nep-ifn New Economics Papers
on International Finance
Issue of 2007‒01‒28
twelve papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange Rate Pass-Through in ASEAN: Implications for the Prospects of Monetary Integration in the Region By Carlos Cortinhas
  2. Random Walk Expectations and the Forward Discount Puzzle By Philippe Bacchetta; Eric van Wincoop
  3. Pricing to Habits and the Law of One Price By Ravn, Morten O.; Schmitt-Grohé, Stephanie; Uribe, Martín
  4. Evaluating An Estimated New Keynesian Small Open Economy Model By Adolfson, Malin; Laséen, Stefan; Lindé, Jesper; Villani, Mattias
  5. Model-free Measurement of Exchange Market Pressure By Franc Klaassen; Henk Jager
  6. Progress toward a Common Currency Basket System in East Asia By OGAWA Eiji; SHIMIZU Junko
  7. Productivity Effects of FDI Inflows: A Literature Review By Hugo Rojas-Romagosa
  8. Exchange Market Pressure: Some Caveats In Empirical Applications By Simone Bertoli; Giampiero Gallo; Giorgio Ricchiuti
  9. Productivity, external balance and exchange rates: evidence on the transmission mechanism among G7 countries By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
  10. Exchange rate sensitivity of China’s bilateral trade flows By Wang , Jiao; Ji, Andy G.
  11. Macroeconomic imbalances and exchange rate regime shifts By Post, Erik
  12. Currency Futures Volatility during the 1997 East Asian Crisis: An Application of Fourier Analysis By Vanessa Mattiussi; Giulia Iori

  1. By: Carlos Cortinhas (Universidade do Minho - NIPE)
    Abstract: This paper investigates, for the first time, the degree of exchange rate pass-through to domestic prices in all five founding members of ASEAN. For this purpose, a three variable recursive VAR model was applied which uses the Choleski decomposition method along the distribution chain of pricing, using data for the period 1968 to 2001. The results show that a strong case for entering a currency union can only be made for the cases of Singapore and Malaysia as in these countries there appears to be a case of exchange rate disconnect. A case for a common currency can also be made for Indonesia but for entirely different reasons. For this country, an independent monetary policy is a clear source of shocks to the economy and therefore a currency union would tend to eliminate then. A weaker case for a common currency can be made for the Philippines as evidence of some exchange rate pass-through to inflation was found but not to import prices. Finally, Thailand exhibits a clear case of exchange rate pass-through to import prices (but not to inflation) and thus evidence that a flexible exchange rate might be preferable as it provides the means to improve the country’s price competitiveness.
    Keywords: Exchange Rate Pass-Through; Monetary Integration; Asean
    JEL: F31 F33 E42
    Date: 2007
  2. By: Philippe Bacchetta (Study Center Gerzensee); Eric van Wincoop (University of Virginia)
    Abstract: Two well-known, but seemingly contradictory, features of exchange rates are that they are close to a random walk while at the same time exchange rate changes are predictable by interest rate dierentials. In this paper we investigate whether these two features of the data may in fact be related. In particular, we ask whether the predictability of exchange rates by interest dierentials naturally results when participants in the FX market adopt random walk expectations. We nd that random walk expectations can explain the forward premium puzzle, but only if FX portfolio positions are revised infrequently. In contrast, with frequent portfolio adjustment and random walk expectations, we nd that high interest rate currencies depreciate much more than what UIP would predict.
    Date: 2007–01
  3. By: Ravn, Morten O.; Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: This paper proposes a novel international transmission mechanism based on the assumption of deep habits. The term deep habits stands for a preference specification according to which consumers form habits on a good-by-good basis. Under deep habits, firms face more elastic demand functions in markets where nonhabitual demand is high relative to habitual demand, creating an incentive to price discriminate. We refer to this type of price discrimination as pricing to habits. In the presence of pricing to habits, innovations to domestic aggregate demand induce a decline in markups in the domestic country but not abroad, leading to a departure from the law of one price. In this way, the proposed pricing-to-habit mechanism can explain the observation that prices of the same good across countries, expressed in the same currency, vary over the business cycle. Furthermore, it can account for the empirical fact that in response to a positive domestic demand shock, such as an increase in government spending, the real exchange rate depreciates, domestic consumption expands, and the trade balance deteriorates.
    Keywords: countercyclical markup; deep habits; government spending; Law of one price; real exchange rate
    JEL: E32 F30 F41
    Date: 2007–01
  4. By: Adolfson, Malin; Laséen, Stefan; Lindé, Jesper; Villani, Mattias
    Abstract: This paper estimates and tests a new Keynesian small open economy model in the tradition of Christiano, Eichenbaum, and Evans (2005) and Smets and Wouters (2003) using Bayesian estimation techniques on Swedish data. To account for the switch to an inflation targeting regime in 1993 we allow for a discrete break in the central bank's instrument rule. A key equation in the model - the uncovered interest rate parity (UIP) condition - is well known to be rejected empirically. Therefore we explore the consequences of modifying the UIP condition to allow for a negative correlation between the risk premium and the expected change in the nominal exchange rate. The results show that the modification increases the persistence and volatility in the real exchange rate and that this model has an empirical advantage compared with the standard UIP specification.
    Keywords: Bayesian inference; DSGE model; DSGE-VAR model; DSGE-VECM model; open economy
    JEL: C11 C53 E17
    Date: 2007–01
  5. By: Franc Klaassen (Universiteit van Amsterdam); Henk Jager (Universiteit van Amsterdam)
    JEL: E58 F31 F33 G15
    Date: 2007–01–02
  6. By: OGAWA Eiji; SHIMIZU Junko
    Abstract: Ogawa and Shimizu (2005, 2006a) have proposed a possible way to create an Asian Monetary Unit (AMU) as a weighted average of the thirteen East Asian currencies (ASEAN + China, Japan, and Korea) and developed AMU Deviation Indicators for a surveillance process under the Chiang Mai Initiative. Both the AMU and the AMU Deviation Indicators are important in helping the countries in the region to recognize the necessity of moving toward a common currency basket system. However, there remains an open question about how to implement this system in East Asian countries. The purpose of this paper is to compile the latest issues of currency basket itself and to develop concrete steps toward a common currency basket system in East Asia. Particularly, we simulate possible individual currency basket weights based on trade shares of each East Asian country and convert them to G3 currency (the US dollar, the euro, and the Japanese yen) basket weights. We also investigate the discrepancies between the converted G3 currency basket weight of the AMU and the weights of the common G3 currency basket, which is to illustrate the reality of implementing a common currency basket system. We propose a possible way to shift from an individual G3 currency basket system to the AMU currency basket system. In this process, we expect that the Japanese yen would play a varying role at each stage toward monetary coordination in East Asia.
  7. By: Hugo Rojas-Romagosa
    Abstract: Foreign Direct Investment (FDI) flows have increased substantially in the past two decades. These developments have motivated the appearance of a large number of empirical papers that test the expected benefits that FDI inflows are assumed to bring to the host countries.We survey the recent theoretical and empirical literature, but restrict our attention to the productivity changes that are induced by increased FDI inflows. We review both the aggregate productivity effects, as well as the spillover effects of FDI on local firms.
    Keywords: FDI; productivity growth
    JEL: F23 O33 O47
    Date: 2006–12
  8. By: Simone Bertoli (Università degli Studi di Firenze, Dipartimento di Economia); Giampiero Gallo (Università degli Studi di Firenze, Dipartimento di Statistica "G. Parenti"); Giorgio Ricchiuti (Università degli Studi di Firenze,Dipartimento di Economia)
    Abstract: The Exchange Market Pressure (EMP) Index, developed by Eichengreen et al. [1994], is widely used to study currency crises as a tool to signal whether pressures on a currency are softened or warded off through monetary authorities’ interventions or whether a currency crisis has originated. In this paper we show how the index is sensitive to some assumptions behind the aggregation of the information available (exchange rates, interest rates and reserves), especially when emerging countries are involved. Specifically, we address the way exchange rate variations are computed and the impact of different definitions of the reserves, and we question the constancy of the weights adopted. These issues compound with the choice of a fixed threshold when crisis episodes are identified through EMP. As a result, the dichotomous crisis variable thus derived when adopted as a dependent variable may lead to varied results in subsequent econometric analysis.
  9. By: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
    Abstract: This paper investigates the international transmission of productivity shocks in a sample of five G7 countries. For each country, using long-run restrictions, we identify shocks that increase permanently domestic labor productivity in manufacturing (our measure of tradables) relative to an aggregate of other industrial countries including the rest of the G7. We find that, consistent with standard theory, these shocks raise relative consumption, deteriorate net exports, and raise the relative price of nontradables - in full accord with the Harrod-Balassa-Samuelson hypothesis. Moreover, the deterioration of the external account is fairly persistent, especially for the US. The response of the real exchange rate and (our proxy for) the terms of trade di¤ers across countries: while both relative prices depreciate in Italy and the UK (smaller and more open economies), they appreciate in the US and Japan (the largest and least open economies in our sample); results are however inconclusive for Germany. These findings question a common view in the literature, that a country's terms of trade fall when its output grows, thus providing a mechanism to contain di¤erences in national wealth when productivity levels do not converge. They enhance our understanding of important episodes such as the strong real appreciation of the dollar as the US productivity growth accelerated in the second half of the 1990s. They also provide an empirical contribution to the current debate on the adjustment of the US current account position. Contrary to widespread presumptions, productivity growthin the US tradable sector does not necessarily improve the US trade deficit, nor deteriorate the US terms of trade, at least in the short and medium run.
    Keywords: International transmission mechanism, net exports, terms of trade, real exchange rates, VAR, long-run restrictions, US current account
    JEL: F32 F41 F42
    Date: 2006
  10. By: Wang , Jiao (BOFIT); Ji, Andy G. (BOFIT)
    Abstract: Traditional assessments of the impact of exchange rate depreciation or appreciation on trade have involved estimating the elasticity of trade volume to relative prices. Such studies relied heavily on aggregated trade data. More recent studies employ bilateral trade data and methodologies such as ECM and gravity models. This study uses a generalized gravity model with data panel analysis in assessing the impact of currency depreciation or appreciation on bilateral trade flows between China and its top trading partners. The empirical evidence suggests exchange rates (both real and nominal) do not exert a significant influence on the overall exports from China. Thus, a devaluation or revaluation of the yuan should be expected to have only limited impact on China’s trade balance. Moreover, previous studies provide limited evidence of a negative relation between exchange rate volatility and trade flows. Given the current revaluation expectations, we find China’s anticipated shift toward a more flexible exchange rate regime fails to address China’s trade surplus issues, and thus will merely lead to a revaluation of the nominal exchange rate and increased exchange rate volatility. It appears a major overhaul of the country’s heavily subsidized export regime must first occur for the exchange rate to assume a larger role in China’s international trade.
    Keywords: exchange rate; trade; China; competition; gravity model; panel
    JEL: C22 C22 F14 F31
    Date: 2007–01–18
  11. By: Post, Erik (Department of Economics)
    Abstract: This paper uses a dynamic stochastic rational expectations model of a small open economy to shed some light on factors determining exits from a fixed to a flexible exchange rate regime. Exits are in the model determined by a concern for macroeconomic stabilization. If cost-push shocks are important relative to demand shocks exits should occur more likely in times of low consumption and output, high interest rates, negative asset holdings, current account deficits, high inflation and high domestic prices. If the policy maker is more sensitive to negative rather than positive output deviations the probability of exits increases overall and is tilted toward exits with accompanying depreciation.
    Keywords: exchange rates; exchange rate regimes; rational expectations model
    JEL: E42 E44 E47
    Date: 2007–01–16
  12. By: Vanessa Mattiussi (Department of Economics, City University, London); Giulia Iori (Department of Economics, City University, London)
    Abstract: We analyze a recently proposed method to estimate volatility and correlation when prices are observed at a high frequency rate. The method is based on Fourier analysis and does not require any data manipulation, leading to more robust estimates than the traditional methodologies proposed so far. In the first part of the paper, we evaluate the performance of the Fourier algorithm to reconstruct the time volatility of simulated univariate and bivariate models. In the second part, the Fourier method is used to investigate the volatility and correlation dynamics of futures markets over the Asian crisis period, with the purpose of detecting possible interdependencies and volatility transmissions across countries amid a period of financial turmoil.
    Keywords: high frequency data, Fourier analysis, Asian crisis, volatility spillover
    Date: 2006–09

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