In addition, the paper describes how Alberto Pani guided the formulation of Mexican economic policy after the Mexican Revolution and his ability to chart an independent course for Mexico. The conclusion is that there is evidence of “intense discussions of economic issues” based on Latin Americans’ economic analysis. The role of foreign advisors was often to break the political impasse and to recommend the policy the inviting government wanted to implement.
    Keywords: exchange rate; Latin America; depression
    JEL: B1 E42 F3
    Date: 2005–06

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