nep-ifn New Economics Papers
on International Finance
Issue of 2007‒04‒09
sixteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Uncovering Yield Parity: A New Insight into the UIP Puzzle through the Stationarity of Long Maturity Forward Rates By Zsolt Darvas; Gábor Rappai; Zoltán Schepp
  2. The Law of One Price: Nonlinearities in Sectoral Real Exchange Rate Dynamics By Luciana Juvenal; Mark P. Taylor
  3. Purchasing Power Parity among developing countries and their trade-partners. Evidence from selected CEECs and Implications for their membership of EU. By Nikolaos Giannellis; Athanasios P. Papadopoulos
  4. Real exchange rates and current account imbalances in the Euro-area By Michael G Arghyrou; Georgios Chortareas
  5. The defense of multilateral XR target zones against contagious crises By Jean-Sébastien Pentecôte
  6. The behaviour of the real exchange rate: Evidence from regression quantiles By Kleopatra Nikolaou
  7. Effects of Exchange Rate Volatility on the Volume and Volatility of Bilateral Exports By Christopher F Baum; Mustafa Caglayan
  8. Forecasting Exchange Rate Volatility with High Frequency Data: Is the Euro Different? By Georgios Chortareas; John Nankervis; Ying Jiang
  9. Foreign exchange markets in south-east Asia 1990-2004: An empirical analysis of spillovers during crisis and non-crisis periods By Alex Mandilaras; Graham Bird
  10. Exchange rate pass-through in emerging markets By Michele Ca’ Zorzi; Elke Hahn; Marcelo Sánchez
  11. Real-Time Effects of Central Bank Interventions in the Euro Market By Rasmus Fatum; Jesper Pedersen
  12. Sentiment in foreign exchange markets: Hidden fundamentals by the back door or just noise? By Rafael R. Rebitzky
  13. Argentina: The Central Bank in the Foreign Exchange Market By Roberto Frenkel
  14. Is Bad News About Inflation Good News for the Exchange Rate? By Richard Clarida; Daniel Waldman
  15. Long-run real exchange rate changes and the properties of the variance of k-differences By Masao Ogaki; Sungwook Park
  16. A No-Arbitrage Analysis of Macroeconomic Determinants of Term Structures and the Exchange Rate<br> By Fousseni Chabi-Yo; Jun Yang

  1. By: Zsolt Darvas (Corvinus University Budapest); Gábor Rappai (University of Pécs); Zoltán Schepp (University of Pécs)
    Abstract: Results and models of this paper are based on a strikingly new empirical observation: long maturity forward rates between bilateral currency pairs of the US, Germany, UK, and Switzerland are stationary. Based on this result, we suggest a new explanation for the UIP-puzzle maintaining rational expectations and risk neutrality. The model builds on the interaction of foreign exchange and fixed income markets. Ex ante short run and long run UIP and the EHTS is assumed. We show that ex post shocks to the term structure could explain the behavior of the nominal exchange rate including its volatility and the failure of ex post short UIP regressions. We present evidence on ex post validity of long run UIP and strikingly new evidence on the stationarity of the long forward exchange rates of major currencies. We set up, calibrate and simulate a stylized model that well captures the observed properties of spot exchange rates and UIP regressions of major currencies. We define the notion of yield parity and test its empirical performance for monthly series of major currencies with favorable results
    Keywords: EHTS, forward discount bias, stationarity of long maturity forward rates, UIP, yield parity
    JEL: E43 F31
    Date: 2007–02–02
  2. By: Luciana Juvenal (University of Warwick); Mark P. Taylor (University of Warwick, Centre for Economic Policy Research)
    Abstract: Using Self-Exciting Threshold Autoregressive Models (SETAR), this paper explores the validity of the Law of One Price (LOOP) for nineteen sectors in ten European countries. We find strong evidence of nonlinear mean reversion in deviations from the LOOP. We highlight the importance of modelling the real exchange rate in a nonlinear fashion in an attempt to solve the PPP Puzzle. Using the US dollar as a reference currency, half-life estimates range from nine to sixteen months (country averages), which are significantly lower than the `consensus estimates' of three to five years. The results also show that transaction costs differ enormously across sectors and countries
    Keywords: Law of One Price, mean reversion, nonlinearities, thresholds
    JEL: F31 F41 C22
    Date: 2007–02–02
  3. By: Nikolaos Giannellis (University of Crete); Athanasios P. Papadopoulos (University of Crete)
    Abstract: The purpose of the paper is twofold. Firstly, we test the validity of the PPP hypothesis for selected CEEC (Czech Republic; Hungary; Poland and Slovak Republic). Secondly, we attempt to define those countries’ trade linkages between Euro Area; US and the rest of the world. By applying both univariate unit root and a multivariate cointegration test, we find stronger evidence of PPP from the latter test. Moreover, any failure to accept PPP cannot be attributed to structural breaks, apart from one case (between Czech Republic and EU). In overall, there is evidence of strong-form PPP in 6 out of the 8 cases, while for the rest two, weak-form PPP is accepted. Thus, we confirm PPP as a long run equilibrium baseline for these exchange rates per EURO. Furthermore, the fact that PPP holds between these countries and Euro Area indicates absence of trade frictions and other barriers. The implied well-developed trade relations are consistent with those countries’ entry into EMU.
    Keywords: PPP, Unit Root, Structural Breaks, Cointegration, Developing Countries
    JEL: C22 C32 C52
    Date: 2007–02–02
  4. By: Michael G Arghyrou (Cardiff Business School); Georgios Chortareas (University of Essex)
    Abstract: Global current account imbalances have been one of the focal points of interest for policymakers during the last few years. Less attention has been paid, however, to the growing imbalances within the Euro-area. In the short period since the commencement of the EMU two distinct groups of member state have emerged: those with consistently improving current accounts and those with consistently worsening current accounts. In this paper we consider the dynamics of current account adjustment and the role of real exchange rates in current account determination in the EMU member countries. Monetary union participation, which entails giving up the nominal exchange rate, can make the correction of current account imbalances more cumbersome. While most theoretical models of open economies rely on a causal relationship between real exchange rates and the current account limited, if any, contemporary evidence exist on the empirical validity of this relationship. We find that the above relationship is substantial in size and subject to pronounced non-linear effects. We identify two groups of countries since the abandonment of European national currencies: those with persistent real exchange rate depreciation leading to current account improvement; and those with systematic real appreciation and deteriorating current accounts. These groups largely correspond to those previous research has identified as respectively belonging and not belonging to a European Optimum Currency Area. Our findings validate the theoretical arguments concerning the potential costs of EMU participation and suggest that meeting the nominal convergence criteria has come, in some countries, at the cost of growing current account imbalances. The latter pose policy-response questions for national authorities and the ECB, suggesting that it may be optimal to add to the EMU-accession criteria one referring to the balance of the current account; and highlighting the importance of increasing the flexibility of relative prices to facilitate real exchange rate and current account adjustment
    Keywords: current account, real exchange rate, EMU, nonlinearities
    JEL: C51 F32 F41
    Date: 2007–02–02
  5. By: Jean-Sébastien Pentecôte (CREM, Universty of Rennes 1)
    Abstract: A growing literature has emerged to assess the importance and the channels of contagion during the recent currency crises which occured in the 1990s. However, little attention has been paid to the policy implications of the way to coordinate interventions in order to defend not only a single, but rather a given set of currencies altogether. To this end, a state-space model is built to describe the dynamics of many bilateral exchange rates. Using the Kalman filter, we check in particular the stability and the controllability of the system. The ERM evidence show that a successfull strategy heavily depends on both the time-horizon and the cost attached by the monetary authority to her interventions
    Keywords: contagion, currency crises, state-space model, mulitvariate control
    Date: 2007–02–02
  6. By: Kleopatra Nikolaou (Warwick Business School)
    Abstract: We test for mean reversion in real exchange rates using a recently developed unit root test for non- normal processes based on quantile autoregression inference in semi-parametric and non-parametric settings. The quantile regression approach allows us to directly capture the impact of di¤erent magnitudes of shocks that hit the real exchange rate, conditional on its past history, and can detect asymmetric, dynamic adjustment of the real exchange rate towards its long run equilibrium. Our results suggest that large shocks tend to induce strong mean reverting tendencies in the exchange rate, with half lives less than one year in the extreme quantiles. Mean reversion is faster when large shocks originate at points of large real exchange rate deviations from the long run equilibrium. However, in the absence of shocks no mean reversion is observed. Finally, we report asymmetries in the dynamic adjustment of the RER
    Keywords: real exchange rate, purchasing power parity, quantile regression
    JEL: F31
    Date: 2007–02–02
  7. By: Christopher F Baum (Boston College); Mustafa Caglayan (University of Glasgow)
    Abstract: We present an empirical investigation of a recently suggested but untested proposition that exchange rate volatility can have an impact on both the volume and variability of trade flows, considering a broad set of countries' bilateral real trade flows over the period 1980-1998. We generate proxies for the volatility of real trade flows and real exchange rates after carefully scrutinizing these variables' time series properties. Similar to the findings of earlier theoretical and empirical research, our first set of results show that the impact of exchange rate uncertainty on trade flows is indeterminate. Our second set of results provide new and novel findings that exchange rate volatility has a consistent positive and significant effect on the volatility of bilateral trade flows.
    Keywords: exchange rates, volatility, fractional integration, trade flows
    JEL: F17 F31 C22
    Date: 2007–02–02
  8. By: Georgios Chortareas (University of Essex); John Nankervis (University of Essex); Ying Jiang (University of Essex)
    Abstract: This paper focuses on forecasting volatility of high frequency Euro exchange rates. Four 15 minute frequency Euro exchange rate series, including Euro/CHF, Euro/GBP, Euro/JPY and Euro/USD, are used to test the forecast performance of six models, including both traditional time series volatility models and the realized volatility model. Besides the normally used regression test and accuracy test, an equal accuracy test, the HLN-DM test, and a superior predictive ability test are also employed in the out-of-sample forecast evaluation. The FIGARCH model is found to be superior in almost all exchange rate series. Although the widely preferred ARFIMA model shows better performance than the traditional daily volatility models, generally speaking, it cannot surpass the FIGARCH model and the intraday GARCH model. Furthermore, the SVX model does not significantly outperform the SV model in the accuracy test, which contradicts the results of some earlier research. The paper confirms the advantage of using high frequency data and modelling the long memory factor. It also analyses the characteristics of Euro exchange rates and compares the test results with the conclusions drawn by previous studies
    Keywords: exchange rates, volatility, euro, high frequency
    JEL: F31 C22
    Date: 2007–02–02
  9. By: Alex Mandilaras (University of Surrey); Graham Bird (University of Surrey)
    Abstract: The East Asian crisis of 1997 sparked an extensive literature in an effort to explain the causes and spread of heightened foreign exchange (FX) market pressures in the region. In this paper we model FX movements and calculate spillover effects covering the extended period between 1990 and 2004. Using Markov switching vector autoregressions, we find substantial evidence that FX correlations vary across crisis and non-crisis states, a result that bears implications for international portfolio diversification and reserve pooling. Contagion effects are also present during crises. Finally, we gauge the ability of stock market indices to forecast time-varying transition probabilities and discover positive results
    Keywords: East Asia, Currency Crisis
    JEL: F3
    Date: 2007–02–02
  10. By: Michele Ca’ Zorzi (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Elke Hahn (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper examines the degree of Exchange Rate Pass-Through (ERPT) to prices in 12 emerging markets in Asia, Latin America, and Central and Eastern Europe. Our results, based on three alternative vector autoregressive models, partly overturn the conventional wisdom that ERPT into both import and consumer prices is always higher in “emerging” than in “developed” countries. For emerging markets with only one digit inflation (most notably the Asian countries), passthrough to import and consumer prices is found to be low and not very dissimilar from the levels of developed economies. The paper also finds robust evidence for a positive relationship between the degree of the ERPT and inflation, in line with Taylor’s hypothesis once two outlier countries (Argentina and Turkey) are excluded from the analysis. Finally, the presence of a positive link between import openness and ERPT, while plausible theoretically, finds only weak empirical support. JEL Classification: C32, E31.
    Keywords: Exchange Rate Pass-Through, Emerging Markets.
    Date: 2007–03
  11. By: Rasmus Fatum (University of Alberta); Jesper Pedersen (Department of Economics, University of Copenhagen)
    Abstract: This paper investigates the real-time effects of foreign exchange intervention using official intraday intervention data provided by the Danish central bank. Denmark is currently pursuing an active intervention policy under the provisions of the Exchange Rate Mechanism (ERM II) and intervenes on a discretionary basis when considered necessary. Prior participation in ERM II is a requirement for adoption of the Euro. Therefore, our study is of particular relevance for the new European Union member states that are either currently participating in ERM II or expected to do so at a later date as well as for Denmark. Our analysis employs the two-step weighted least squares estimation procedure of Andersen, Bollerslev, Diebold and Vega (2003) and an array of robustness tests. We find that intervention exerts a statistically and economically significant influence on exchange rate returns when the direction of intervention is consistent with fundamentals and intervention is carried out during a period of high exchange rate volatility. We also show that the exchange rate does not adjust instantaneously to the unannounced and discretionary interventions under study. We conclude that intervention can be an important short-term policy instrument for exchange rate management.
    Keywords: foreign exchange intervention; intraday data; ERM II
    JEL: D53 E58 F31 G15
    Date: 2007–03
  12. By: Rafael R. Rebitzky (University of Hannover)
    Abstract: Foreign exchange markets have to deal next to hard facts with lots of expectations and emo-tions. One of the major puzzles in international finance remains the “exchange rate discon-nect puzzleâ€. Analyzing sentiment in foreign exchange markets, it appears in fact that senti-ment contains some forward looking information. Particularly due to the unknown economic relevance of sentiment in foreign exchange markets so far, we first analyze the relationship between fundamentals and sentiment in order to reveal underlying forces of the latter; sec-ond we accomplish our analysis by concentrating on popular expectation concepts and con-sidering threshold effects. Third, we evaluate sentiment by testing on accuracy and on for-ward looking elements of subsequent exchange rate returns
    Keywords: Foreign exchange market, sentiment, bootstrap, threshold
    JEL: G14 F31
    Date: 2007–02–02
  13. By: Roberto Frenkel
    Abstract: This article, originally published in Spanish in La Nación, December 31, 2006, explains the mechanics of the Argentine Central Bank's intervention in exchange rates markets to target a stable and competitive exchange rate, a macroeconomic policy that has played a significant role in Argentina's economic growth since 2002.
    JEL: E58 E52 E42
    Date: 2007–02
  14. By: Richard Clarida; Daniel Waldman
    Abstract: We show in a simple -- but robust -- theoretical monetary exchange rate model that the sign of the covariance between an inflation surprise and the nominal exchange rate can tell us something about how monetary policy is conducted. Specifically, we show that 'bad news' about inflation -- that it is higher than expected -- can be 'good news' for the nominal exchange rate -- that it appreciates on this news -- if the central bank has an inflation target that it implements with a Taylor Rule. The empirical work in this paper examines point sampled data on inflation announcements and the reaction of nominal exchange rates in 10 minute windows around these announcements for 10 countries and several different inflation measures for the period July 2001 through March 2005. When we pool the data, we do in fact find that bad news about inflation is indeed good news for the nominal exchange rate, that the results are statistically significant, and that the r-square is substantial, in excess of 0.25 for core measures of inflation. We also find significant differences comparing the inflation targeting countries and the two non-inflation targeting countries.
    JEL: E31 F3 F31
    Date: 2007–04
  15. By: Masao Ogaki (Department of Economics, Ohio State University); Sungwook Park (Department of Economics, Ohio State University)
    Abstract: Engel (1999) computes the variance of k-differences for each time horizon us- ing the method of Cochrane (1988) in order to measure the importance of the traded goods component in U.S. real exchange rate movements. The importance of traded goods should decrease as the horizon increases if the law of one price holds for traded goods in the long run. However, Engel ?nds that the variance of k-di¤erences decreases only initially and then increases as k approaches the sample size. He interpets the increasing variance as evidence of an increase in the long-run importance of the traded goods component. By contrast, we show that the variance of k-di¤erences tends to return to the initial value as k approaches the sample size whether the variable is stationary or unit root nonstationary. Our results imply that the increasing variances for k-values close to the sample size cannot be inter- preted as evidence of an increase in the importance of the traded goods component in the long run. We ?nd that our test results regarding the variance of k-di¤erences are consistent with smaller importance of the traded goods component in the longer run.
    Keywords: Real exchange rate, Variance ratio, Traded and nontraded goods
    JEL: F31
    Date: 2007–02
  16. By: Fousseni Chabi-Yo; Jun Yang
    Abstract: We study the joint dynamics of macroeconomic variables, bond yields, and the exchange rate in an empirical two-country New-Keynesian model complemented with a no-arbitrage term structure model. With Canadian and US data, we are able to study the impact of macroeconomic shocks from both countries on their yield curves and the exchange rate. The variance decomposition of the yield level shows that the US monetary policy and aggregate supply shocks explain a majority of the unconditional variations in Canadian yields. They also explain up to 50% of the variations in the expected excess holding period returns of Canadian bonds. In addition, Canadian monetary policy shocks explain more than 70% of the variations in Canadian yields over short and medium forecast horizons. It also explains around 40% of the expected excess holding period returns of Canadian bonds. Both Canadian and US macroeconomic shocks help explain the dynamics of the exchange rate and the time-varying exchange risk premium.
    Keywords: Debt management; Exchange rates; Interest rates; Financial markets; Econometric and statistical methods
    JEL: E12 E43 F41 G12 G15
    Date: 2007

This nep-ifn issue is ©2007 by Yi-Nung Yang. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.