nep-ifn New Economics Papers
on International Finance
Issue of 2005‒12‒20
nine papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. The Information in Long-Maturity Forward Rates: Implications for Exchange Rates and the Forward Premium Anomaly By Jacob Boudoukh; Matthew Richardson; Robert Whitelaw
  2. Monetary Policy News and Exchange Rate Responses: Do Only Surprises Matter? By Rasmus Fatum; Barry Scholnick
  3. Monetary policy and exchange rate interactions in a small open economy By Hilde C. Bjørnland
  4. The Importance of Nontradable Goods' Prices in Cyclical Real Exchange Rate Fluctuations By Ariel Burstein; Martin Eichenbaum; Sergio Rebelo
  5. Does a free trade area favors an optimum currency area? The Case of Morocco and the European Union By Lahcen ACHY; Juliette Milgram
  6. Trade, Production-Sharing and the Exchange Rate: A Decade of U.S.-Mexican Integration By Sven W. Arndt; Alex Huemer
  7. Reduced-Rank Identification of Structural Shocks in VARs By Yuriy Gorodnichenko

  1. By: Jacob Boudoukh; Matthew Richardson; Robert Whitelaw
    Abstract: The forward premium anomaly is one of the most robust puzzles in financial economics. We recast the underlying parity relation in terms of cross-country differences between forward interest rates rather than spot interest rates with dramatic results. These forward interest rate differentials have statistically and economically significant forecast power for annual exchange rate movements, both in- and out-of-sample, and the signs and magnitudes of the corresponding coefficients are consistent with economic theory. Forward interest rates also forecast future spot interest rates and future inflation. Thus, we attribute much of the forward premium anomaly to the anomalous behavior of short-term interest rates, not to a breakdown of the link between fundamentals and exchange rates.
    JEL: G15 F31
    Date: 2005–12
  2. By: Rasmus Fatum (School of Business, University of Alberta); Barry Scholnick (School of Business, University of Alberta)
    Abstract: This paper shows that exchange rates respond to only the surprise component of an actual US monetary policy change and that failure to disentangle the surprise component from the actual monetary policy change can lead to an underestimation of the impact of monetary policy, or even to a false acceptance of the hypothesis that monetary policy has no impact on exchange rates. This finding implies that there is a need for reexamining the empirical analyses of asset price responses to macro news that do not isolate the unexpected component of news from the expected element. In addition, we add to the debate on how quickly exchange rates respond to news by showing that the exchange rates under study absorb monetary policy surprises within the same day as the news are announced.
    Keywords: expectations; monetary policy; federal funds futures; exchange rates
    JEL: E52 F31 G14
    Date: 2005–11
  3. By: Hilde C. Bjørnland (University of Oslo and Norges Bank (Central Bank of Norway))
    Abstract: This paper analyses the transmission mechanisms of monetary policy in a small open economy like Norway through structural VARs, paying particular attention to the interdependence between the monetary policy stance and exchange rate movements in the inflation-targeting period. Previous studies of the effects of monetary policy in open economies have typically found small or puzzling effects on the exchange rate; puzzles that may arise due to the recursive restrictions imposed on the contemporaneous interaction between monetary policy and the exchange rate. By instead imposing a long-run neutrality restriction on the real exchange rate, thereby allowing the interest rate and the exchange rate to react simultaneously to any news, the interdependence increases considerably. In particular, following a contractionary monetary policy shock, the real exchange rate appreciates immediately and thereafter depreciates back to baseline. Furthermore, output and consumer price inflation fall gradually as expected; thereby also ruling out any price puzzle that has commonly been found in the literature. Results are compared and found to be consistent with among other the findings from an “event study” that focuses on immediate responses in asset prices following a surprise monetary policy decision.
    Keywords: VAR, monetary policy, open economy, identification, event study
    JEL: C32 E52 F31 F41
    Date: 2005–05–15
  4. By: Ariel Burstein (University of California at Los Angeles); Martin Eichenbaum (Northwestern University, NBER, and Federal Reserve of Chicago.); Sergio Rebelo (Northwestern University, NBER, and CEPR.)
    Abstract: Changes in the price of nontradable goods relative to tradable goods account for roughly 50 percent of the cyclical movements in real exchange rates
    JEL: F31
    Date: 2005–12
  5. By: Lahcen ACHY (INSEA, Rabat, Morocco); Juliette Milgram (Grenade University, Spain)
    Abstract: The purpose of this paper is to investigate simultaneously the potential effects of European Union's Association Agreement with Morocco and the adoption of the Euro as a single currency on exchange rate regime of Moroccan Dirham. Since Morocco depends heavily on EU as a market for its exports and a source for its imports, limited variability of the DH against the Euro seems à priori, to be an appropriate policy option. This option may even be strengthened within the FTA. However, the nature and the composition of Moroccan exports are typical of North-South trade with little diversification and high concentration on textiles and agricultural products. From this perspective, the risk of asymmetric shocks is more likely, which reduces the expected gains from nominal anchorage. This paper aims at contributing to the future exchange rate regime in Morocco and focuses on three main issues. The first issue is to investigate the potential effects of the FTA on trade structure and industrial specialization in Morocco. To this end, a computable general equilibrium model is used to simulate macroeconomic and sectoral effects of the implementation of the FTA on industrial sector. The second issue is to estimate the real exchange rate equilibrium based on macroeconomic fundamentals and assess the degree of misalignment of the actual value of the Dirham. Finally, the question of exchange rate arrangement is examined by combining the expected effects of free trade area between Morocco and the European Union, the existing degree of misalignment of the Dirham, and considering the adoption of the Euro as a single currency in 12 European countries. Our results seem to suggest that the implementation of a FTA may lead to a reallocation of industrial production toward an even more specialization in labor-intensive products. Under such circumstances, the symmetry of shocks, as an important condition for anchoring the DH to the Euro, is not satisfied making this option non-desirable.
    Keywords: Free Trade Area, CGE Model, Exchange rate
    JEL: F1 F2
    Date: 2005–12–14
  6. By: Sven W. Arndt; Alex Huemer (Lowe Institute of Political Economy, Claremont McKenna College)
    Abstract: This paper examines the effect of cross-border production sharing on the sensitivity of trade to the exchange rate and to other key variables. Theoretically, the response of a country's exports to the exchange rate should decline as the share of exported components for use in the manufacture of its imports rises. Similarly, the response of its imports of end products should decline as the share of its exported components in those imports rises. The response of a country's imports to domestic GDP should decline and the response to the exporting country's GDP should rise as the share of imported components for use in the manufacture of exports rises. These propositions are tested for trade between the U.S. and Mexico, using OLS and VEC techniques and allowing for the impact of NAFTA. The findings broadly confirm the aforementioned priors. In addition to their implications for trade-balance adjustment, these results have potentially important implications for the choice of exchange-rate regime.
    Keywords: trade balance; fragmentation; intra-industry trade; exchange rates; NAFTA.
    JEL: F14 F15 F32
  7. By: Yuriy Gorodnichenko (University of Michigan)
    Abstract: This paper integrates imposing a factor structure on residuals in vector autoregressions (VARs) into structural VAR analysis. Identification, estimation and testing procedures are discussed. The paper applies this approach to the well-known problem of studying the effects of monetary policy in open economy VAR models. The use of factor structure in identifying structural shocks is shown to resolve three long-standing puzzles in VAR literature. First, the price level does not increase in response to a monetary tightening. Second, the exchange rate appreciates on impact and then gradually depreciates. Hence, no price level and exchange rate puzzles are found. Third, monetary policy shocks are much less volatile than suggested by standard VAR identification schemes. In addition, the paper suggests that the apparent weak contemporaneous cross-variable responses and strong own responses in structural VARs can be an artifact of identifying assumptions and vanish after imposing a factor structure on the shocks.
    Keywords: Vector autoregressions, identification, factor structure, monetary policy
    JEL: E52 C32
    Date: 2005–12–15
  8. By: Dimitris Kenourgios (Athens University of Economics & Business)
    Abstract: The FTSE/ASE-20 futures market, as the first organised Greek derivatives market, established in August 1999 and its operation rests with the Athens Derivatives Exchange (ADEX) and the Athens Derivatives Exchange Clearing House (ADECH). Cointegration tests are used and an error correction model is developed in order to examine the relationship between price movements of FTSE/ASE-20 three-month futures index and the underlying cash market in Athens Stock Exchange (ASE). Ôhe investigation of its price discovery mechanism has been motivated by the existing paucity of similar research in such newly established (emerging) futures markets and the growing importance of this market for both investors and the Greek capital market. The results show the presence of a bi- directional causality between stock index spot and futures markets, indicating that the newly established ADEX can provide futures contracts that serve as a focal point of information assimilation and fulfil their price discovery.
    Keywords: Athens Derivatives Exchange, FTSE/ASE 20 futures contract, Price discovery, Cointegration analysis, Causality
    JEL: G13 G14
    Date: 2005–12–12
  9. By: Dimitris Kenourgios (Athens University of Economics & Business)
    Abstract: This paper investigates the joint hypothesis of market efficiency and unbiasedness of futures prices for the FTSE-20 blue chip index futures contract. The FTSE/ATHENS STOCK EXCHANGE (ASE)-20 futures market is the first organized derivatives market established in Greece and its operation rests with the Athens Derivatives Exchange (ADEX) and the Athens Derivatives Exchange Clearing House (ADECH). The growing importance of this new market for both investors and the Greek capital market motivated this empirical examination of its efficiency, even though it is an emerging market with low liquidity, compared to other European developed futures markets, but strong growth rates. The Johansen cointegration procedure used to test the market efficiency shows that the joint hypothesis of market efficiency and unbiasedness in futures prices is rejected, indicating market inefficiency. This finding is consistent to earlier but limited studies in other European emerging futures markets, implying that, despite the significant role of an organized futures/derivatives market for a capital market and an economy more general, further necessary steps have to be taken in order to contribute to its efficiency.
    Keywords: Market efficiency, Unbiasedness hypothesis, Athens Derivatives Exchange, FTSE/ASE-20 futures market
    JEL: G13 G14
    Date: 2005–12–12

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