nep-ifn New Economics Papers
on International Finance
Issue of 2007‒02‒17
fourteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. A Classroom Experiment on Exchange Rate Determination with Purchasing Power Parity By Mitchell, David; Rebelein, Robert P.; Schneider, Patricia; Simpson, Nicole B.; Eric Fisher
  2. Testing the purchasing power parity in China By Olivier Darné; Jean-François Hoarau
  3. Pricing-to-Market Effects in Foreign Trade Prices. Evidence from a Cointegration Approach for Germany By Sabine Stephan
  4. Currency Crises in Emerging Markets: An Application of Signals Approach to Turkey By Mete Feridun
  5. Currency Crises and Monetary Policy in Economies with Partial Dollarisation of Liabilities By Peter Flaschel; Christian Proano; Willi Semmler
  6. Determinants of Currency Crises in Emerging Markets: An Empirical Investigation on Turkey By Mete Feridun
  7. Beyond the IMF By Devesh Kapur; Richard Webb
  8. Instability of the Eurozone? On Monetary Policy, House Prices and Labor Market Reforms By Ansgar Belke; Daniel Gros
  9. On the relationship between Nominal Exchange Rates and domestic and foreign prices By David Peel; Ivan Paya
  10. China’s Exchange Rate Appreciation in the Light of the Earlier Japanese Experience By McKinnon, Ronald
  11. Talks, financial operations or both? Generalizing central banks’ FX reaction functions By Oscar Bernal; Jean-Yves Gnabo
  12. Analyse microstructurelle du comportement du teneur de marché des changes : étude intra-journalière de l'activité d'un teneur de marché tunisien By Imen Kouki; Hélène Raymond
  13. Evaluating An Estimated New Keynesian Small Open Economy Model By Adolfson, Malin; Laséen, Stefan; Lindé, Jesper; Villani, Mattias
  14. Equity premium: Historical, expected, required and implied By Fernandez, Pablo

  1. By: Mitchell, David (St. Mary's College of CA Department of Economics); Rebelein, Robert P. (Vassar College Department of Economics); Schneider, Patricia (Mount Holyoke College Department of Economics); Simpson, Nicole B. (Colgate College Department of Economics); Eric Fisher (California Polytechnic State University and Federal Reserve Bank of Cleveland)
    Abstract: We develop a classroom experiment on exchange rate determination appropriate for undergraduate courses in macroeconomics and international economics. Students represent citizens from different countries and need to obtain currency to purchase goods. By participating in a sealed bid auction to buy currency, students gain a better understanding of currency markets and the determination of exchange rates. The implicit framework for exchange rate determination is one in which prices are perfectly flexible (in the long run) so that purchasing power parity (PPP) prevails. Additional treatments allow students to examine the impact of transport costs, nontradable goods and tariffs on the exchange rate and to explore possible deviations from PPP.
  2. By: Olivier Darné; Jean-François Hoarau
    Abstract: In this paper we examine whether purchasing power parity holds in the long run in China for the period 1970:1 to 2006:5 from an alternative method relative to the previous studies. We underlined the effects of large, but infrequent shocks due to changes of Chinese exchange policy (undertaken since the China's foreign exchange reform) on the real exchange rate, using outlier methodology. We also show that there is no endency to the purchasing power parity in China to hold in the long run during this period.
    Keywords: Purchasing power parity; real exchange rate; unit root tests; outliers; renminbi.
    JEL: C22 F31
    Date: 2006
  3. By: Sabine Stephan (IMK at the Hans Boeckler Foundation)
    Abstract: The article analyses the impact of exchange rate changes on German export and import prices. The analytical framework is a mark-up model which is based on the assumption that the markets under consideration are imperfectly competitive as well as segmented. Hence, firms will no longer set prices at marginal costs, but charge a mark-up on costs to earn above normal profits. The mark-up is not fixed, but can be adjusted in response to demand pressure and competitive pressure in the relevant market. Consequently, firms can practice price discrimination. We find evidence that domestic and foreign producers follow different price setting strategies: German exporters largely pass-through exchange rate changes; i.e. an appreciation of domestic currency is reflected in a significant increase in export prices (expressed in terms of foreign currency) indicating that German exporters have significant market power and/or face a fairly inelastic export demand curve. Foreign exporters to Germany, however, largely follow a pricing-to-market strategy; i.e. they absorb price increases due to an appreciation of foreign currency into their profit margins in order to stabilise export prices (expressed in terms of domestic currency). Thus, they can protect market shares in the highly competitive German market.
    Keywords: export prices, import prices, exchange rate pass-through, pric- ing to market, error correction model
    JEL: C51 E31 F31
    Date: 2005–12
  4. By: Mete Feridun (Department of Economics, Loughborough University)
    Abstract: This article aims at identifying the leading indicators of currency crises in Turkey in its post-liberalization history through the signals approach introduced by Kaminsky et al (1998). Based on a broad set of potential indicators, a number of variables are found to be persistently signaling the currency crises during the period 1980:01-2006:06. Particularly, variables such as short-term debt/international reserves, imports, exports, M2/international reserves, and current account balance/GDP are consistent with the results of previous work in the literature. Analysis of the average lead time of the indicators reveals that the first signal is issued 4.4 months before a crisis erupts with public debt/GDP offering the longest lead time with 10.2 months, and government consumption/GDP offering the shortest with 2.2 months. Analysis of the persistence of the indicators reveals that the indicator issuing the most persistent signals is the government consumption/GDP and the one issuing the least persistent signals is FDI/GDP. Results are encouraging from the vantage point of an early warning system since signaling, on average, occurs sufficiently early to allow preemptive policy actions.
    Keywords: Speculative attacks; currency crises; signals approach, Turkey.
    JEL: F30 E44
    Date: 2006–12
  5. By: Peter Flaschel (University of Bielefeld); Christian Proano (University of Bielefeld, IMK at the Hans Boeckler Foundation); Willi Semmler (New School for Social Research, New York)
    Abstract: The right response to a speculative attack on the domestic currency by monetary authorities in a country with liabilities in US dollars has been a matter of hot debate among academics and policy makers especially after the East Asian Crisis. Using a modified version of the currency crisis model discussed in Proano, Flaschel and Semmler (2005) the authors show that an increase of the domestic interest rate by the central bank as a response to the speculative attack can have serious negative effects on aggregate demand by depressing the investment activity of those domestic firms which are not indebted in foreign currency. The authors demonstrate that in specific situations the standard (IMF supported) increase of the domestic interest rate might not be the best response to a speculative attack on the domestic currency from a medium term point of view.
    Keywords: Mundell-Fleming-Tobin model, liability dollarisation, debt-financed investment, financial crisis, currency crisis, deflation.
    JEL: E31 E32 E37 E52
    Date: 2006–06
  6. By: Mete Feridun (Department of Economics, Loughborough University)
    Abstract: This article aims at identifying the determinants of currency crises in Turkey the period 1980:01-2006:06. Following a general-to-specific model selection methodology, a broad set of pre-selected variables were tested through bivariate logit regressions. Significant variables were then used in a multivariate logit model. Strong evidence emerged that current account balance/GDP, short-term debt/long-term debt, domestic credit/GDP, foreign liabilities/foreign assets of banks, and fiscal balance/GDP are significant with correct signs. The measures of goodness-of-fit and in-sample predictive power of the model turned out to be favorable. The resulting model correctly calls 87.18% and 73.08% of the months at 10% and 20% levels, respectively.
    Keywords: Speculative attacks; currency crises; logit model, Turkey.
    JEL: F30 E44
    Date: 2007–01
  7. By: Devesh Kapur; Richard Webb
    Abstract: A consensus has developed that the International Monetary Fund (IMF) is not fulfilling its role, prompting multiple proposals for reform. However, this paper argues that the focus on reform should be complemented with an exploration of alternatives outside the IMF which hold the potential to not only give developing countries greater bargaining leverage with the Fund but also, by increasing competition, spurring the institution to better performance. The paper argues that most of the IMF’s functions are being carried out in part through alternative institutional arrangements. It focuses in particular on the insurance role of the Fund and argues that developing countries are developing alternative insurance mechanisms, from a higher level of reserves, to regional co-insurance facilities to remittances as a counter-cyclical source of foreign exchange. The de facto exit of its clientele has been driven by the high political costs associated with Fund borrowing and now poses unprecedented challenges for the Fund, in particular pressures on its income. The paper argues for a rapid restructuring and significant cuts of the Fund’s administrative budget with the budget savings instead directed to lower the interest rates charged to borrowers.
    Keywords: IMF, reform, developing countries, insurance, foreign exchange, remittances,
    JEL: F33 F34 F35
    Date: 2006–08
  8. By: Ansgar Belke (University of Hohenheim and IZA); Daniel Gros (Centre for European Policy Studies, Brussels and San Paolo IMI Asset Management, Milan)
    Abstract: This paper deals with potential instabilities in the Eurozone stemming from an insufficient interplay between monetary policy and reform effort on the one hand and the emergence of intra-Euro area divergences on the other. As a first step, we assess the effect of EMU on structural reform and investigate this question by an examination of the relationship between fixed exchange rates and reform in two wider samples of countries. We also stress that loose monetary conditions, which prevailed until some months ago, can also manifest themselves in asset price inflation, notably in the housing market. When these bubbles burst (e.g., when housing prices stop rising) this often leads to a prolonged period of economic instability and weakness rather than consumer price inflation. As a second step, we point out that risks for EMU are not only increasing because longer-term disequilibria become evident in fiscal and monetary policy, but also because serious divergences are now appearing within the Euro area which threaten its long-term cohesiveness. The most manifest example of this threat comes from what promises to be a long-term divergence between Germany and Italy, which for the time being was offset by asynchronous developments of house prices in both countries. There are still large differences within the Euro area, with the small countries performing much better than the large ones on almost every indicator. This suggests that better policies can make a large difference even if monetary policy is the same for everybody.
    Keywords: asset prices, international competitiveness, EMU, instabilities, labor markets, monetary policy regime, structural reform
    JEL: D78 E52 E61
    Date: 2007–01
  9. By: David Peel; Ivan Paya
    Abstract: A number of authors have found significant cointegrating relationships between spot exchange rates and domestic and foreign price levels for the major currencies where the magnitude of the coefficients makes economic interpretation of PPP cumbersome. Using theoretically well motivated nonlinear models for "artifitially" created real exchange rates, this paper investigates the properties of two alternative cointegration procedures, namely the Johansen and Saikkonen methodologies. The latter procedure appears to outperform the former one in terms of finding the "true" cointegrating coefficients. The new weights obtained with the Saikkonen method are then used to estimate nonlinear ESTAR model for the real exchange rate. The "new" real exchange rates exhibit, in most cases, much lower half-life shocks than the ones predicted by the Rogoff (1996) puzzle.
    Keywords: PPP, Johansen, Saikkoen, bootstrap
    Date: 2006
  10. By: McKinnon, Ronald
    Abstract: For creditor countries on the periphery of the dollar standard such as China with current account surpluses, foreign mercantile pressure to appreciate their currencies and become more flexible is misplaced. Just the expectation of variable exchange appreciation seriously disrupts the natural tendency for wage growth to balance productivity growth and thus worsens the (incipient) deflation that China now faces. It could create a zero-interest liquidity trap in financial markets that leaves the central bank helpless to combat future deflation arising out of actual currency appreciation, as with the earlier experience of Japan. Exchange rate appreciation, or the threat of it, causes macroeconomic distress without having any predictable effect on the trade surpluses of creditor economies.
    Keywords: exchange rate, current account, China, Japan
    JEL: F31 F33 F42
    Date: 2006
  11. By: Oscar Bernal (DULBEA, Free University of Brussels); Jean-Yves Gnabo (University of Namur)
    Abstract: This paper generalizes central banks’ FX interventions reaction functions to include oral interventions alongside actual ones. Using Japanese data for the 1991-2004 period, we estimate an ordered probit explaining the occurrence of each type of intervention and evaluating the extent to which oral and actual interventions are substitutes or complements. Our results indicate that monetary authorities tend to adopt progressively stronger measures as the exchange rate behaves in an increasingly unfavorable way. This suggests that words and acts are used as complements only in extreme cases.
    Keywords: Central banks; Foreign exchange market; Interventions; Communication policy
    JEL: E58 F31 G15
    Date: 2007–02
  12. By: Imen Kouki; Hélène Raymond
    Abstract: The aim of this paper is to test if the price setting strategy of a Tunisian trader on the foreign exchange market can be adequately described by the microstructural model developed by Madhavan and Smidt (1991) and Lyons (1995). We test for informational and inventory effects. The dataset used involves intraday quotes of a medium size bank on the USDTND and EURTND exchange rates, from the 1st January 2002 to the 27th November 2003. Our results confirm an inventory effect and an informational effect from the transactions with the Central Bank of Tunisia, but only for the USDTND exchange rate. The microstructure approach does not help to explain the EURTND quotes. The management of Tunisia exchange rate regime could offer an explanation for these mitigated results. Our results also show that, despite the financial liberalization politics followed by Tunisia for two decades, the Central Bank of Tunisia interventions still strongly act on both USDTND and EURTND quotes.
    Date: 2006
  13. By: Adolfson, Malin (Research Department, Central Bank of Sweden); Laséen, Stefan (Monetary Policy Department, Central Bank of Sweden); Lindé, Jesper (Research Department, Central Bank of Sweden); Villani, Mattias (Research Department, Central Bank of Sweden)
    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: DSGE; VAR; VECM; Open economy; Bayesian inference
    JEL: C11 C53 E17
    Date: 2007–02–01
  14. By: Fernandez, Pablo (IESE Business School)
    Abstract: Equity premium designates four different concepts: Historical Equity Premium (HEP); Expected Equity Premium (EEP);Required Equity Premium (REP); and Implied Equity Premium (IEP). We highlight the confusing message conveyed in the literature regarding equity premium and its evolution. The confusion arises from not distinguishing among the four concepts and from not recognizing that although the HEP is equal for all investors, the REP, the EEP and the IEP differ for different investors. A unique IEP requires assuming homogeneous expectations for expected growth (g), but we show that there are several pairs (IEP, g) that satisfy current prices. We claim that different investors have different REPs and that it is impossible to determine the REP for the market as a whole, because it does not exist. We also investigate the relationship between (IEP - g) and the risk-free rate. There is a kind of schizophrenic approach to valuation: while all authors admit different expectations of equity cash flows, most authors look for a single discount rate. It seems as if the expectations of equity cash flows are formed in a democratic regime, while the discount rate is determined in a dictatorship.
    Keywords: equity premium; equity premium puzzle; required market risk premium; historical market risk premium; expected market risk premium; risk premium; market risk premium; market premium;
    Date: 2006–12–13

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