nep-ifn New Economics Papers
on International Finance
Issue of 2007‒01‒13
nineteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Monetary and Exchange Rate Stability in South East Asia By Christian Bauer; Bernhard Herz
  2. "Post-crisis Exchange Rate Regimes in ASEAN:A New Empirical Test Based on Intra-daily Data" By Shin-ichi Fukuda; Sanae Ohno
  3. Testing for Balance Sheet Effects in Emerging Market Countries By Uluc Aysun
  4. Industry Restructuring, Mark-ups, and Exchange Rate Pass-Through By Beverly Lapham; Danny Leung
  5. Trade Integration, Competiton, and the Decline in Exchange-rate Pass-through By Christopher Gust; Sylvain Leduc; Robert Vigfusson
  6. Monetary Policy Rules and Exchange Rates:A Structural VAR Identified by No Arbitrage By Sen Dong
  7. Modeling the Term Structure of Exchange Rate Expectations By Christian Bauer; Sebastian Horlemann
  8. A Habit-Based Explanation of the Exchange Rate Risk Premium By Adrien Verdelhan
  9. Automatic Stabilizer Feature of Fixed Exchange Rate Regimes in Emerging Markets By Uluc Aysun
  10. The Returns to Currency Speculation By Craig Burnside; Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo
  11. Financial Crisis and Foreign Exchange Exposure of Korean Exporting Firms By Ronald A. Ratti; Sung-Wook Yoon; Jae-Young Choi
  12. Could capital gains smooth a current account rebalancing? By Michele Cavallo; Cedric Tille
  13. Implications for the Yen of Japanese Current Account Adjustment By Maurice Obstfeld
  14. Expectations and Exchange Rate Dynamics: A State-Dependent Pricing Approach By Anthony Landry
  15. The Unsustainable US Current Account Position Revisited* By Maurice Obstfeld; Kenneth Rogoff
  16. Expectations and Contagion in Self-fulfilling Currency Attacks By Todd Keister
  17. Experimental Evidence on the Benefits of Eliminating Exchange Rate Uncertainties and Why Expected Utility Theory causes Economists to Miss Them By Robin Pope; Reinhard Selten; Sebastian Kube; Jürgen von Hagen
  18. The Other Twins: Currency and Debt Crises By Bernhard Herz; Christian Bauer; Volker Karb
  19. Globalization, Macroeconomic Performance, and the Exchange Rates of Emerging Economies By Maurice Obstfeld

  1. By: Christian Bauer; Bernhard Herz
    Abstract: Regaining exchange rate stability has been a major monetary policy goal of East Asian countries in the aftermath of the 1997/98 currency crisis. While most countries have abstained from re-establishing a formal US Dollar peg, they have typically managed the US Dollar exchange rate de facto. We show that most of these countries were able to regain their monetary credibility within a relatively short time period. The Argentine crisis in 2001 caused a minor setback in this process for some countries. We measure the credibility of monetary policy by separating the fundamental and excess volatility of the exchange rate on the basis of a chartist fundamentalist model. The degree of excess volatility is interpreted as the ability of the central bank to manage the exchange rate via the coordination channel.
    Keywords: monetary policy, exchange rate policy, credibility, technical trading, East Asia
    JEL: D84 E42 F31
  2. By: Shin-ichi Fukuda (Faculty of Economics, University of Tokyo); Sanae Ohno (Faculty of Economics, Musashi University)
    Abstract: The purpose of this paper is to investigate what affected the post-crisis exchange rates of three ASEAN countries: Singapore, Thailand, and Malaysia. Our critical departure from previous studies is the use of intra-daily exchange rates. The use of the intra-daily data is useful in removing possible estimation biases which the choice of numeraire may cause. It can also contrast exchange rate movements during the time zone when the government intervention is active with those when the intervention is not active. We examine how and when the ASEAN currencies changed their correlations with the U.S. dollar and the Japanese yen. We find significant structural breaks in the correlations during the time zone when East Asian market is open. In the post-crisis period, the first structural break happened when Malaysia adopted the fixed exchange rate and the second break happened when some East Asian countries introduced inflation targeting. The structural breaks suggest strong monetary and real linkages among the ASEAN countries.
    Date: 2006–10
  3. By: Uluc Aysun (University of Connecticut)
    Abstract: This paper tests the presence of balance sheets effects and analyzes the implications for exchange rate policies in emerging markets. The results reveal that the emerging market bond index (EMBI) is negatively related to the banks. foreign currency leverage, and that these banks. foreign currency exposures are relatively unhedged. Panel SVAR methods using EMBI instead of advanced country lending rates find, contrary to the literature, that the amplitude of output responses to foreign interest rate shocks are smaller under relatively fixed regimes. The findings are robust to the local projections method of obtaining impulse responses, using country specific and GARCH-SVAR models.
    Keywords: EMBI, bank balance sheets, leverage, country risk premium, exchange rates.
    JEL: E44 F31 F41
    Date: 2006–08
  4. By: Beverly Lapham (Queen's University); Danny Leung
    Abstract: Consumer prices are not very responsive to movements in nominal exchange rates and their response has fallen considerably in Canada since the mid 1980s. This paper explores two of the most likely explanations for this decline in exchange rate pass-through to consumer prices: (1) lower inflation and (2) restructuring in the retail sector. We believe that both explanations are important but our focus in this paper is the latter explanation. We first present estimates which suggest that mark-ups in the retail sector in Canada have decreased while concentration has increased over this time period. We also discuss other trends in Canadian retailing which suggest considerable restructuring in this sector which have led to changes in the nature of competition. Based on this evidence, we argue that it is important to examine pass-through in industrial organization models with strategic elements. We present such a model which generates lower mark-ups, higher concentration, and lower exchange rate pass-through simultaneously.
    Keywords: Exchange Rate Pass-Through, Strategic Pricing
    JEL: F31 F12
    Date: 2006–12–03
  5. By: Christopher Gust; Sylvain Leduc; Robert Vigfusson
    Abstract: Over the past twenty years, U.S. import prices have become less responsive to the exchange rate. We propose that this decline is a result of increased trade integration. To illustrate this effect, we develop an open economy DGE model in which there is strategic complementarity in price setting so that a firm's pricing decision depends on the prices set by its competitors. Because of the complementarity in price setting, a foreign exporter finds it optimal to vary its markup over cost in response to shocks that change the exchange rate, which insulates import prices from exchange rate movements. With increased trade integration, exporters have become more responsive to the prices of their competitors and this change in pricing behavior accounts for a significant portion of the observed decline in the sensitivity of U.S import prices to the exchange rate. Our environment of low pass-through also has important implications for the welfare benefits of trade integration: we find that the benefits are substantially reduced compared to an environment with complete pass-through.
    Keywords: Pass-through, Trade Integration, Strategic Complementarities
    JEL: F15 F41
    Date: 2006–12–03
  6. By: Sen Dong (Finance and Ecnomomics Department Columbia University)
    Abstract: Expected exchange rate changes are determined by interest rate differentials across countries and risk premia, while unexpected changes are driven by innovations to macroeconomic variables, which are amplified by time-varying market prices of risk. In a model where short rates respond to the output gap and inflation in each country, I identify macro and monetary policy risk premia by specifying no-arbitrage dynamics of each country's term structure of interest rates and the exchange rate. Estimating the model with US/German data, I find that the correlation between the model-implied exchange rate changes and the data is over 60%. The model implies a countercyclical foreign exchange risk premium with macro risk premia playing an important role in matching the deviations from Uncovered Interest Rate Parity. I find that the output gap and inflation drive about 70% of the variance of forecasting the conditional mean of exchange rate changes
    Keywords: exchange rate, monetary policy,term structure, no arbitrage
    JEL: C13 E43 E52
    Date: 2006–12–03
  7. By: Christian Bauer; Sebastian Horlemann
    Abstract: Recent approaches in international finance on exchange rates explicitly account for the maturity of interest rates. We integrate the interest parity idea into a modern microstructure model of foreign exchange and national bond markets and develop a model of the term structure of exchange rate expectations. The reaction function of the spot rate on changes of the basic economic variables such as the interest rate is generalized. This capital market model is able to reproduce standard results (e.g. overshooting) without reference to macroeconomic variables like rigid prices. In addition, the semi-elasticity of the spot exchange rate on interest rate changes depends on both the term structure of interest rates in both countries and determinants of the financial markets. The effects of interest rate changes on the spot exchange rate are diminished, if the exchange rate expectations for short and for long horizons have opposite signs. Finally, we show that there are several rational methods of building expectations which are not mutually consistent. This ambiguity of rational expectation building might contribute to explanations of the diversity of empirical results in the literature known as UIP puzzle.
    Keywords: exchange rates, expectation, term structure, interest parity
    JEL: F31 D84 E43
  8. By: Adrien Verdelhan
    Abstract: This paper presents a fully rational general equilibrium model that produces a time-varying exchange rate risk premium and solves the uncovered interest rate parity (U.I.P) puzzle. In this two-country model, agents are characterized by slow-moving external habit preferences similar to Campbell & Cochrane (1999). Endowment shocks are i.i.d and real risk-free rates are time-varying. Agents can trade across countries, but when a unit is shipped, only a fraction of the good arrives to the foreign shore. The model gives a rationale for the U.I.P puzzle: the domestic investor receives a positive exchange rate risk premium when she is effectively more risk-averse than her foreign counterpart. Times of high risk-aversion correspond to low interest rates. Thus, the domestic investor receives a positive risk premium when interest rates are lower at home than abroad. The model is both simulated and estimated. The simulation recovers the usual negative coefficient between exchange rate variations and interest rate differentials. When the iceberg-like trade cost is taken into account, the exchange rate variance produced is in line with its empirical counterpart. A nonlinear estimation of the model using consumption data leads to reasonable parameters when pricing the foreign excess returns of an American investor
    Keywords: Exchange rate, Time-varying risk premium, Habits
    JEL: F31 G12 G15
    Date: 2006–12–03
  9. By: Uluc Aysun (University of Connecticut)
    Abstract: This paper shows that countries characterized by a financial accelerator mechanism may reverse the usual finding of the literature -- flexible exchange rate regimes do a worse job of insulating open economies from external shocks. I obtain this result with a calibrated small open economy model that endogenizes foreign interest rates by linking them to the banking sector.s foreign currency leverage. This relationship renders exchange rate policy more important compared to the usual exogeneity assumption. I find empirical support for this prediction using the Local Projections method. Finally, 2nd order approximation to the model finds larger welfare losses under flexible regimes.
    Keywords: accelerator, balance sheets, welfare, EMBI
    JEL: E44 F31 F41
    Date: 2006–08
  10. By: Craig Burnside (Department of Economics Duke University); Martin Eichenbaum; Isaac Kleshchelski; Sergio Rebelo
    Abstract: Currencies that are at a forward premium tend to depreciate. This `forward premium-depreciation anomaly' represents an egregious deviation from uncovered interest parity. We document the 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 those 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. We display a simple microstructure model that simultaneously rationalizes `price pressure' and the forward premium-depreciation puzzle. The central feature of this model is that market makers face an adverse selection problem that is less severe when, based on public information, the currency is expected to appreciate
    Keywords: uncovered interest parity, BGT regressions, price pressure
    JEL: G12 G13 G15
    Date: 2006–12–03
  11. By: Ronald A. Ratti (Department of Economics, University of Missouri-Columbia); Sung-Wook Yoon; Jae-Young Choi
    Abstract: During the Asian crisis, a rise in short-term for debt relative to short-term debt denominated in domestic currency results in a significant decline in negative exposure of Korean firms, with Chaebol firms able to benefit more. Exposure of non-Chaebol firms is significantly affected by maturity of debt. Results are consistent with recent work modeling firm level phenomena during financial crisis that emphasizes the importance of credit constraints, and with observations that exporting firms have significantly higher foreign debt ratios and eve of crisis export and foreign debt ratios are strongly correlated with growth in sales immediately after the crisis.
    Keywords: Foreign exchange rate exposure; Foreign debt; Short term debt; Financial crisis; Credit rationing
    JEL: G15 F31 F34
    Date: 2006–11–28
  12. By: Michele Cavallo; Cedric Tille (Federal Reserve Bank of New York)
    Abstract: A narrowing of the U.S. current account deficit through exchange rate movements is likely to entail a substantial depreciation of the dollar, as stressed in research by Obstfeld and Rogoff. We assess how the adjustment is affected by the high degree of financial integration in the world economy. A growing body of research emphasizes the increasing leverage in international financial positions, with industrialized economies holding substantial and growing financial claims on each other. Exchange rate movements then lead to valuation effects as the currency composition of a country's assets and liabilities are not matched. In particular, a dollar depreciation generates valuation gains for the United States by boosting the dollar value of much of its foreign-currency-denominated assets. We consider an adjustment scenario in which the U.S. net external debt is held constant. The key finding is that as the current account moves into balance, the pace of adjustment is smooth. Intuitively, the valuation gains from the depreciation of the dollar allow the United States to finance ongoing, albeit shrinking, current account deficits. We find that the smooth pattern of adjustment is robust to alternative scenarios, although the ultimate movements in exchange rates will vary under different conditions
    Keywords: current account, exchange rates, global imbalances
    JEL: F31 F32 F41
    Date: 2006–12–03
  13. By: Maurice Obstfeld (University of California, Berkeley)
    Abstract: This paper presents a quantitative evaluation of the effect on the yen of some alternative scenarios under which Japan reaches current account balance. The analytical framework is a global general-equilibrium model, based closely on Obstfeld and Rogoff (2005a, 2005b), within which relative prices clear the world markets for traded goods as well as the domestic markets for nontraded goods. Depending on assumptions about the critical substitution elasticities underlying the model, the yen could appreciate by as much as 10 per cent for each 1 percent of GDP reduction in its current account surplus. The effect would be smaller if substitution elasticities are larger, or if adjustment is accompanied by an expansion of Japanese nontradable output, the latter presumably implied by a return to a more efficient level of labor utilization.
    Keywords: current account adjustment, international capital flows, exchange rates, external imbalance, net foreign assets, real exchange rate, sustainability,
    Date: 2006–07–11
  14. By: Anthony Landry (Economics Federal Reserve Bank of Dallas)
    Abstract: We introduce elements of state-dependent pricing and strategic complementarity into an otherwise standard New Open Economy Macroeconomics (NOEM) model. Relative to previous NOEM work, there are striking new implications for the dynamics of real and nominal economic activity: complementarity in the timing of price adjustment dramatically alters an open economy's response to monetary disturbances. Using a two-country Producer-Currency-Pricing environment, our framework replicates key international features following a domestic monetary expansion: (i) a high international output correlation relative to consumption correlation, (ii) a delayed overshooting of exchange rates, (iii) a J-curve dynamic in the domestic trade balance, and (iv) a delayed surge in inflation across countries. Overall, the model is consistent with many empirical aspects of international economic fluctuations, while stressing pricing behavior and exchange rate effects highlighted in the traditional work of Mundell, Fleming, and Dornbusch
    Keywords: international monetary policy transmission
    JEL: F41 F42
    Date: 2006–12–03
  15. By: Maurice Obstfeld (University of California, Berkeley and CEPR and NBER); Kenneth Rogoff (Harvard University)
    Abstract: Keywords: US current account deficit, external imbalance, net foreign assets, real exchange rate, sustainability JEL Codes: F21, F32, F36, F41ABSTRACT:We show that the when one takes into account the global equilibrium ramifications of an unwinding of the US current account deficit, currently running at more than 6% of GDP, the potential collapse of the dollar becomes considerably larger than our previous estimates (Obstfeld and Rogoff 2000a)--as much as 30% or even higher. It is true that global capital market deepening appears to have accelerated over the past decade (a fact documented by Lane and Milesi-Ferreti (2003, 2004) and recently emphasized by outgoing US Federal Reserve Chairman Alan Greenspan), and that this deepening may have helped allowed the United States to a recordbreaking string of deficits. Unfortunately, however, global capital market deepening turns out to be of only modest help in mitigating the dollar decline that will almost inevitably occur in the wake of global current account adjustment. As the analysis of our earlier papers (2000a,b) showed, and the model of this paper reinforces, adjustments to large current account shifts depend mainly on the flexibility and global integration of goods and factor markets. Whereas the dollar's decline may be benign as in the 1980s, we argue that the current conjuncture more closely parallels the early 1970s, when the Bretton Woods system collapsed. Finally, we use our model to dispel some common misconceptions about what kinds of shifts are needed to help close the US current account imbalance. For example, faster growth abroad helps only if it is relatively concentrated in nontradable goods; faster productivity growth in foreign tradable goods will actually exacerbate the US adjustment problem.
    Keywords: US current account deficit, external imbalance, net foreign assets, real exchange rate, sustainability,
    Date: 2006–06–27
  16. By: Todd Keister (Research and Statistics Group Federal Reserve Bank of New York)
    Abstract: This paper shows how expectations-driven contagion of currency crises can arise even if the currency market has a unique equilibrium when viewed in isolation. The model of Morris and Shin (1998) is extended to allow speculators to trade in a second currency market. If speculators believe that a devaluation of this other currency will make a domestic devaluation more likely, they will engage in trades that link the two markets. A sharp devaluation of the other currency will then be propagated to the domestic market and will increase the likelihood of a crisis there, fulfilling the original expectations. Even though this contagion is driven solely by expectations, the model places restrictions on observable variables, and these restrictions are broadly consistent with existing empirical evidence
    Keywords: Contagion, Currency Crisis, Coordination, Global Games
    JEL: F31 G15 D82
    Date: 2006–12–03
  17. By: Robin Pope; Reinhard Selten; Sebastian Kube; Jürgen von Hagen
    Abstract: Conclusions favourable to flexible exchange rates typically accord with expected utility theory in ignoring the costs that exchange rate uncertainty generates for governments, central banks, firms and unions in: (i) choosing among available acts; and (ii) existing until learning the outcome of the chosen act. Allowing for these costs involves the stages of knowledge ahead framework, Pope (1983, 1995, 2005). A laboratory experiment suggests that (i) and (ii) together outweigh the advantages of having a flexible exchange rate as an additional instrument for managing a country’s employment, interest rate, price level and international competitiveness goals
    Keywords: experiment
    JEL: C90
    Date: 2006–10
  18. By: Bernhard Herz; Christian Bauer; Volker Karb
    Abstract: Empirically, currency crises are more frequently accompanied by simultaneous sovereign debt crises than by banking crises. Nevertheless the phenomenon of twin currency and debt crises has so far been treated in economic literature only sparsely. We analyse the optimal policy of a government that may choose and combine two policy alternatives. She may choose at the same time whether to keep or alternatively exit an existing exchange rate peg and whether or not to default on her debt. Both parameters have a large impact not only on the public welfare but on the government’s budget as well. The resulting incentive system can generate situations with self-fulfilling expectations. In some situations an internal contagion effect arises. A crisis in the sovereign debt market spreads to the sector of exchange rate policy and causes a devaluation as well. Private investors’ default expectations thus can not only cause a sovereign debt crisis but may lead to a currency crisis as well.
    Keywords: Currency crises, internal contagion, self-fulfilling expectations and sovereign debt
    JEL: E61 F34 F41
  19. By: Maurice Obstfeld (University of California, Berkeley and CEPR and NBER)
    Abstract: Among the developing countries of the world, those emerging markets that have sought some degree of integration into world finance are characterized by higher per capita incomes, higher long-run growth rates, and lower output and consumption volatility. These characteristics are more likely to be causes than effects of financial integration. The measurable gains from financial integration appear to be lower for emerging markets than for higher-income countries, and appear to have been limited by recent crises. One factor limiting the gains from financial integration is the difficulty emerging economies face in resolving the open-economy trilemma. Given their structural and institutional features, many emerging economies cannot live comfortably either with fixed or with freely floating exchange rates. Most recently, the exchange rates of several emerging countries display attempts at stabilization punctuated by high volatility in periods of market stress.
    Keywords: Developing countries, emerging markets, convergence, macroeconomic volatility, exchange-rate regimes, institutions, dollarization, original sin,
    Date: 2006–06–27

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