nep-ifn New Economics Papers
on International Finance
Issue of 2007‒01‒14
fifteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Non-linear adjustment in law of one price deviations and physical characteristics of goods By Berka, Martin
  2. The Harrod-Balassa-Samuelson Effect: A Survey of Empirical Evidence By Josip Tica; Ivo Družić
  3. Some evidence of exchange market pressure in the EU4 countries By Stavarek, Daniel
  4. Long maturity forward rates of major currencies are stationary By Zsolt Darvas; Zoltán Schepp
  5. The effectiveness of official intervention in foreign exchange market in Malawi By Simwaka, Kisu
  6. Future and Forward Contracts: Taking a speculative position and/or hedging By Govori, Fadil
  7. Computational Intelligence in Exchange-Rate Forecasting By Andreas S. Andreou; George A. Zombanakis
  8. What drives investors’ behaviour in different FX market segments? A VAR-based return decomposition analysis By Olli Castrén; Chiara Osbat; Matthias Sydow
  9. Exchange rate uncertainty and monetary transmission in the Philippines By Bayangos, V.B.
  10. Ability of the New EU Member States to Fulfill the Exchange Rate Stability Convergence Criterion By Stavarek, Daniel
  11. Quantile Forecasts of Daily Exchange Rate Returns from Forecasts of Realized Volatility By Clements, Michael P.; Galvão, Ana Beatriz; Kim, Jae H.
  12. Equilibrium Exchange Rates in EU New Members: Applicable for Setting the ERM II Central Parity? By Horvath, Roman; Komarek, Lubos
  13. Is There an Exchange Rate Channel in the Forward-Looking Phillips Curve? A Theoretical and Empirical Investigation By Alfred V. Guender; Yu Xie
  14. Transaction taxes, traders' behavior and exchange rate risks By Demary, Markus
  15. Financial power laws : empirical evidence, models, and mechanism By Lux, Thomas

  1. By: Berka, Martin
    Abstract: At the level of individual goods, heterogeneity in marginal transaction costs, proxied by price-to-weight and price-to-volume ratios, together with measures of pricing power within industries, explains a large part of the variation in thresholds of no-adjustment as well as in conditional half-life of law of one price deviations. Prices of goods that are more heavy or voluminous deviate further before becoming mean-reverting. Moreover, after becoming mean-reverting, prices of heavier (more voluminous) goods converge more slowly. Size of the market is also important in explaining threshold heterogeneity. These factors explain up to 60% of the variation in no-adjustment threshold estimates across 49 goods in US-Canada post Bretton Woods monthly CPI data.These results open two avenues for the importance of marginal transaction costs in accounting for real exchange rate persistence: First through generating persistence in individual real exchange rate components, and second by accentuating persistence in the process aggregation of geneous components (the "aggregation bias" of Imbs,et. al. 2005). They also highlight the evance of theoretical modeling of transaction frictions for understanding real exchange rate persistence.
    Keywords: Law of One Price Deviations; Real Exchange Rate Persistence; Non- Linearities; transaction costs; Physical Weight; Physical Volume; Threshold Autregres- sive Models
    JEL: F36 F31
    Date: 2006–11
  2. By: Josip Tica (Faculty of Economics and Business, University of Zagreb); Ivo Družić (Faculty of Economics and Business, University of Zagreb)
    Abstract: The paper surveys empirical evidence on the Harrod-Balassa-Samuelson effect. The survey encompasses the published empirical work on the phenomenon since its (re)discovery in 1964. In total, 58 empirical papers are examined within a specialized analytical framework. The body of empirical evidence is synthesized through four major elements. The analysis starts with the ongoing controversy related to the name of the theory. This is followed by a presentation of the evolution of the theoretical and econometric model. It ends with an analysis of the results of the surveyed empirical studies. Results of the survey indicate that growing body of evidence definitely points towards professional rethinking about the significance of the Harrod-Balassa-Samuelson effect.
    Keywords: Harrod Balassa Samuelson effect, real exchange rate, purchasing power parity, productivity
    JEL: E31 F31 F41
    Date: 2006–09–13
  3. By: Stavarek, Daniel
    Abstract: This paper estimates the exchange market pressure (EMP) on currencies of EU4 countries (Czech Republic, Hungary, Poland, Slovakia) during the period 1993-2005. Therefore, it is one of a very few studies focused on this region and the very first paper applying the model-dependent approach to the EMP estimation on these countries. Moreover, the model proposed by Spolander (1999) is used in the paper along with quarterly data. Thus, this paper, tests the suitability of this model for the countries analysed. Regarding the results obtained, EMP is of similar magnitude in all countries except Poland. We found that EMP was significantly lower and less volatile during the periods when a floating exchange rate arrangement was applied than in periods with fixed exchange rates. It implies that unavoidable entry into ERM II (a quasi-fixed regime) could lead to the EMP increase during the period of the exchange rate stability criterion fulfilment. Hence, a revision of the current definition and understanding of the criterion fulfilment is suggested. Since the model estimation was burdened by some factors reducing the estimates validity we also propose some modifications and extensions of the methodology applied.
    Keywords: market pressure; Central Europe; model-dependent approach; exchange rate stability criterion
    JEL: E58 F31
    Date: 2006–09
  4. By: Zsolt Darvas (Department of Mathematical Economics and Economic Analysis, Corvinus University of Budapest); Zoltán Schepp (University of Pécs)
    Abstract: Using eight unit root tests and a stationarity test and three decades of monthly data for the currencies between the US, Germany, UK and Switzerland, we find that, while spot exchange rates are non-stationary, long maturity forward rates are stationary.
    Keywords: forward exchange rate, unit root tests
    JEL: C22 F31
    Date: 2006–02–14
  5. By: Simwaka, Kisu
    Abstract: The Malawi Kwacha was floated in February 1994. Since then, the Reserve Bank of Malawi has periodically intervened in the foreign exchange market. This paper analyses the effectiveness of foreign exchange market interventions carried out by the Reserve Bank of Malawi. We use a GARCH (1, 1) model to simultaneously estimate the effect of intervention on the mean and volatility of the Malawi kwacha. Using monthly exchange rates and official intervention data from January 2002 to February 2006, the empirical results suggest that intervention activities of the Reserve Bank of Malawi affect the kwacha. In line with similar findings elsewhere in the literature, the paper finds that net sales of dollars by the Reserve Bank of Malawi depreciate, rather than appreciate, the kwacha. This effect is very small, however. Moreover, the paper also finds that the Reserve Bank of Malawi intervention reduces the volatility of the kwacha. This shows that the Reserve Bank actually achieves its objective of smoothing out fluctuations of the kwacha. This can be evidenced by the stability of the kwacha during a greater part of 2004. Thus intervention is, to some extent, used as an effective tool for moderating fluctuations of the kwacha. However, its effectiveness is constrained by the amounts of foreign exchange reserves, which are usually low.
    Keywords: Official intervention; foreign exchange market; garch model
    JEL: E58
    Date: 2006–11–20
  6. By: Govori, Fadil
    Abstract: A future contract involves a contractual agreement between parties to purchase or sell something at a future point in time, called the delivery month. The buyer is called the long and the seller is called the short. The actual purchase of the commodity is not scheduled to take place until the delivery month. In practice, most futures contracts are closed out by an offsetting position before delivery occurs. A long offsets by going short; a short offsets by going long. Offsetting does not involve any incremental brokerage fees because the fee to establish the initial short position includes the commission to take the offsetting long position, a so called, round trip commission. Futures contracts are standardized and actively traded on impersonal exchange. Since the short and long do not know each other, the risk of default is real. To reduce the likelihood of default, futures contracts require a performance bond and marking-to-market. As further protections, daily price limits and position limits are also used. With futures contracts, cash flows occur before the delivery date as the gains or losses from marking-to-market are settled daily. A particular futures contract is traded in a designated “pit” at the exchange. A pit is a series of steps above the trading floor. The traders stand on the steps and engage in open outcry and hand signal trading. The total number of outstanding contracts is called the open interest. For every outstanding contract, one person is short and one is long. For the open interest to change, the number of shorts and longs must change. If a particular transaction involves a new long and a new short, the open interest increases by one contract. If a transaction involves offsetting by an existing long and offsetting by an existing short, the open interest declines by one contract. If a transaction entails offsetting by an existing short or long, and if the other side of the transaction is a new investor, the open interest remains unchanged. Each futures exchange has a clearinghouse to keep track of short and long positions. The clearinghouse cancels the offsetting positions. The amount of trading is different from the open interest. For example, if 50 longs decided to offset by going short and the other sides of the transactions were taken by 50 new long investors, we would have 50 trades and an unchanged open interest. Every long and short position is required to post a performance bond called margin with the clearinghouse. The margin allows the clearinghouse to guarantee the financial integrity of contracts. If one side defaults, the clearinghouse should have sufficient margin funds to ensure that the other side of the contract does not suffer financially. Because an investor in futures markets must put down margin equal to only a small proportion of the market value of the underlying commodity, the investor’s position is highly levered and quite risky. A small percentage change in the price of the futures contract brings about a much larger percentage change in the value of the margin. Each day the exchange computes a settlement price. The settlement price is not the closing price, the price from the very last trade of the day. Instead, the settlement price is an average of the prices near the end of trading. The funds used to settle the accounts of the shorts and the longs come from the collateral deposited by investors with the clearinghouse. When prices increase, the collateral of the longs is increased and the shorts’ collateral is reduced by the same amount. If an individual investor’s collateral becomes too small as a result of market price changes, the investor is required to put up more margins or the position is closed. Thus, marking-to-market helps to guarantee performance on the contract. The forward market is a small, private market. Forward contracts have a number of similarities and differences with futures contracts. Forward markets exist in the foreign exchange markets. Typically, banks regularly dealing with each other write forward contracts on foreign currencies. Since the banks dealing in these forward markets know each other quite well and have many interactions, default on a particular contractual agreement is unlikely. Consequently, these forward contracts do not involve collateral, although compensating balances may be expected. No cash flows occur between the initiation of the forward contract and the delivery date. The parties merely agree to exchange currencies at some future date. Delivery is usually made on forward contracts. Terms on particular contracts are tailor-made to meet the specific needs of the parties, making individual contracts unattractive to other parties and creating a thin resale market for forward contracts. The markets for forward foreign exchange attempt to solve the problem of default by having a small and private market in which the parties are unlikely to default because of their close ties. In contrast, futures markets attempt to solve the problem of possible default and contractual nonperformance by required margin and by marking-to-market. If all interest rates are certain, futures and forward prices are identical, even though futures contracts have marking-to-market. Since interest rates are uncertain in practice, a difference between futures and forward prices may exist. Empirically, any difference between futures and forwards appears to be second orders effect-perhaps a fraction of a percent. Possession of a particular commodity may have a convenience value to a firm. The convenience yield reduces the futures price relative to the spot price. The convenience yield increases in absolute value as the delivery date becomes more distant. For most futures contracts, the futures price increases as the delivery date becomes more distant, and the total interest and storage costs increase as the delivery date becomes more distant. The futures price for distant delivery dates should exceed the spot price by the amount of interest and storage until the delivery date. Going short or long in futures without any offsetting position is often described as taking a speculative position. In a futures hedge, an investor offsets a position in the spot market with a nearly opposite position in the futures market with the objective of reducing the overall risk of the position. The hedged position also has a lower expected return than an unhedged position. Hedges allow those unwilling or unable to bear the risk to transfer the risk to another party willing and able to take on the risks and possible rewards. This risk transfer function of futures markets is socially desirable. In a long hedge, the investor takes a long position in futures. In short hedges, the investor takes a short position in futures. A very important type of short hedge occurs when an investor with a long position in the spot market simultaneously shorts futures contracts.
    Keywords: Futures and Forwards; Future Contracts; Forward Contracts; Futures Market; Derivative Financial Instruments
    JEL: G13 G11 G24 G21 G12 G15
    Date: 2006–06–16
  7. By: Andreas S. Andreou (University of Cyprus); George A. Zombanakis (Bank of Greece)
    Abstract: This paper applies computational intelligence methods to exchange rate forecasting. In particular, it employs neural network methodology in order to predict developments of the Euro exchange rate versus the U.S. Dollar and the Japanese Yen. Following a study of our series using traditional as well as specialized, non-parametric methods together with Monte Carlo simulations we employ selected Neural Networks (NNs) trained to forecast rate fluctuations. Despite the fact that the data series have been shown by the Rescaled Range Statistic (R/S) analysis to exhibit random behaviour, their internal dynamics have been successfully captured by certain NN topologies, thus yielding accurate predictions of the two exchange-rate series.
    Keywords: Exchange - rate forecasting, Neural networks
    JEL: C53
    Date: 2006–11
  8. By: Olli Castrén (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Chiara Osbat (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Matthias Sydow (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We apply the Campbell-Shiller return decomposition to exchange rate returns and fundamentals in a stationary panel vector autoregression framework. The return decomposition is then used to analyse how different investor segments react to news as captured by the different return components. The results suggest that intrinsic value news are dominating for equity investors and speculative money market investors while investors in currency option markets react strongly to expected return news. The equity and speculative money market investors seem able to distinguish between transitory and permanent FX movements while options investors mainly focus on transitory movements. We also find evidence that offsetting impact on the various return components can blur the effect of macroeconomic data releases on aggregate FX excess returns. JEL Classification: C23, F31, F32, G15.
    Keywords: FX return prediction, investor flows, news surprises, panel estimation, stationary VAR.
    Date: 2006–12
  9. By: Bayangos, V.B.
    Keywords: exchange rate; monetary transfers; Philippines;
    Date: 2006
  10. By: Stavarek, Daniel
    Abstract: This paper assesses exchange rate development and volatility in six new EU member states (Cyprus, Czech Republic, Hungary, Poland, Slovakia, and Slovenia) during the period November 1996 - April 2006. The study is motivated by the unavoidable participation of the new member states’ currencies in the Exchange Rate Mechanism II and fulfillment of the exchange rate stability convergence criterion. The development of exchange rates is examined by the calculation of various rates of return and the exchange rate volatility is analyzed using moving average standard deviations of the annualized daily returns of the nominal bilateral exchange rates. The results suggest that the dilemma of “participation or non-participation in ERM II” have been solved properly so far by all countries analyzed. The three ERM II participating currencies (SIT, CYP, SKK) entered into the mechanism at the optimal time of stable exchange rate development and low volatility. On the other hand, the admissible fluctuation band ± 2.25 % seems to be still too narrow for the remaining three currencies (CZK, HUF, PLN), thus the currencies should remain out of ERM II for some time.
    Keywords: exchange rates; rate of return; volatility; ERM II; exchange rate stability criterion; new EU Member States
    JEL: F31
    Date: 2006–05
  11. By: Clements, Michael P. (University of Warwick); Galvão, Ana Beatriz (Queen Mary, University of London); Kim, Jae H. (Monash University)
    Abstract: Quantile forecasts are central to risk management decisions because of the widespread use of Value-at-Risk. A quantile forecast is the product of two factors : the model used to forecast volatility, and the method of computing quantiles from the volatility forecasts. In this paper we calculate and evaluate quantile forecasts of the daily exchange rate returns of five currencies. The forecasting models that have been used in recent analyses of the predictability of daily realized volatility permit a comparison of the predictive power of different measures of intraday variation and intraday returns in forecasting exchange rate variability. The methods of computing quantile forecasts include making distributional assumptions for future daily returns as well as using the empirical distribution of predicted standardized returns with both rolling and recursive samples. Our main ?ndings are that the HAR model provides more accurate volatility and quantile forecasts for currencies which experience shifts in volatility, such as the Canadian dollar, and that the use of the empirical distribution to calculate quantiles can improve forecasts when there are shifts.
    Keywords: realized volatility ; quantile forecasting ; MIDAS ; HAR ; exchange rates
    JEL: C32 C53 F37
    Date: 2006
  12. By: Horvath, Roman; Komarek, Lubos
    Abstract: In this paper we discuss the estimation and methodology of the real equilibrium exchange rate partial equilibrium models and analyze to what extent the resulting estimates are applicable for setting the central parity prior to ERM II entry in the new EU member states. Given the uncertainty surrounding the estimates, we argue that they are informative in the sign rather than the size of the misalignment of the exchange rate, but may still serve as useful consistency checks for the decision on the setting of the central parity. We argue that policy makers should consider the estimates in their decision-making only if the real exchange rate is substantially misaligned.
    Keywords: Equilibrium Exchange Rate; ERM II; EU New Member States
    JEL: E58 E61 C52 F31 C53
    Date: 2006–10–20
  13. By: Alfred V. Guender (University of Canterbury); Yu Xie
    Abstract: This paper shows how the exchange rate affects the price-setting behavior of monopolistically competitive firms in the sticky price framework that gives rise to a forward-looking Phillips Curve at the aggregate level. The open economy Phillips Curve differs from its closed economy counterpart in that the real exchange rate exerts a direct effect on domestic inflation. The exchange rate channel in the Phillips Curve is pivotal in determining the optimal policy setting in an open economy. On balance, we find only scant empirical evidence for the existence of a direct exchange rate channel in the Phillips Curve in a sample of six OECD countries. Indeed, the forward-looking Phillips Curve does not receive much backing from the data. The use of highly aggregated data may account for the poor fit.
    Keywords: Open economy Phillips Curve; Exchange rate channel; Output gap
    JEL: E3 F4
    Date: 2006–12–01
  14. By: Demary, Markus
    Abstract: We propose a new model of chartist-fundamentalist-interaction in which both groups of traders are allowed to select endogenously between different forecasting models and different investment horizons. Stochastic interest rates in both countries and different behavioral assumptions for trend-extrapolating and fundamental based forecasts determine the agents’ market orders which drive the exchange rate. A numerical analysis of the model shows that it is able to replicate stylized facts of observed financial return time series like excess kurtosis and volatility clustering. Within this framework we study the effects of transaction taxes on exchange rate volatil- ity and traders’ behavior measured by their population fractions. Simula- tions yield the result that on the macroscopic level these taxes reduce the variance of exchange rate returns, but also increase their kurtosis. Moreover, on the microscopic level the tax harms short-term speculation in favor of long-term investment, while it also harms trading rules based on economic fundamentals in favor to trend extrapolating trading rules.
    Keywords: Chartist-Fu e ist-Interaction, Exchange Rates, Financial Market Volatility, Tra tion Taxes
    Date: 2006
  15. By: Lux, Thomas
    Abstract: Financial markets (share markets, foreign exchange markets and oth- ers) are all characterized by a number of universal power laws. The most prominent example is the ubiquitous ¯nding of a robust, approximately cubic power law char- acterizing the distribution of large returns. A similarly robust feature is long-range dependence in volatility (i.e., hyperbolic decline of its autocorrelation function). The recent literature adds temporal scaling of trading volume and multi-scaling of higher moments of returns. Increasing awareness of these properties has recently spurred attempts at theoretical explanations of the emergence of these key characteristics form the market process. In principle, di®erent types of dynamic processes could be responsible for these power-laws. Examples to be found in the economics literature include multiplicative stochastic processes as well as dynamic processes with mul- tiple equilibria. Though both types of dynamics are characterized by intermittent behavior which occasionally generates large bursts of activity, they can be based on fundamentally di®erent perceptions of the trading process. The present chapter reviews both the analytical background of the power laws emerging from the above data generating mechanism as well as pertinent models proposed in the economics literature.
    Date: 2006

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