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on International Finance |
| By: | Zsolt Darvas; Gábor Rappai; Zoltán Schepp |
| Abstract: | Results and models of this paper are based on a strikingly new empirical observation: long maturity forward rates between bilateral currency pairs of the US, Germany, UK, and Switzerland are stationary. Based on this result, we suggest a new explanation for the UIP-puzzle maintaining rational expectations and risk neutrality. The model builds on the interaction of foreign exchange and fixed income markets. Ex ante short run and long run UIP and the EHTS is assumed. We show that ex post shocks to the term structure could explain the behavior of the nominal exchange rate including its volatility and the failure of ex post short UIP regressions. We present evidence on ex post validity of long run UIP and strikingly new evidence on the stationarity of the long forward exchange rates of major currencies. We set up, calibrate and simulate a stylized model that well captures the observed properties of spot exchange rates and UIP regressions of major currencies. We define the notion of yield parity and test its empirical performance for monthly series of major currencies with favorable results. |
| Keywords: | EHTS; forward discount bias; stationarity of long maturity forward rates; UIP; yield parity |
| JEL: | E43 F31 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:098&r=ifn |
| By: | Antonio Montañés; Marcos Sanso-Navarro |
| Abstract: | Long-horizon uncovered interest parity during the post-Bretton Woods era in the G7 countries is analyzed in this paper. The main di¤erence with previous studies relies in the use of cointegration methods due to the non-stationary behavior of the variables involved. Moreover, the consideration of structural breaks becomes a key element for this relationship to hold. These shifts are identi.ed as sharp changes in the time-varying risk premium as a consequence of turning points in monetary policy and exchange rates regimes. Finally, the robustness of the obtained results to recent developments in the Eurozone is checked. |
| URL: | http://d.repec.org/n?u=RePEc:fda:fdaeee:221&r=ifn |
| By: | M. Hashem Pesaran; Ron P. Smith; Takashi Yamagata; Liudmyla Hvozdyk |
| Abstract: | In this paper we adopt a new approach to testing for purchasing power parity, PPP, that is robust to base country effects, cross-section dependence, and aggregation. We test for PPP applying a pairwise approach to the disaggregated data set recently analysed by Imbs, Mumtaz, Ravan and Rey (2005, QJE). We consider a variety of tests applied to all 66 possible pairs of real exchange rate among the 12 countries and estimate the proportion of the pairs that are stationary, for the aggregates and each of the 19 commodity groups. To deal with small sample problems, we use a factor augmented sieve bootstrap approach and present bootstrap pairwise estimates of the proportions that are stationary. The bootstrapped rejection frequencies at 26%-49% based on unit root tests suggest some evidence in favour of the PPP in the case of the disaggregate data as compared to 6%-14% based on aggregate price series. |
| Keywords: | Purchasing Power Parity, Panel Data, Pairwise Approach, Cross Section Dependence. |
| JEL: | C23 F31 F41 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:cam:camdae:0634&r=ifn |
| By: | Jose Manuel Campa; Linda S. Goldberg |
| Abstract: | Border prices of traded goods are highly sensitive to exchange rates; however, the consumer price index (CPI) and the retail prices of goods that make up the CPI are more stable. This paper decomposes the sources of this price stability for twenty-one OECD (Organisation for Economic Co-operation and Development) countries, focusing on the important role of distribution margins and imported inputs in transmitting exchange rate fluctuations into consumption prices. We provide rich cross-country and cross-industry details on distribution margins and their sensitivity to exchange rates, imported inputs used in different categories of consumption goods, and weights in the consumption of nontradables, home tradables, and imported goods. While distribution margins damp the sensitivity of consumption prices of tradable goods to exchange rates, they also lead to enhanced pass-through when the prices of nontraded goods are sensitive to exchange rates. Such price sensitivity arises because imported inputs are used in the production of home nontradables. Calibration exercises show that, of all countries examined, the United States has the lowest expected CPI sensitivity to exchange rates-at less than 5 percent. On average, the calibrated exchange rate pass-through into CPI is expected to be closer to 15 percent. |
| Keywords: | Consumer price indexes ; Foreign exchange rates ; Organisation for Economic Co-operation and Development ; Prices |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:247&r=ifn |
| By: | Frömmel, Michael |
| Abstract: | We investigate the exchange rate volatility of six Central and Eastern European countries (CEEC) between 1994 and 2004. The analysis merges two approaches, the GARCH-model (Bollerslev 1986) and the Markov Switching Model (Hamilton 1989). We discover switches between high and low volatility regimes which are consistent with policy settings for Hungary, Poland and, less pronounced, the Czech Republic, whereas Romania and Slovakia do not show a clear picture. Slovenia, finally, shows some kind of anticipation of the wide fluctuation margins in ERM2. |
| Keywords: | CEEC, exchange rate volatility, regime switching GARCH, Markov switching model, transition economies |
| JEL: | E42 F31 F36 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:han:dpaper:dp-333&r=ifn |
| By: | Etsuro Shioji |
| Abstract: | China has recently announced its intention to fundamentally reform its currency regime in the future. This paper studies how the country's choice of its exchange rate regime interacts with the rest of East Asia's choice. For that purpose, I build a four country new open economy macroeconomic model that consists of East Asia, China, Japan and the US. It is assumed that both East Asia and China peg their respective currencies to certain weighted averages of the Japanese yen and the US dollar. Each side takes the other's choice as given and chooses its own basket weight. The game is characterized by strategic complementarity. It is shown that the currency in which the traded goods prices are quoted plays an important role. The paper considers two alternative cases, the standard producer currency pricing (PCP) case and the vehicle currency pricing (VCP) case in which all the prices of traded goods are preset in the units of US dollars. In the PCP case, trade volume is the important determinant of the equilibrium basket weights, and the balances of trade are inconsequential. However, in the VCP case, trade balances between the four economies are shown to play an important role. Under VCP, and starting from realistic initial trade balances, the equilibrium basket weights far exceed what are implied by Japan's presence in international trade. |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:eti:dpaper:06024&r=ifn |
| By: | Todd Keister |
| Abstract: | This paper presents a model in which currency crises can spread across countries as a result of the self-fulfilling beliefs of market participants. An incomplete-information approach is used to overcome many undesirable features of existing multiple-equilibrium explanations of contagion. If speculators expect contagion across markets to occur, they have an incentive to trade in both currency markets to take advantage of this correlation. These actions, in turn, link the two markets in such a way that a sharp devaluation of one currency will be propagated to the other market, fulfilling the original expectations. Even though this contagion is driven solely by expectations, the model places restrictions on observable variables that are broadly consistent with existing empirical evidence. |
| Keywords: | Financial crises ; Foreign exchange market ; Devaluation of currency |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:249&r=ifn |
| By: | Hsiao Chink Tang |
| Abstract: | This study empirically examines whether a group of 12 Asian countries is suitable to form an Asian Monetary Union (AMU). The criteria of suitability are based on the Optimum Currency Area (OCA) literature whereby countries experiencing symmetrical shocks, have smaller size of shock and faster speed of adjustment are considered as potentially good partners in a monetary union. The Blanchard and Quah (BQ) structural vector autoregression (SVAR) methodology is used to identify the demand and supply shocks. The overall finding provides no support for the formation of a full-fledged AMU. Instead, what appears more feasible initially is the formation of smaller sub-groupings within the region. |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:pas:camaaa:2006-13&r=ifn |