nep-ifn New Economics Papers
on International Finance
Issue of 2006‒07‒28
nine papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. A structural break in the effects of Japanese foreign exchange intervention on yen/dollar exchange rate volatility. By Eric Hillebrand; Gunther Schnabl
  2. A Habit-Based Explanation of the Exchange Rate Risk Premium By Adrien Verdelhan
  3. Foreign Exchange Risk Premium Determinants: Case of Armenia By Tigran Poghosyan; Evzen Kocenda
  4. Exchange rate stabilization in developed and underdeveloped capital markets. By Viera Chemlarova; Gunter Schnabl
  5. Real Exchange Rate Volatility and Asset Market Structure By Christoph Thoenissen
  6. Real Exchange Rate and International Reserves in the Era of Growing Financial and Trade Integration By Joshua Aizenman; Daniel Riera-Crichton
  7. Did capital market convergence lower the effectiveness of the interest rate as a monetary policy tool? By Jansen, Pieter W.
  9. The 90-Day DTF Interest Rate: Why Does It Remain Constant? By Peter Rowland

  1. By: Eric Hillebrand (Department of Economics, Louisiana State University, Baton Rouge, LA 70803, USA.); Gunther Schnabl (Department of Economics and Business Administration, Leipzig University, Marschenerstr. 31, 04109 Leipzig, Germany.)
    Abstract: While up to the late 1990s Japanese foreign exchange intervention was fully sterilized, Japanese monetary authorities left foreign exchange intervention unsterilized when Japan entered the liquidity trap in 1999. According to previous research on foreign exchange intervention, unsterilized intervention has a higher probability of success than sterilized intervention. Based on a GARCH framework and change point detection, we test for a structural break in the effectiveness of Japanese foreign exchange intervention. We find a changing impact of Japanese foreign exchange intervention on exchange rate volatility at the turn of the millennium when Japanese foreign exchange intervention started to remain unsterilized. JEL Classification: E58; F31; F33; G15.
    Keywords: Japan; foreign exchange intervention; exchange rate volatility; GARCH; change point detection; structural breaks.
    Date: 2006–06
  2. By: Adrien Verdelhan (Boston University)
    Keywords: Exchange rate, Time-varying risk premium, Habits
    JEL: F31 G12 G15
    Date: 2006–07–04
  3. By: Tigran Poghosyan; Evzen Kocenda
    Abstract: This paper studies foreign exchange risk premium using the uncovered interest rate parity framework in a model economy. The analysis is performed using weekly data on foreign and domestic currency deposits in the Armenian banking system. Results of the study indicate that contrary to the established view there is a positive correspondence between exchange rate depreciation and interest rate differentials. Further, it is shown that a systematic positive risk premium required by economic agents for foreign exchange transactions increases over the investment horizon. One-factor two-currency affine term structure framework applied in the paper is not sufficient to explain the driving forces behind the positive exchange rate risk premium. GARCH approach shows that central bank interventions and deposit volumes are two factors explaining time-varying exchange rate risk premium.
    Keywords: “Forward premium” puzzle, exchange rate risk, time-varying risk premium, affine term structure models, GARCH-in-Mean, foreign and domestic deposits, transition and emerging markets, Armenia.
    JEL: E43 E58 F31 G15 O16 P20
    Date: 2006–05
  4. By: Viera Chemlarova (Sam Houston State University - Department of Economics and International Business, SHSU Box 2118, Huntsville , TX 77341-2118, United States.); Gunter Schnabl (University of Leipzig - Faculty of Economics and Business Administration, Marschnerstrasse 31, D-04109 Leipzig, Germany.)
    Abstract: The target zone model by Krugman (1991) assumes that foreign exchange intervention targets exchange rate levels. We argue that the fit of this model depends on the stage of development of capital markets. Foreign exchange intervention of countries with highly developed capital markets is in line with Krugman's (1991) model as the exchange rate level is targeted (mostly to sustain the competitiveness of exports) and the volatility of day-to-day exchange rate changes are left to market forces. In contrast, countries with underdeveloped capital markets control both volatility of day-to-day exchange rate changes as well as long-term fluctuations of the exchange rate levels to sustain the competitiveness of exports as well as to reduce the risk for short-term and long-term payment flows. Estimations of foreign exchange intervention reaction functions for Japan and Croatia trace the asymmetric pattern of foreign exchange intervention in countries with developed and underdeveloped capital markets. JEL Classification: F31.
    Keywords: Foreign exchange intervention; target zones; underdeveloped capital markets.
    Date: 2006–06
  5. By: Christoph Thoenissen
    Abstract: We examine the influence of financial asset market structure for the volatility of the real exchange rate. Adding distribution costs to two-country two-sector models has been shown to increase the volatility of the terms of trade and thus the real exchange rate. We argue that incomplete markets are a necessary condition for the terms of trade and real exchange rate to display realistic levels of volatility. We also illustrate that for some parameter values, how one models incomplete markets also matters for international business cycle properties of the these models.
    Keywords: Real exchange rate volatility, financial market structure, non-traded goods, distribution costs.
    JEL: F31 F41
    Date: 2006–07
  6. By: Joshua Aizenman; Daniel Riera-Crichton
    Abstract: This paper evaluates the impact of international reserves, terms of trade (TOT) shocks and capital flows on the real exchange rate (REER). We observe that international reserves (IR) cushions the impact of TOT shocks on REER, and that this effect is important for developing but not for industrial countries. This buffer effect is especially significant for Asian countries, and for countries exporting natural resources. As suggested by theory, financial depth reduces the buffer role of IR in developing countries. The role of shock absorber for IR remains robust to the addition of various controls, dealing with capital flows (FDI, hot money, etc.), exchange rate management and monetary policy, as well as trade openness. We also find that short term capital inflows (Other Investment, Portfolio Investment) and increases in foreign reserves are associated with appreciated real exchange rate. Developing countries REER seem to be more sensitive to changes in reserve assets; whereas industrial countries display a significant relationship between hot money and REER and no effect on REER due to changes in reserve assets.
    JEL: F15 F21 F32 F36
    Date: 2006–07
  7. By: Jansen, Pieter W. (Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics)
    Abstract: International capital market convergence reduces the ability for monetary authorities to set domestic monetary conditions. Traditionally, monetary policy transmission is channelled through the short-term interest rate. Savings and investment decisions are effected through the response of the bond yield to changes in the short-term interest rate. We find that capital market integration increased correlation between long-term interest rates across countries. Short-term interest rates also show more integration across countries and the correlation with the international business cycle has increased. A stronger linkage between international economic conditions and bond yields has important implications for the effectiveness of monetary policy. Monetary policy makers, especially in small countries, will face more difficulties in influencing domestic conditions in the bond market when they apply the traditional monetary policy framework in case of a country specific shock.
    Keywords: Monetary policy; Term structure of interest rates; International capital market convergence
    JEL: E43
    Date: 2006
  8. By: Kazuhiko Nishina (Graduate School of Economics, Osaka University, Japan); Nabil Maghrebi (Graduate School of Economics, Wakayama, Japan University)
    Abstract: This paper examines nonlinearities in the dynamics of volatility expectations using benchmarks of implied volatility for the US and Japanese markets. The evidence from Markov regime-switching models suggests that volatility expectations are likely to be governed by regimes featuring a long memory process and significant leverage effects. Market volatility is expected to increase in bear periods and decrease in bull periods. Leverage effects constitute thus an important source of nonlinearities in volatility expectations. There is no evidence of long swings associated with financial crises, which do not have the potential of shifting volatility expectations from one regime to another for long protracted periods.
    Keywords: Markov Regime Switching, Implied Volatility Index, Nonlinear Modelling.
    JEL: C32 C51 G13 G15
    Date: 2006–07
  9. By: Peter Rowland
    Abstract: Since mid-July 2002 this rate has remained more or less constant at around 7.8 percent. More importantly, it did not react to any of two 100-basis-point increases in the overnight repo rate, the main tool of monetary policy that Banco de la República has to influence domestic interest rates, which has rendered the repo rate rather inefficient as a monetary policy tool. This paper studies the DTF rate and its development over time. It shows that a significant pass-through from the overnight interest rates to the DTF rate that was present before July 2002 thereafter seems to have vanished. It also provides a number of explanations to why the DTF rate has remained constant: Overnight rates have in real terms been negative and might, therefore, have been more out of the market than the DTF rate; due to heavy government borrowing, the yield curve has been too steep to allow a further lowering of the DTF rate; competition in the financial system is low, leading to sticky interest rates; the DTF rate is not a free-market auction rate but an offer rate set by the banks; and the DTF rate is a very dominant benchmark.

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