nep-ifn New Economics Papers
on International Finance
Issue of 2006‒12‒01
five papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. The yen real exchange rate may be stationary after all: evidence from non-linear unit root tests By Georgios Chortareas; George Kapetanios
  2. Optimal currency shares in international reserves - the impact of the euro and the prospects for the dollar By Elias Papaioannou; Richard Portes; Gregorios Siourounis
  3. Chartist Trading in Exchange Rate Theory By Selander, Carina
  4. Hot Money Inflows in China : How the People's Bank of China Took up the Challenge By Vincent Bouvatier
  5. Do Trade Costs in Goods Market Lead to Home Bias in Equities? By Coeurdacier, Nicolas

  1. By: Georgios Chortareas; George Kapetanios
    Abstract: The empirical literature that tests for purchasing power parity (PPP) by focusing on the stationarity of real exchange rates has so far provided, at best, mixed results. The behaviour of the yen real exchange rate has most stubbornly challenged the PPP hypothesis and deepened this puzzle. This paper contributes to this discussion by providing new evidence on the stationarity of bilateral yen real exchange rates. We employ a non-linear version of the Augmented Dickey-Fuller test, based on an exponentially smooth-transition autoregressive model (ESTAR) that enhances the power of the tests against mean-reverting non-linear alternative hypotheses. Our results suggest that the bilateral yen real exchange rates against the other G7 and Asian currencies were mean reverting during the post-Bretton Woods era. Thus, the real yen behaviour may not be so different after all but simply perceived to be so due to the use of a restrictive alternative hypothesis in previous tests.
  2. By: Elias Papaioannou (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany); Richard Portes (London Business School, Sussex Place, Regent's Park, London NW1 4SA, United Kingdom); Gregorios Siourounis (London Business School, Sussex Place, Regent's Park, London NW1 4SA, United Kingdom)
    Abstract: Foreign exchange reserve accumulation has risen dramatically in recent years. The introduction of the euro, greater liquidity in other major currencies, and the rising current account deficits and external debt of the United States have increased the pressure on central banks to diversify away from the US dollar. A major portfolio shift would significantly affect exchange rates and the status of the dollar as the dominant international currency. We develop a dynamic mean-variance optimization framework with portfolio rebalancing costs to estimate optimal portfolio weights among the main international currencies. Making various assumptions on expected currency returns and the variance-covariance structure, we assess how the euro has changed this allocation. We then perform simulations for the optimal currency allocations of four large emerging market countries (Brazil, Russia, India and China), adding constraints that reflect a central bank’s desire to hold a sizable portion of its portfolio in the currencies of its peg, its foreign debt and its international trade. Our main results are: (i) The optimizer can match the large share of the US dollar in reserves, when the dollar is the reference (risk-free) currency. (ii) The optimum portfolios show a much lower weight for the euro than is observed. This suggests that the euro may already enjoy an enhanced role as an international reserve currency ("punching above its weight"). (iii) Growth in issuance of euro-denominated securities, a rise in euro zone trade with key emerging markets, and increased use of the euro as a currency peg, would all work towards raising the optimal euro shares, with the last factor being quantitatively the most important. JEL Classification: F02, F30, G11, G15.
    Keywords: Currency optimizer, euro, foreign reserves, international currencies.
    Date: 2006–11
  3. By: Selander, Carina (Department of Economics, Umeå University)
    Abstract: This thesis consists of four papers, of which paper 1 and 4 are co-written with Mikael Bask. Paper [1] <p> implements chartists trading in a sticky-price monetary model for determining the exchange rate. It is <p> demonstrated that chartists cause the exchange rate to "overshoot the overshooting equilibrium" of a <p> sticky-price monetary model. Chartists base their trading on a short-long moving average. The <p> importance of technical trading depends inversely on the time horizon in currency trade. The exchange <p> rate's perfect foresight path near long-run equilibrium is derived and it is demonstrated that the shorter <p> the time horizon, the greater the exchange rate overshooting. <p> The aim of Paper [2] is to see how the dynamics of the basic target zone model changes when <p> chartists and fundamentalists are introduced. Chartists use technical trading and the relative importance <p> of technical and fundamental analyses depend on the time horizon in currency trade. The model also <p> includes realignment expectations, which increase with the weight of chartists. The introduction of <p> chartists may significantly reduce and reverse, the so-called "honeymoon effect" of a fully credible <p> target zone. Further, chartists may cause the correlation between the exchange rate and the <p> instantaneous interest rate differential to become either positive or negative. <p> Using a chartist-fundamentalist set-up, Paper [3] derives the effects on the current exchange rate of <p> central bank intervention. Fundamentalists have rational expectations and chartists use so called <p> support and resistance levels in their trading. This technique results in chartists having both <p> bandwagon expectations and regressive expectations. Chartists may enhance or suppress the effect of <p> intervention depending on their expectations. The results indicate that a chartist channel exists. <p> The aim of Paper [4] is threefold; (i) to investigate if there is a unique rational expectations <p> equilibrium (REE) in a new Keynesian macroeconomic model augmented with technical trading, (ii), <p> to investigate if the unique REE is adaptively learnable and, (iii), to investigate if this unique and <p> adaptively learnable REE is desirable in an inflation rate targeting regime. The monetary authority is <p> using a Taylor rule when setting the interest rate. A main conclusion is that a robust Taylor rule <p> implies that the monetary authority should increase (decrease) the interest rate when the CPI inflation <p> rate increases (decreases) and when the currency gets stronger (weaker).
    Keywords: Chartist Trading; Foreign Exchange; Overshooting; Sterilized Intervention; Target zone; Taylor rules
    JEL: E43 E52 F31 F33 F37 F41
    Date: 2006–11–20
  4. By: Vincent Bouvatier (CES - Centre d'économie de la Sorbonne - [CNRS : UMR8174] - [Université Panthéon-Sorbonne - Paris I])
    Abstract: This paper investigates hot money inflows in China. The financial liberalization comes into effect and the effectiveness of capital controls tends to diminish over time. As a result, China is fuelled by hot money inflows. The US interest rate cut since 2001 and expectations of exchange rate adjustments are the main factors explaining these capital inflows. This study use the Bernanke and Blinder (1988) model extended to an open economy to examine implications of hot money inflows for the Chinese economy. A Vector Error Correction Model (VECM) on monthly data from March 1995 to March 2005 is estimated to investigate the recent upsurge in foreign reserves and shows that the interaction between domestic credit and foreign reserves was stable and consistent with monetary stability. Granger causality tests are implemented to show how the People's Bank of China (PBC) achieved this result.
    Keywords: Hot money inflows, domestic credit, VECM, Granger causality.
    Date: 2006–11–03
  5. By: Coeurdacier, Nicolas (ESSEC Business School)
    Abstract: Two of the main puzzles in international economics are the consumption and the portfolio home biases. They are empirically related: countries that are more open to trade also have more internationally diversified portfolios. In a two-country stochastic equilibrium model, I prove that introducing trade costs in goods market alone, as suggested by Obstfeld and Rogoff [2000], is not sufficient to explain these two puzzles simultaneously. On the contrary, for reasonable parameter values, trade costs create a foreign bias in portfolios. To reconcile facts and theory, I introduce a combination of small frictions in financial markets and trade costs in goods market. The interaction between the two types of frictions determines optimal portfolio allocation. When trade costs increase, competition in the goods market softens and the volatility of domestic income falls. Facing lower risk, investors have less incentive to pay the financial transaction cost and increase their holdings of domestic assets. The model correctly predicts that the larger the home bias in consumption, the larger the home bias in portfolios.
    Keywords: International Macroeconomics; Home Bias; Portfolio Choice; Trade Costs
    JEL: F30 F36 F41 G11
    Date: 2006–10

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