nep-ifn New Economics Papers
on International Finance
Issue of 2007‒03‒17
nine papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Do Exchange Rates Move in Line With Uncovered Interest Parity? By Huisman, R.; Mahieu, R.J.; Mulder, A.
  2. On the contingency of equilibrium exchange rates with time- consistent economic policies By Antoine Bouveret; Bruno Ducoudré
  3. Estimation Bias and Inference in Overlapping Autoregressions: Implications for the Target Zone Literature By Zsolt Darvas
  4. Current Account Deficits: The Australian Debate By Rochelle Belkar; Lynne Cockerell; Christopher Kent
  5. Dollarization and exchange rate fluctuations By Honohan, Patrick
  6. The Influence of Actual and Unrequited Interventions By Kathryn M.E. Dominguez; Freyan Panthaki
  7. Efficiency of stability-oriented institutions: the European case By Fabrice Capoen; Jerome Creel
  8. Is there an identity within international stock market volatilities? By Caiado, Jorge; Crato, Nuno; Peña, Daniel
  9. Stress testing of the stability of the Italian banking system: a VAR approach By Renato Filosa

  1. By: Huisman, R.; Mahieu, R.J.; Mulder, A. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: According to uncovered interest rate Parity (UIP), the expected relative change in an exchange rate is equal to the difference between interest rates between the two currencies. Empirically, UIP is frequently rejected. In this paper, we examine whether exchange rates have at least any tendency to move in the direction predicted by UIP and whether exchange rates tend to move more in line with UIP in periods with large interest rate differentials.
    Keywords: Exchange rates;Uncovered interest rate parity;Logit models;
    Date: 2007–02–19
  2. By: Antoine Bouveret (Observatoire Français des Conjonctures Économiques); Bruno Ducoudré (Observatoire Français des Conjonctures Économiques)
    Date: 2007
  3. By: Zsolt Darvas (Department of Mathematical Economics and Economic Analysis, Corvinus University of Budapest)
    Abstract: Samples with overlapping observations are used for the study of uncovered interest rate parity, the predictability of long run stock returns, and the credibility of exchange rate target zones. This paper quantifies the biases in parameter estimation and size distortions of hypothesis tests of overlapping linear and polynomial autoregressions, which have been used in target zone applications. We show that both estimation bias and size distortions generally depend on the amount of overlap, the sample size, and the autoregressive root of the data generating process. In particular, the estimates are biased in a way that makes it more likely that the predictions of the Bertola-Svensson-model will be supported. Size distortions of various tests also turn out to be substantial even when using a heteroskedasticity and autocorrelation consistent covariance matrix.
    Keywords: drift-adjustment method, exchange rate target zone, HAC covariance, overlapping observations, polynomial autoregression, size distortions, small sample bias
    JEL: C22 F31
    Date: 2007–02–27
  4. By: Rochelle Belkar (Reserve Bank of Australia); Lynne Cockerell (Reserve Bank of Australia); Christopher Kent (Reserve Bank of Australia)
    Abstract: This paper documents the clear change of view, which has taken place in Australia over the past three decades or so, concerning the relevance of the current account deficit for policy. Historical experience under a fixed exchange rate regime suggested that large persistent deficits were unsustainable and could leave the economy vulnerable to sudden reversals in sentiment. These concerns persisted after the floating of the Australian dollar and financial deregulation, and it was thought that all arms of policy should help to rein in the then much larger current account deficits. However, these policies were shown to be ineffective and, by the early 1990s, the argument that current account deficits represent the optimal outcomes of decisions made by ‘consenting adults’ gained wide support. This paper presents some empirical evidence consistent with optimal smoothing in the face of temporary shocks; the persistence of the deficit is attributed to a modest degree of impatience relative to the rest of the world. Although it is now widely accepted that policy should not seek to influence the current account balance, the issue of external vulnerability remains of interest. Here, country-specific considerations are important, and it is argued that the factors that have made Australia relatively resilient to external shocks are also those that helped to attract foreign capital in the first place.
    Keywords: current account; external vulnerability; exchange rate regimes
    JEL: E60 F32 N10
    Date: 2007–03
  5. By: Honohan, Patrick
    Abstract: Although the worldwide growth in dollarization of bank deposits has recently slowed, it has already reached very high levels in dozens of countries. Building on earlier findings that allowed the main cross-country variations in the share of dollars to be explained in terms of national policies and institutions, this paper turns to analysis of short-run variations, particularly the response of dollarization to exchange rate changes, which is shown to be too small to warrant " fear of floating " by dollari zed economies. But high dollarization is shown to increase the risk of depreciation and even suspension, as indicated by interest rate spreads. While specific policy is needed to deal with the risks associated with dollarization, the underlying causes of unwanted dollarization should also be tackled.
    Keywords: Economic Theory & Research,Banks & Banking Reform,Macroeconomic Management,Fiscal & Monetary Policy,Financial Economics
    Date: 2007–03–01
  6. By: Kathryn M.E. Dominguez; Freyan Panthaki
    Abstract: Intervention operations are used by governments to manage their exchange rates but officials rarely confirm their presence in the market, leading inevitably to erroneous reports in the financial press. There are also reports of what we term, unrequited interventions, interventions that the market expects but do not materialize. In this paper we examine the effects of various types of intervention news on intra-day exchange rate behavior. We find that unrequited interventions have a statistically significant influence on returns, volatility and order flow, suggesting that the expectation of intervention, even when governments do not intervene, can affect currency values.
    JEL: F3 F31 G14 G15
    Date: 2007–03
  7. By: Fabrice Capoen (Université de Caen); Jerome Creel (Observatoire Français des Conjonctures Économiques)
    Abstract: Stability-oriented European institutions correspond to the general prescriptions of the ‘new macroeconomics consensus’. This contribution provides an assessment of the pros and cons of these institutions in terms of macro stabilisation and exchange-rate swings drawing on different scenarios. We argue that the institutions which have been associated with the Euro – limits on public deficits and a conservative central bank – have somewhat jeopardized the efficiency of this new exchange-rate regime. Adaptation of institutions is thus needed: either cooperation or coordination may enhance European welfare.
    Keywords: monetary policy, fiscal policy, central bank; stability pact; time-consistency; exchange rate, cooperation, coordination
    JEL: E63 F41 H60
    Date: 2007
  8. By: Caiado, Jorge; Crato, Nuno; Peña, Daniel
    Abstract: Previous studies have investigated the comovements of international equity returns by using mean correlations, cointegration, common factor analysis, and other approaches. This paper investigates the evolution of the affinity among major euro and non-euro area stock markets in the period 1966-2006 by using distance-based methods for clustering analysis of time series. A periodogram-based metric for mean and squared returns is used to compute distances between the series. This method solves the shortcoming of unequal sample sizes found for different countries. Then, by using dendrogram and multidimensional scaling techniques based on the computed distances, we display clusters for the series of returns and volatilities. The data were divided into two sample periods: previous and subsequent to the introduction of the euro as an electronic currency. For market returns, euro-area countries do not seem to come closer after the introduction of the euro. There is some identity that is maintained after 1998. For squared returns, we found a clear change with the introduction of the euro. Up to 1998, there is a weak linkage among euro area countries. After 1998, the euro area stock markets volatilities have become considerably more homogenous. For reference, we explored also the correlations among the series. We found that some stock markets within the European Monetary Union are strongly correlated in returns and in squared returns, and that some euro and non-euro area markets are not correlated in returns, but are weakly correlated in squared returns.
    Keywords: Cluster analysis; Euro area; International stock markets; Returns and squared returns; Periodogram; Volatility.
    JEL: G15
    Date: 2007
  9. By: Renato Filosa
    Abstract: With the aim of contributing to the use of stress testing techniques, by now a commonly-used practice adopted by the financial community to understand the determinants of financial instability, and to measure the size of financial risk, this work represents an application of macro stress testing to the Italian banking system. The paper tries to provide an answer to two interrelated questions. Whether, and the extent to which, procyclicality is a prominent feature of banks’ soundness and whether exogenous, or policy induced, tightening of monetary conditions (sharp and sustained increases in the interest rate and/or appreciation of the exchange rate) significantly increases banks’ fragility. The task is accomplished by the estimation of three alternative VAR models each using different indicators of banks’ soundness: the ratio of non performing loans (flow and stock data) and interest margins to outstanding loans. Two main conclusions emerge. First: the behaviour of either non performing loans or interest margins is only weakly procyclical: i.e. that the solidity of Italian banks could be seriously undermined only in case of falls in output far more severe than in any previous recession since the end of the World War II. The preoccupation expressed by the literature about the dangers of financial procyclicality seems, therefore, grossly exaggerated in the case of Italy. Second: in a hypothetical scenario where monetary conditions are drastically tightened our banks’ soundness indicators exhibit little variations. In this case too the importance attached by the literature to exchange rate swings, or monetary tightening more generally, for the setting off of financial crises is vastly overstated.
    Keywords: banking crises; financial crises; procyclicality; profitability; stress testing; VAR
    JEL: E32 E44 G21
    Date: 2007–03

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