nep-ifn New Economics Papers
on International Finance
Issue of 2007‒04‒14
six papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. If exchange rates are random walks, then almost everything we say about monetary policy is wrong By Fernando Alvarez; Andrew Atkeson; Patrick J. Kehoe
  2. The Optimal Monetary Policy Response to Exchange Rate Misalignments By Campbell Leith; Simon Wren-Lewis
  3. Resolving the unbiasedness and forward premium puzzles By Daniel L.Thornton
  4. The Forward Premium Puzzle only emerges gradually By Kerstin Bernoth; Jürgen von Hagen; Casper G. de Vries
  5. Exchange Rates and Fundamentals : Is there a Role for Nonlinearities in Real Time? By Kurmas Akdogan; Yunus Aksoy
  6. The foreign exchange rate rate exposure of nations By Entorf, Horst; Moeber, Jochen; Sonderhof, Katja

  1. By: Fernando Alvarez; Andrew Atkeson; Patrick J. Kehoe
    Abstract: The key question asked by standard monetary models used for policy analysis, How do changes in short-term interest rates affect the economy? All of the standard models imply that such changes in interest rates affect the economy by altering the conditional means of the macroeconomic aggregates and have no effect on the conditional variances of these aggregates. We argue that the data on exchange rates imply nearly the opposite: the observation that exchange rates are approximately random walks implies that fluctuations in interest rates are associated with nearly one-for-one changes in conditional variances and nearly no changes in conditional means. In this sense standard monetary models capture essentially none of what is going on in the data. We thus argue that almost everything we say about monetary policy using these models is wrong.
    Date: 2007
  2. By: Campbell Leith; Simon Wren-Lewis
    Abstract: A common feature of exchange rate misalignments is that they produce a divergence between traded and non-traded goods sectors, leading to pressures on monetary policy makers to react. In this paper we develop a small open economy model which features traded and non-traded goods sectors with which to assess the extent to which monetary policy should respond to exchange rate misalignments. To do so we initially contrast the efficient outcome of the model with that under flexible prices and find that the flex-price equilibrium exhibits an excessive exchange rate appreciation in the face of a positive UIP shock. By introducing sticky prices in both sectors we provide a role for policy in the face of UIP shocks. We then derive a quadratic approximation to welfare which comprises quadratic terms in the output gaps in both sectors as well as sectoral rates of inflation. These can be rewritten in terms of the usual aggregate variables, but only after including terms in relative sectoral prices and/or the terms of trade to capture the sectoral composition of aggregates. We derive optimal policy analytically before giving numerical examples of the optimal response to UIP shocks. Finally, we contrast the optimal policy with a number of alternative policy stances and assess the robustness of results to changes in model parameters.
    Keywords: Exchange Rate Misalignment, Monetary Policy, Non-Traded Goods
    JEL: F41 E52
    Date: 2007
  3. By: Daniel L.Thornton
    Abstract: There are two unresolved puzzles in the empirical foreign exchange literature. The first is the finding that tests of forward rate unbiasedness using the forward rate and forward premium equations yield markedly different conclusions. A companion puzzle?the forward premium puzzle?is the fact that the forward premium incorrectly predicts the direction of the subsequent change in the spot rate, which implies a massive rejection of uncovered interest parity. This paper resolves both puzzles.
    Keywords: Foreign exchange
    Date: 2007
  4. By: Kerstin Bernoth (De Nederlandsche Bank, and ZEI-University of Bonn); Jürgen von Hagen (University of Bonn, Indiana University, and CEPR); Casper G. de Vries (Erasmus Universiteit Rotterdam)
    Abstract: The forward premium puzzle (FPP) is the negative correlation between the forward premium and the realized exchange rate return at maturities of a month and beyond. Some recent evidence shows that at maturities of multiple years and at the highest intra day frequency the correlation is positive and close to one. This paper contributes by using futures data instead of forwards to complete the maturity spectrum at the (multi-) day level. We find that the correlation only slowly turns negative as the number of days to maturity is increased to the monthly level. The typical shape of the premium correlation with regard to the forward maturity length appears to be V-shaped.
    Keywords: exchange rates; market efficiency; forward premium puzzle; uncovered interest parity; futures rates
    JEL: F31 F37 G13
    Date: 2007–03–29
  5. By: Kurmas Akdogan; Yunus Aksoy
    Date: 2007
  6. By: Entorf, Horst; Moeber, Jochen; Sonderhof, Katja
    Abstract: Following the well-known approach by Adler and Dumas (1984) we evaluate the foreign exchange rate exposure of nations. Results based on data from 27 countries show that national foreign exchange rate exposures are significantly related to the current trade balance variables of corresponding economies.
    Keywords: Exchange rate exposure, international trade, current trade balance
    JEL: F31 G15
    Date: 2007

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