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on International Finance |
| 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 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2005-07&r=ifn |
| By: | Yin-Wong Cheung; Kon S. Lai |
| Abstract: | This study investigates whether exchange rate flexibility aids real exchange rate adjustment based on intra-period data on dual exchange rates from developing countries. Specifically, it analyzes whether the flexible parallel market rate produces faster or slower real exchange rate adjustment than the much less flexible official rate does. Half-life estimates of adjustment speeds are obtained using fractional time series analysis. We find no systematic evidence that greater exchange rate flexibility tends to produce faster or slower real exchange rate adjustment, albeit there is substantial heterogeneity in speed estimates across countries. With officially pegged exchange rates, developing countries often use parallel exchange markets as a back-door channel to facilitate real exchange rate adjustment, but the empirical evidence suggests that these parallel markets in most cases fail to help promote real rate adjustment. |
| Keywords: | real exchange rate, fractional time series, half life |
| JEL: | C22 F31 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_1512&r=ifn |
| By: | Menzie Chinn; Jeffrey Frankel |
| Abstract: | Might the dollar eventually follow the precedent of the pound and cede its status as leading international reserve currency? Unlike ten years ago, there now exists a credible competitor: the euro. This paper econometrically estimates determinants of the shares of major currencies in the reserve holdings of the world’s central banks. Significant factors include: size of the home country, inflation rate (or lagged depreciation trend), exchange rate variability, and size of the relevant home financial center (as measured by the turnover in its foreign exchange market). We have not found that net international debt position is an important determinant. Network externality theories would predict a tipping phenomenon. Indeed we find that the relationship between currency shares and their determinants is nonlinear (which we try to capture with a logistic function, or else with a dummy “leader” variable for the largest country). But changes are felt only with a long lag (we estimate a weight on the preceding year’s currency share around .9). The advent of the euro interrupts the continuity of the historical data set. So we estimate parameters on pre-1999 data, and then use them to forecast the EMU era. The equation correctly predicts a (small) narrowing in the gap between the dollar and euro over the period 1999-2004. Whether the euro might in the future rival or surpass the dollar as the world’s leading international reserve currency appears to depend on two things: (1) do the United Kingdom and enough other EU members join euroland so that it becomes larger than the US economy, and (2) does US macroeconomic policy eventually undermine confidence in the value of the dollar, in the form of inflation and depreciation. What we learn about functional form and parameter values helps us forecast, contingent on these two developments, how quickly the euro might rise to challenge the dollar. Under two important scenarios the remaining EU members, including the UK, join EMU by 2020 or else the recent depreciation trend of the dollar persists into the future the euro may surpass the dollar as leading international reserve currency by 2022. |
| JEL: | F02 F31 F33 |
| Date: | 2005–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11510&r=ifn |
| By: | Theodore Panagiotidis (Loughborough University) |
| Abstract: | The behaviour of an emerging market, the Athens Stock Exchange (ASE), after the introduction of the euro is investigated. The underlying assumption is that stock prices would be more transparent; their performance easier to compare; the exchange rate risk eliminated and as a result we expect the new currency to strengthen the argument, in favour of the EMH. The General ASE Composite Index and the FTSE/ASE 20, which consists of “high capitalisation” companies, are used. Five statistical tests are employed to test the residuals of the random walk model: the BDS, McLeod-Li, Engle LM, Tsay and Bicovariance test. Bootstrap and asymptotic values of these tests are estimated. Alternative models from the GARCH family (GARCH, EGARCH and TGARCH) are also presented in order to investigate the behaviour of the series. Lastly, linear, asymmetric and non-linear error correction models are estimated and compared. |
| Keywords: | Non-Linearity, Market Efficiency, Random Walk, GARCH, non- linear error correction |
| JEL: | C22 C52 G10 |
| Date: | 2005–07–29 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpfi:0507022&r=ifn |
| By: | Prasad V. Bidarkota (Department of Economics, Florida International University) |
| Abstract: | We investigate time varying risk premia in forward dollar/pound monthly exchange rates over the last two decades. We study this issue using a signal plus noise model and separately using regression techniques. Our models account for time varying volatility and non-normalities in the observed series. Our signal plus noise model fails to isolate a statistically significant risk premium component whereas our regression model does. We attribute the discrepancy in the results from the two methods to the low power of the signal plus noise model in discriminating between a time varying risk premium component and a serially uncorrelated spot exchange rate expectational error. An important reason for the low power of the signal plus noise model is its failure to use information on current period forward rates in extracting the risk premium. |
| Keywords: | spot foreign exchange rates; forward foreign exchange rates; timevarying risk premium; signal extraction; non-normality; volatility persistence |
| JEL: | F31 C5 G12 |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:fiu:wpaper:0501&r=ifn |
| By: | Anne-Marie Brook; Patrice Ollivaud; Franck Sédillot |
| Abstract: | <P>In this paper the OECD’s interlink model is used to explore several possible channels through which a narrowing of the US current account deficit could occur. The shocks considered include dollar depreciation, fiscal consolidation, and an improvement in the non-price competitiveness of US producers. A key conclusion is that shocks would have to be very large in order to materially reduce the US external deficit. In part, this is because second-round effects, including domestic policy responses, tend to offset the shocks’ initial impact. In addition, it is clear that each of the channels for narrowing the deficit involves risks to growth in the rest of the world, particularly in Japan where the authorities have limited room to use monetary or fiscal policy to offset any contractionary pressures. The exchange rate simulations highlight the fact that more exchange rate flexibility in Asia would spread the burden of adjustment more evenly across US trading partners. Attention is also ...</P> <P>Des canaux permettant de réduire le déficit de la balance courante américaine et leurs implications pour les autres économies <P>Dans cette étude, le model Interlink de l’OCDE est utilisé pour étudier quelques moyens permettant de réduire le déficit courant américain. Les chocs considérés inclus une dépréciation du dollar, une consolidation fiscale et une amélioration de la compétitivité hors-prix des producteurs américains. Un des principaux enseignements de cette étude est que les chocs doivent être suffisamment importants pour diminuer de façon significative le déficit courant des États-Unis. Ceci est dû en partie au fait que les effets de second tour, incluant politiques économiques nationales, tendent à compenser l’impact du choc initial. En plus, chacun des chocs étudiés se traduit par des risques sur la croissance des autres régions du monde, particulièrement au Japon ou la marge de manoeuvre des autorités monétaire et budgétaire pour contrebalancer les pressions récéssionistes est limitée. Les simulations du taux de change soulignent qu’une plus grande flexibilité du taux de change en Asie ...</P> |
| Keywords: | simulations, simulations, international transmission, current account adjustment, ajustement du compte courant, transmission internationale |
| JEL: | F32 F42 F47 |
| Date: | 2004–05–18 |
| URL: | http://d.repec.org/n?u=RePEc:oec:ecoaaa:390-en&r=ifn |
| By: | Hurd, Matthew; Salmon, Mark; Schleicher, Christoph |
| Abstract: | We model the joint risk neutral distribution of the euro-sterling and the dollar-sterling exchange rates using option-implied marginal distributions that are connected via a copula function that satisfies the triangular no-arbitrage condition. We then derive a univariate distribution for a simplified sterling effective exchange rate index (ERI). Our results indicate that standard parametric copula functions, such as the commonly used Normal and Frank copulas, fail to capture the degree of asymmetry observed in the data. We overcome this problem by using a non-parametric dependence function in the form of a Bernstein copula, which is shown to produce a very close fit. We further give an example of how our approach can be used to price currency index options. |
| Keywords: | copulae; exchange rates; option implied pdfs; triangular arbitrage |
| JEL: | F31 G12 |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5114&r=ifn |
| By: | Anne-Laure Baldi; Nanno Mulder |
| Abstract: | <P>This paper analyses the impact of exchange rate regimes on real exchange rates, as defined by the relative price of nontradables to tradables in Argentina, Brazil, Chile (ABC) and Mexico from 1990 to 2002. The real exchange rate is determined in the long-run by the Balassa-Samuelson effect, but in the medium run also by government expenditure and terms of trade. Another determinant is fixed exchange rate regimes, which force exporters to adjust their local price of tradables. Moreover, fixed regimes attract portfolio inflows that increase demand and prices for nontradables. The econometric results of the paper confirm the impact of exchange rate regimes on relative prices in all countries except Chile, which maintained exchange rate flexibly and adopted capital controls ...</P> <P>L'impact des régimes de change sur le taux de change réel en Amérique latine, 1990-2002 <P>Cet article analyse l'impact des régimes de change sur le taux de change réel- défini comme le prix relatif des biens du secteur abrité et des biens du secteur exposé- en Argentine, Brésil, Chili (ABC) et au Mexique de 1990 à 2002. Le taux de change réel est déterminé dans le long terme par l'effet Balassa- Samuelson et à moyen terme par les dépenses du gouvernement et les termes de l'échange. Les régimes de change fixes peuvent constituer un nouveau déterminant car ils forcent les exportateurs à geler le prix local des biens échangeables. Simultanément ils attirent des flux de portefeuille qui exercent une pression à la hausse sur la demande et donc les prix des biens abrités. Les résultats économétriques de l'article confirment l'impact des régimes de change sur les prix relatifs de tous les pays sauf le Chili qui a aintenu une flexibilité de change et imposé des contrôles de capitaux ...</P> |
| Keywords: | exchange rate policy, real exchange rates, Latin America, politique de change, taux de change reels, Amérique latine |
| JEL: | E52 N16 |
| Date: | 2004–06–30 |
| URL: | http://d.repec.org/n?u=RePEc:oec:ecoaaa:396-en&r=ifn |
| By: | Pavlova, Anna; Rigobon, Roberto |
| Abstract: | This paper examines the co-movement among stock market prices and exchange rates within a three-country Centre-Periphery dynamic equilibrium model in which agents in the Centre country face portfolio constraints. In our model, international transmission occurs through the terms of trade, through the common discount factor for cash flows, and, finally, through an additional channel reflecting the tightness of the portfolio constraints. Portfolio constraints are shown to generate endogenous wealth transfers to or from the Periphery countries. These implicit transfers are responsible for creating contagion among the terms of trade of the Periphery countries, as well as their stock market prices. Under a portfolio constraint limiting investment of the Centre country in the stock markets of the Periphery, stock prices also exhibit a flight to quality: a negative shock to one of the Periphery countries depresses stock prices throughout the Periphery, while boosting the stock market in the Centre. |
| Keywords: | asset pricing; contagion; international finance; portfolio constraints; terms of trade |
| JEL: | F31 F36 G12 G15 |
| Date: | 2005–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5117&r=ifn |
| By: | Michel Beine (DULBEA, Université libre de Bruxelles, Brussels); Oscar Bernal (DULBEA, Université libre de Bruxelles, Brussels) |
| Abstract: | This paper empirically investigates the main determinants of secret interventions in the foreign exchange (FX) market. Using the recent experience of the Bank of Japan, we estimate a model that explains the share of secret to reported interventions in the FX market. Two sets of determinants are clearly identified: the first is related to the probability of detection of the central bank orders by market participants; the second, to the central bank’s internal decision to opt for secrecy. Our estimations support the arguments of current microstructure theories that rationalize the use of secret interventions. |
| Keywords: | Central Bank Interventions, Exchange Rates Market, Secrecy Puzzle. |
| JEL: | E58 F31 G15 |
| Date: | 2005–04 |
| URL: | http://d.repec.org/n?u=RePEc:dul:wpaper:05-09rs&r=ifn |
| By: | Hui Huang; Yi Wang; Yiming Wang; John Whalley; Shunming Zhang |
| Abstract: | We combine a model of combined inter-spatial and inter-temporal trade between countries recently — used by Huang, Whalley and Zhang (2004) to analyze the merits of trade liberalization in services when goods trade is restricted — with a model of foreign exchange rationing due to Clarete and Whalley (1991) in which there is a fixed exchange rate with a surrender requirement for foreign exchange generated by exports. In this model, when services remain unliberalized there is an optimal trade intervention, even in the small open price-taking economy case. Given monetary policy and an endogenously determined premium value on foreign exchange, an optimal setting of the exchange rate can provide the optimal trade intervention. We suggest this model has relevance to the current situation in China where services remain unliberalized and tariff rates are bound in the WTO. Since there is an optimal exchange rate, a move to a free Renminbi float can be welfare worsening. We use numerical simulation methods to explore the properties of the model, since it has no closed form solution. Our analysis provides an intellectual counter argument to those presently advocating a free Renminbi float for China. |
| JEL: | F00 F11 F31 F40 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_1471&r=ifn |
| By: | Menzie D. Chinn |
| Abstract: | Several alternative measures of "effective" exchange rates are discussed in the context of their theoretical underpinnings and actual construction. Focusing on contemporary indices and recently developed econometric methods, the empirical characteristics of these differing series are examined, including the exchange rates for the U.S., the euro area and several East Asian countries. The issues that confront the applied economist or policymaker in using the measures of real effective exchange rates available are illustrated in several case studies from current interest: (i) evaluating exchange rate misalignment, (ii) testing the Balassa-Samuelson effect, (iii) estimating the price responsiveness of trade flows, and (iv) assessing the potential impact of competitive devaluations. |
| JEL: | F31 F41 |
| Date: | 2005–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11521&r=ifn |