nep-ifn New Economics Papers
on International Finance
Issue of 2006‒11‒04
eleven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Is reversion to PPP in euro exchange rates non-linear? By Bernd Schnatz
  2. Exchange Rate Pass-Through and Monetary Policy: Evindence from OECD countries By Cesar Carrera; Mahir Binici
  3. Price Discovery in Currency Markets By Osler, Carol; Mende, Alexander; Menkhoff, Lukas
  4. Volatility transmissions between renminbi and Asia-Pacific on-shore and off-shore U.S. dollar futures By Colavecchio , Roberta; Funke, Michael
  5. Persistence, Performance and Prices in Foreign Exchange Markets By Ramadorai, Tarun
  6. Real Exchange Rates Over the Past Two Centuries : How Important is the Harrod-Balassa-Samuelson Effect? By Lothian, James R.; Taylor, Mark P.
  7. Exchange rate policy and the relative distribution of FDI among host countries By Xing, Yuqing
  8. BALANCE OF PAYMENTS CRISES UNDER FIXED EXCHANGE RATE IN COLOMBIA: 1938-1967 By Fabio Sánchez; Andrés Fernández; Armando Armenta
  9. The Returns to Currency Speculation By Burnside, A Craig; Eichenbaum, Martin; Kleshchelski, Isaac; Rebelo, Sérgio
  10. The Obstinate Passion of Foreign Exchange Professionals : Technical Analysis By Menkhoff, Lukas; Taylor, Mark P.
  11. Profitability of simple trading strategies exploiting the forward premium bias in foreign exchange markets and the time premium in yield curves By Andres Vesilind

  1. By: Bernd Schnatz (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The paper tests for nonlinearities in the adjustment of the euro exchange rate towards purchasing power parity (PPP). It presents new survey based evidence consistent with non-linear patterns in euro exchange rate dynamics. Moreover, based on an exponential smooth transition autoregressive (ESTAR-) model, it finds strong evidence that the speed of mean reversion in euro exchange rates increases non-linearly with the magnitude of the PPP deviation. Accordingly, while the euro real exchange rate can be well approximated by a random walk if PPP deviations are small, in periods of significant deviations, gravitational forces are set to take root and bring the exchange rate back towards its long-term trend. Consistent with higher euro-dollar volatility, deviations from the PPP equilibrium for this pair need to be stronger in order to reach the same adjustment intensity as for other currencies. JEL Classification: F31.
    Keywords: Purchasing power parity, real exchange rate, non-linearities, STAR models.
    Date: 2006–10
  2. By: Cesar Carrera (University of California, Santa Cruz and Central Bank of Peru); Mahir Binici (University of California, Santa Cruz and Central Bank of Turkey)
    Abstract: We provide an empirical analysis about the relationship between exchange rate and different price indexes for each OECD country. We were focused on how different inflation environments could explain a decreasing degree of the exchange rate pass-through over prices in each country. In a second stage, we estimate the relationship between pass-through and prices using individual-country pass-through. We find evidence in favor of the hypothesis that the exchange rate pass-through is lower when it is taken into account environments in which it is observed lower and stables rates of inflation, result which would be associated with a more effective monetary policy in terms of transparency and inflation control.
    Keywords: Pass-through, Exchange rate, Inflation, Monetary Policy
    JEL: E31 E52 F3 F4 C22 C31
    Date: 2006–10
  3. By: Osler, Carol; Mende, Alexander; Menkhoff, Lukas
    Abstract: This paper makes three contributions to our understanding of the price discovery process in currency markets. First, it provides evidence that this process cannot be the familiar one based on adverse selection and customer spreads, since such spreads are inversely related to a trade's likely information content. Second, the paper suggests three potential sources for the pattern of customer spreads, two of which rely on the information structure of the market. Third, the paper suggests an alternative price discovery process for currencies, centered on inventory management strategies in the interdealer market, and provides preliminary evidence for that process.
    Keywords: Bid-ask spread, foreign exchange, asymmetric information, microstructure, price discovery, interdealer, inventory, market order, limit order
    JEL: F31 G14 G15
    Date: 2006–11
  4. By: Colavecchio , Roberta (BOFIT); Funke, Michael (BOFIT)
    Abstract: This paper uses multivariate GARCH techniques to study volatility spillovers between the Chinese non-deliverable forward market and seven of its Asia-Pacific counterparts over the period January 1998 to March 2005. To account for the time-variability of conditional correlation, a dynamic correlation structure is included in the volatility model specification. The empirical results demonstrate that the renminbi non-deliverable forward (NDF) has been a driver of various Asian currency markets but that such co-movements exhibit a substantial degree of heterogeneity. As to the determinants of the magnitude of these co-movements, we test the relevance of potential factors and find that it is the degree of real and financial integration, in particular, that exerts the largest influence on volatility transmission.
    Keywords: China; renminbi; Asia; forward exchange rates; non-deliverable forward market; multivariate GARCH models
    JEL: C22 F31 F36
    Date: 2006–10–26
  5. By: Ramadorai, Tarun
    Abstract: Using detailed data on currency transactions of institutional investors, this paper shows that funds that experience high returns on their currency holdings also execute currency trades at more favourable prices. This observation is consistent with foreign exchange dealers bidding for information from successful traders. If true, this provides little incentive for successful funds to intertemporally split orders to avoid tipping off dealers. In accordance with this, the paper finds that better performing funds have less persistent currency order flow. These results are consistent with the theoretical model of Naik, Neuberger and Viswanathan [1999]. The results can also be explained by the funds acting as secondary providers of liquidity in these markets, or by dealers perceiving that funds have different price elasticities of demand for currencies, and pricing accordingly.
    Keywords: foreign exchange; microstructure; order flow; performance
    JEL: G10 G15
    Date: 2006–10
  6. By: Lothian, James R. (Fordham University); Taylor, Mark P. (University of Warwick and Centre for Economic Policy Research, London)
    Abstract: Using data since 1820 for the US, the UK and France, we test for the presence of real effects on the equilibrium real exchange rate (the Harrod-Balassa-Samuelson, HBS effect) in an explicitly nonlinear framework and allowing for shifts in real exchange rate volatility across nominal regimes. A statistically signifcant HBS effect for sterling-dollar captures its longrun trend and explains a proportion of variation in changes in the real rate that is proportional to the time horizon of the change. There is signifcant evidence of nonlinear reversion towards long-run equilibrium and downwards shifts in volatility during &xed nominal exchange rate regimes.
    Keywords: purchasing power parity ; real exchange rate ; nonlinear dynamics ; Harrod-Balassa-Samuelson effect ; productivity differentials
    JEL: F31 F41 C1
    Date: 2006
  7. By: Xing, Yuqing (BOFIT)
    Abstract: This paper examines the FDI-exchange rate nexus in the context of one FDI source and two host countries. It focuses on the effect of exchange rates on relative FDI inflows between the two host countries. The theoretical analysis shows explicitly that relative FDI inflows are a function of relative real exchange rates. In particular, if one host country devalues its currency against that of the source country more than the other does, FDI into the former country will be expected to increase relative to the other country. The theoretical inference is examined with Japanese FDI in manufacturing industries of China and ASEAN-4 (Indonesia, Malaysia, the Philippines and Thailand). The empirical results generally support the theoretical conclusion, suggesting that the real devaluation of the Chinese Yuan undercut FDI into the ASEAN-4.
    Keywords: FDI; exchange rate; China; ASEAN-4
    JEL: F14 F23 F31
    Date: 2006–10–26
  8. By: Fabio Sánchez; Andrés Fernández; Armando Armenta
    Abstract: Between 1938 and 1967, including the Bretton Woods period after 1947, Colombia pegged its currency to the dollar. Although the exchange rate was fixed, the peso was devaluated more than 12% on six occasions. The devaluation episodes were complex, traumatic, highly politicized and had costly macroeconomic effects. The Bretton Woods agreement stated that countries could only devalue their exchange rate in the presence of fundamental imbalances driven, for example, by structural terms of trade deterioration. However, this paper states that in Colombia, the imbalance in the money market was a key factor in explaining the exchange rate crises during the period. The paper is organized as follows: first, a simple theoretical model of a small open economy with imperfect capital mobility is described in order to examine the possible causes of nominal devaluations; second, a narrative approach is used to describe the economic circumstances that surrounded each of the devaluation episodes; finally, a set of econometric tests are used in order to identify the key variables behind the macroeconomic imbalances that preceded each exchange rate crisis. The results show that the external imbalances were mainly associated with the imbalances in the money market. Terms of trade deterioration account for just a small part of current account crises
    Date: 2006–02–02
  9. By: Burnside, A Craig; Eichenbaum, Martin; Kleshchelski, Isaac; Rebelo, Sérgio
    Abstract: Currencies that are at a forward premium tend to depreciate. This ‘forward-premium puzzle’ represents an egregious deviation from uncovered interest parity. We document the properties of returns to currency speculation strategies that exploit this anomaly. The first strategy, known as the carry trade, is widely used by practitioners. This strategy involves selling currencies forward that are at a forward premium and buying currencies forward that are at a forward discount. The second strategy relies on a particular regression to forecast the payoff to selling currencies forward. We show that these strategies yield high Sharpe ratios which are not a compensation for risk. However, these Sharpe ratios do not represent unexploited profit opportunities. In the presence of microstructure frictions, spot and forward exchange rates move against traders as they increase their positions. The resulting ‘price pressure’ drives a wedge between average and marginal Sharpe ratios. We argue that marginal Sharpe ratios are zero even though average Sharpe ratios are positive.
    Keywords: carry trade; exchange rates; uncovered interest parity
    JEL: F31
    Date: 2006–10
  10. By: Menkhoff, Lukas (University of Hannover); Taylor, Mark P. (University of Warwick and Centre for Economic Policy Research)
    Abstract: Technical analysis involves the prediction of future exchange rate (or other assetprice) movements from an inductive analysis of past movements. A reading of the large literature on this topic allows us to establish a set of stylised facts, including the facts that technical analysis is an important and widely used method of analysis in the foreign exchange market and that applying certain technical trading rules over a sustained period may lead to significant positive excess returns. We then analyze four arguments that have been put forward to explain the continuing widespread use of technical analysis and its apparent profitability: that the foreign exchange market may be characterised by not-fully-rational behaviour; that technical analysis may exploit the influence of central bank interventions; that technical analysis may be an efficient form of information processing ; and finally that it may provide information on nonfundamental influences on foreign exchange movements. Although all of these positions may be relevant to some degree, neither non-rationality nor official interventions seem to be widespread and persistent enough to explain the obstinate passion of foreign exchange professionals for technical analysis.
    Keywords: foreign exchange market ; technical analysis ; market microstructure
    JEL: F31
    Date: 2006
  11. By: Andres Vesilind
    Abstract: This paper focuses on two actively studied inefficiencies in financial markets: the forward premium bias in foreign exchange markets (see, for example, Hansen and Hodrick 1980, Fama 1984, Bansal and Dahlquist 2000, etc.) and the empirical finding that the time expectations theory performs relatively poorly in describing the average shape of yield curves (for a list of papers see, for example, Backus et al. 1998, p 1). The goal of the article is to test whether these two inefficiencies can still offer the possibilities of earning positive and stable excess return for investors. For that purpose, first two very simple trading strategies are tested based on the abovementioned inefficiencies: buying the currencies of the countries with higher short-term interest rates against the currencies of the countries with lower short-term interest rates (i.e. simple FX carry-strategy) and holding long-only positions in longerterm interest rate futures. The results show that the two studied risk premiums are still present in the markets and enable investors to earn excess returns even with simple strategies. Additional tests show that the performance of these simple strategies can be further improved by the inclusion of a risk factor in the foreign exchange carry-strategy and by the addition of monetary policy direction and yield curve steepness filters in the long-only strategy in interest rate futures.
    Keywords: trading rules, forward premium bias, time expectations theory
    JEL: E44 E47 E58 F37 G11 G15
    Date: 2006–10–10

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