nep-ifn New Economics Papers
on International Finance
Issue of 2006‒04‒08
thirteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  2. Nonlinearity in Deviations from Uncovered Interest Parity: An Explanation of the Forward Bias Puzzle By Leon, Hyginus; Sarno, Lucio; Valente, Giorgio
  3. The Interaction Between Capital Controls and Exchange Rate Regimes: Evidence from Developing Countries By von Hagen, Jürgen; Zhou, Jizhong
  4. "A New Approach to Modeling Early Warning Systems for Currency Crises : can a machine-learning fuzzy expert system predict the currency crises effectively?" By Chin-Shien Lin; Haider A. Khan; Ying-Chieh Wang; Ruei-Yuan Chang
  5. Exchange Rate Volatility and Productivity Growth: The Role of Financial Development By Philippe Aghion; Philippe Bacchetta; Romain Ranciere; Kenneth Rogoff
  6. Sovereign Risk in the Classical Gold Standard Era By Gavin Cameron; Kang Yong Tan; Prasanna Gai
  7. Monetary Policy and Exchange Rate Dynamics: New Evidence from the Narrative Approach to Shock Identification By John C. Bluedorn; Christopher Bowdler
  8. On the Equality of Real Interest Rates Across Borders in Integrated Capital Markets By Minford, Patrick; Peel, David
  9. Fear of Floating and Fear of Pegging: An Empirical Analysis of De Facto Exchange Rate Regimes in Developing Countries By von Hagen, Jürgen; Zhou, Jizhong
  10. Hedging, Speculation, and Investment in Balance-Sheet Triggered Currency Crises By Andreas Röthig; Willi Semmler; Peter Flaschel
  11. "Intra-day Seasonality in Activities of the Foreign Exchange Markets: Evidence from the Electronic Broking System" By Takatoshi Ito; Yuko Hashimoto
  12. Optimal Monetary Policy in a Small Open Economy with Home Bias By Faia, Ester; Monacelli, Tommaso
  13. The Effects of Uncertainty on Currency Substitution and Inflation: Evidence from Emerging Economies By K C Neanidis; C S Savva

  1. By: Michael Bleaney
    Abstract: Fundamentals may determine the range of real exchange rate fluctuation, through signals of misalignment, even if they are not a major influence on the level within that range. This can explain the puzzle that more open economies experience lower real exchange rate volatility. Adjustment of domestic prices to nominal exchange rate movements can account for only a small proportion of this effect. Sustainability analysis focuses on the ratio of the current account to GDP (rather than to total trade flows) as a misalignment signal, which implies narrower bounds for real exchange rates in more open economies.
  2. By: Leon, Hyginus; Sarno, Lucio; Valente, Giorgio
    Abstract: We provide empirical evidence that deviations from the uncovered interest rate parity (UIP) condition display significant nonlinearities, consistent with theories based on transactions costs or limits to speculation. This evidence suggests that the forward bias documented in the literature may be less indicative of major market inefficiencies than previously thought. Monte Carlo experiments allow us to reconcile these results with the large empirical literature on the forward bias puzzle since we show that, if the true process of UIP deviations were of the nonlinear form we consider, estimation of conventional spot-forward regressions would generate the anomalies documented in previous research.
    Keywords: foreign exchange; forward bias; nonlinearity; uncovered interest parity
    JEL: F31
    Date: 2006–03
  3. By: von Hagen, Jürgen; Zhou, Jizhong
    Abstract: The choice of the exchange rate regime and the capital account regime are among the core macro economic policy decisions for developing countries, with important repercussions for a country's macro economic stability, ability to attract foreign capital, and international trade. Existing literature has considered the determinants of these decisions, taking the capital account regime as given when considering the exchange rate regime and vice versa. This paper provides an empirical analysis of the interaction between the two regime choices treating both as simultaneously endogenous. Using a panel data set for developing countries in the 1980s and 1990s, we estimate a simultaneous-equations panel mixed logit model for the joint determination of both choices. We find strong influences from the official, de jure exchange rate regime on capital account policies, but only weak feedback effects. Using de-facto exchange rate regimes, the influences in both directions are similar to each other.
    Keywords: capital controls; exchange rate regimes; panel mixed logit model; simultaneous equations model
    JEL: C33 C35 F20 F33
    Date: 2006–03
  4. By: Chin-Shien Lin (National Chung Hsing University); Haider A. Khan (GIGS, University of Denver); Ying-Chieh Wang (Providence University); Ruei-Yuan Chang (Providence University)
    Abstract: This paper presents a hybrid model for predicting the occurrence of currency crises by using the neuro fuzzy modeling approach. The model integrates the learning ability of neural network with the inference mechanism of fuzzy logic. The empirical results show that the proposed neuro fuzzy model leads to a better prediction of crisis. Significantly, the model can also construct a reliable causal relationship among the variables through the obtained knowledge base. Compared to the traditionally used techniques such as logit, the proposed model can thus lead to a somewhat more prescriptive modeling approach towards finding ways to prevent currency crises.
    Date: 2006–04
  5. By: Philippe Aghion; Philippe Bacchetta; Romain Ranciere; Kenneth Rogoff
    Abstract: This paper offers empirical evidence that real exchange rate volatility can have a significant impact on long-term rate of productivity growth, but the effect depends critically on a country’s level of financial development. For countries with relatively low levels of financial development, exchange rate volatility generally reduces growth, whereas for financially advanced countries, there is no significant effect. Our empirical analysis is based on an 83country data set spanning the years 1960-2000; our results appear robust to time window, alternative measures of financial development and exchange rate volatility, and outliers. We also offer a simple monetary growth model in which real exchange rate uncertainty exacerbates the negative investment effects of domestic credit market constraints. Our approach delivers results that are in striking contrast to the vast existing empirical exchange rate literature, which largely finds the effects of exchange rate volatility on real activity to be relatively small and insignificant.
    Date: 2006–03
  6. By: Gavin Cameron; Kang Yong Tan; Prasanna Gai
    Abstract: This paper explores the determinants of sovereign bond yields during the classical gold standard period (1872-1913). Using the Pooled Mean Group methodology, we find that the main benefit of the gold standard can be seen as a short-hand device that enhanced a country`s reputation in international capital markets. By conveying important information to investors and enhancing the speed of adjustment of sovereign bond spreads to long-run equilibrium levels, the gold standard allowed country risk to be priced more effectively. In contrast to other studies, our results indicate that fundamental factors appear to be more important in determining a country`s creditworthiness in the long-run than the exchange rate regime per se.
    Keywords: Gold Standard, Sovereign Risk, Heterogeneous Dynamic Panels, Pooled Mean Group Estimator
    JEL: F33 F34 F41 N10 N20
    Date: 2006
  7. By: John C. Bluedorn (Nuffield College, Oxford University); Christopher Bowdler (Nuffield College, Oxford University)
    Abstract: We argue that endogenous and anticipated movements in interest rates lead to underestimates of the speed and magnitude of the exchange rate response to monetary policy. Employing the Romer and Romer (2004) exogenous monetary policy shock measure, we find that the effect of a one percentage point increase in the U.S. interest rate is up to twice as large and 3 times as fast as that obtained using the actual federal funds rate to identify monetary shocks. Moreover, new evidence from open economy VARs emphasises the adjustment role of the exchange rate. U.S. prices and output respond almost twice as quickly as they do in a closed economy VAR using the Romer and Romber shock measure. There is also evidence of stronger international transmission of U.S. monetary shocks. Overall, the estimated response speeds and magnitudes are more easily reconciled with existing models than previous empirical work.
    Keywords: monetary policy shocks, exchange rate dynamics, open economy VARs
    JEL: E52 F31 F41
    Date: 2005–08–01
  8. By: Minford, Patrick; Peel, David
    Abstract: The purpose in this letter is first to review briefly the empirical results on the relationship between real interest rates and real exchange rates; this empirical literature provides little support for the hypothesis of Roll that expected real interest rates are equal in general. Our second aim is to discuss the theoretical conditions that have to be met for his hypothesis to hold.
    Keywords: real exchange rates; real interest rates; roll
    JEL: C22 C51 F31
    Date: 2006–04
  9. By: von Hagen, Jürgen; Zhou, Jizhong
    Abstract: This paper uses a panel probit model with simultaneous equations to explain the joint determination of de facto and de jure exchange rate regimes in developing countries since 1980. We also derive an ordered-choice panel probit model to explain the causes of discrepancies between the two regime choices. Both models are estimated using simulation-based maximum likelihood methods. The results of the simultaneous equations model suggest that the two regime choices are dependent of each other and exhibit considerable state dependence. The ordered probit model provides evidence that regime discrepancies reflect an error-correction mechanism, and the discrepancies are persistent over time.
    Keywords: de facto exchange rate regimes; developing countries; simulated maximum likelihood; simultaneous equations model
    JEL: C35 F33 F41
    Date: 2006–03
  10. By: Andreas Röthig (Institut für Volkswirtschaftslehre (Department of Economics), Technische Universität Darmstadt (Darmstadt University of Technology)); Willi Semmler (Institut für Volkswirtschaftslehre (Department of Economics), Universität Bielefeld (University of Bielefeld)); Peter Flaschel (Institut für Volkswirtschaftslehre (Department of Economics), Universität Bielefeld (University of Bielefeld))
    Abstract: This paper explores the linkage between corporate risk management strategies, investment, and economic stability in an open economy with a flexible exchange rate regime. Firms use currency futures contracts to manage their exchange rate exposure - caused by balance sheet effects as in Krugman (2000) - and therefore their investments' sensitivity to currency risk. We find that, depending on whether futures contracts are used for risk reduction (i.e., hedging) or risk taking (i.e., speculation), the implied magnitudes of recessions and booms are decreased or increased. Corporate risk management can therefore substantially affect economic stability on the macrolevel.
    Keywords: Mundell-Fleming-Tobin model, foreign-debt financed investment, currency crises, real crises, currency futures, hedging, speculation.
    JEL: E32 E44 F31 F41
    Date: 2006–02
  11. By: Takatoshi Ito (Faculty of Economics, University of Tokyo); Yuko Hashimoto (Faculty of Economics, Toyo University)
    Abstract: This paper examines intra-day patterns of the exchange rate behavior, using the "firm" bid-ask quotes and transactions of USD-JPY (Alec: The EBS notations define the base currency as the first currency in the name of the currency pair. Note that trading in EBS is done in millions of the base currency) and Euro-USD pairs recorded in the electronic broking system of the spot foreign exchange markets. The U-shape of intra-day activities is confirmed for Tokyo and London participants, but not for New York participants. Activities (deals and price changes) do not increase toward the end of business hours in the New York market, even on Fridays (ahead of weekend hours of non-trading). It is generally observed a negative correlation between the number of deals and the width of bid-ask spread during business hours, but in the first business minutes of Tokyo, bid-ask spread and activities have high correlation. It is also found that the concentration of transaction during overlapping business hours between Tokyo and London markets (London and New York markets) may arise from heterogeneous expectations among participants from different regions, that is waking up of participants of the next region in time line of the day.
    Date: 2006–03
  12. By: Faia, Ester; Monacelli, Tommaso
    Abstract: We analyze optimal monetary policy in a small open economy characterized by home bias in consumption. Peculiar to our framework is the application of a Ramsey-type analysis to a model of the recent open economy New Keynesian literature. We show that home bias in consumption is a sufficient condition for inducing monetary policy-makers of an open economy to deviate from a strategy of strict markup stabilization and contemplate some (optimal) degree of exchange rate stabilization. We focus on the optimal setting of policy both in the case in which firms set prices one period in advance as well as in the case in which firms set prices in a dynamic forward-looking fashion. While the first setup allows us to analytically highlight home bias as an independent source of equilibrium markup variability, the second setup allows us to study the effects of future expectations on the optimal policy problem and the effect of home bias on optimal inflation volatility. The latter, in particular, is shown to be related to the degree of trade openness in a U-shaped fashion, whereas exchange rate volatility is monotonically decreasing in openness.
    Keywords: home bias; optimal monetary policy; Ramsey planner; sticky prices
    JEL: E52 F41
    Date: 2006–03
  13. By: K C Neanidis; C S Savva
    Abstract: MThis paper examines the effects of inflation and currency substitution volatility on the average rates of inflation and currency substitution for twelve emerging market economies. Using a bivariate GARCH-in-Mean model, which accommodates for asymmetric and spillover effects of inflation and currency substitution innovations on their volatilities, we find that for the majority of the countries in the sample the variability of inflation exerts a positive influence on both the average rates of inflation and currency substitution. Similarly, higher uncertainty in currency substitution displays enhancing effects on inflation and currency substitution. These results indicate an alternative avenue that stresses the importance of currency substitution for the conduct of monetary policy in terms of price stability, and provide an additional explanation to the phenomenon of dollarization hysteresis.
    Date: 2006

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