nep-ifn New Economics Papers
on International Finance
Issue of 2007‒04‒28
twelve papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Testing the Purchasing Power Parity: Evidence from the New EU Countries By Minoas Koukouritakis
  2. Pricing strategies by European Low Cost Carriers. By Claudio A. Piga; Enrico Bachis
  3. Purchasing power parity exchange rates for the poor: using household surveys to construct PPPs By Angus Deaton
  4. Assessing China’s Exchange Rate Regime By Frankel, Jeffrey A; Wei, Shang-Jin
  5. A forewarning indicator system for financial crises: the case of six Central and Eastern European countries By Irène Andreou; Gilles Dufrénot; Alain Sand-Zantman; Aleksandra Zdzienicka-Durand
  6. Exchange Rate Regimes, Globalisation, and the Cost of Capital in Emerging Markets By Antonio Diez de los Rios
  7. Markov switching GARCH models of currency turmoil in Southeast Asia By Celso Brunetti; Roberto S. Mariano; Chiara Scotti; Augustine H.H. Tan
  8. Modeling the impact of real and financial shocks on Mercosur: the role of the exchange rate regime By Jean-Pierre Allegret; Alain Sand-Zantman
  9. Equilibrium exchange rates in oil-dependent countries By Korhonen, Iikka; Juurikkala, Tuuli
  10. Customer Trading in the Foreign Exchange Market: Empirical Evidence from an Internet Trading Platform By Ingmar Nolte; Sandra Lechner
  11. On the Rand: Determinants of the South African Exchange Rate By Jeffrey Frankel
  12. Remittances and the real exchange rate By Bussolo, Maurizio; Molina, Luis; Lopez, Humberto

  1. By: Minoas Koukouritakis (Department of Economics, University of Crete, Greece)
    Abstract: This paper examines the validity of the purchasing power parity between each of the twelve new EU countries vis-à-vis the Eurozone. Using the Johansen cointegration methodology for a period that begins from the mid-1990s and allowing for a structural break for the countries that joined the EU on May 2004, it is found that there is a long-run equilibrium relationship among the nominal exchange rate, the domestic prices and the foreign prices, for all the new EU countries. The evidence also suggests that the PPP vector enters the cointegration space for Bulgaria, Cyprus, Romania and Slovenia, which means that only for these countries the long-run PPP vis-à-vis the Eurozone is verified. For the rest of the new EU countries the long-run PPP is violated, may due to the fact that the currencies of these countries have been pegged to the euro and cannot reflect the inflation differences vis-à-vis the Eurozone.
    Keywords: Purchasing Power Parity, EU Enlargement, Cointegration, Structural Break, Symmetry and Proportionality.
    JEL: F15 F42
    Date: 2007–04–17
  2. By: Claudio A. Piga (Dept of Economics, Loughborough University); Enrico Bachis (Business School, Nottingham University)
    Abstract: We introduce an on-line pricing tactic where airlines post, at the same time and for the same flight, fares in different currencies that violate the law of One Price. Unexpectedly for an on-line market, we find that price discrimination may be accompanied by arbitrage opportunities and that both tend to persist before a flight’s departure. We find discrimination to be of a competitive type, although arbitrage opportunities are more likely in concentrated routes. Finally, the evidence suggests that discrimination may be used to manage stochastic demand.
    Keywords: on-line pricing; price discrimination; Law of One Price; sample selection; dispersion; airlines, exchange rate.
    JEL: L11 L13 L93
    Date: 2007–04
  3. By: Angus Deaton (Princeton University)
    Abstract: This paper builds a bridge between two literatures, that on purchasing power parity (PPP) exchange rates, which is an extension of national income accounting, and that on poverty measurement, which is based on household survey data on consumption expenditures. It also aims to serve as a manual for those who wish to calculate PPP price indexes using household surveys, particularly, although not exclusively, the PPP price indexes for the poor to be used to construct internationally comparable poverty lines. Because poverty analysts are often unfamiliar with PPP construction, PPP indexes are dealt with from something like first principles. The paper begins with the idea that PPP price indexes, like the usual domestic consumer price indexes, can be computed using weights from household surveys. Section 1 deals with the case of two countries, each with a set of consumer prices, and each with a household survey detailing expenditures on each good for a national sample of households. This first section is concerned with national aggregates, as in standard PPP comparisons, so that the household survey is used only to provide the national average consumption pattern. In this simplified two-country case, where the object of interest is a standard national PPP consumption comparison, it is possible to set up a framework that can be easily extended to deal with many countries and with poverty-weighting. In particular, standard errors are defined and formulas given. Prices are treated as known, so that the source of estimation variance is the sampling variability of the expenditure weights from the household survey, a sampling variability that depends on the sample size and on the survey design. A second type of standard error is distinguished which is new to the literature. In a world of perfect arbitrage and costless trade, relative prices would be the same in all countries, and all methods of computing PPP indexes would give the same answer. Deviations of prices from this ideal give rise to uncertainty about the index. Treating these deviations as random, as in the stochastic approach to price indexes, but with expenditure weights as non-stochastic, gives a second set of standard errors that reflect the uncertainty associated with the failure of arbitrage that is the fundamental reason why we need PPP index numbers. Formulas are given for these standard errors for the usual PPP price index numbers, including the Fisher and Törnqvist versions of the EKS index, as well as weighted CPD indexes. Section 2 provides illustrative calculations for a national consumer PPP index for food, fuel, alcohol, and tobacco for Indonesia in terms of India in 1999–2000. Section 3 extends the two-country analysis to the case of “poverty” PPPs, which are international price indexes calculated for people at or near the poverty line, under the requirement that the ratio of the two poverty lines is equal to the PPP index. It shows that, when the Engel curves take a specific but realistic functional form, there is a closed form solution for the poverty PPP index, and proposes using this case as a starting value for a non-parametric, but iterative, calculation. Section 4 applies this case to the Indonesian to Indian comparison. Section 5 extends the analysis in Sections 1 and 3 to the multiple country case, and Section 6 provides illustrative calculations of food and tobacco PPPs for India, Indonesia, Bangladesh, and Pakistan.
    Date: 2006–08
  4. By: Frankel, Jeffrey A; Wei, Shang-Jin
    Abstract: This paper examines two related issues: (a) the implicit methodology used by the U.S. Treasury in determining whether China and its other trading partners manipulate their exchange rates, and (b) the nature of the Chinese exchange rate regime since July 2005. On the first issue, we investigate the roles of both economic variables consistent with the IMF definition of manipulation - the partners' overall current account/GDP, its reserve changes, and the real overvaluation of its currency - and variables suggestive of American domestic political considerations -- the bilateral trade balance, US unemployment, and an election year dummy. The econometric results suggest that the Treasury verdicts are driven heavily by the US bilateral deficit, though other variables also turn out to be quite important. On the issue of China's de facto exchange rate regime, we apply the technique introduced by Frankel and Wei (1994) to estimate implicit basket weights and add several refinements. Within 2005, the de facto regime remained a peg to the dollar. However, there was a modest but steady increase in flexibility subsequently. We test whether US pressure has promoted RMB flexibility. We also test whether the recent appreciation against the dollar is due to a trend appreciation against the reference basket or a declining weight on the dollar in the reference basket, and argue that they have different policy implications.
    Keywords: Chinese economy; implicit currency weights; renminbi
    JEL: F3 F5 O1
    Date: 2007–04
  5. By: Irène Andreou (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Gilles Dufrénot (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - [Université de la Méditerranée - Aix-Marseille II][Université de droit, d'économie et des sciences - Aix-Marseille III] - [Ecole des Hautes Etudes en Sciences Sociales]); Alain Sand-Zantman (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Aleksandra Zdzienicka-Durand (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines])
    Abstract: We propose a measure of the probability of crises associated with an aggregate indicator, where the percentage of false alarms and the proportion of missed signals can be combined to give an appreciation of the vulnerability of an economy. In this perspective, the important issue is not only to determine whether a system produces true predictions of a crisis, but also whether there are forewarning signs of a forthcoming crisis prior to its actual occurrence. To this end, we adopt the approach initiated by Kaminsky, Lizondo and Reinhart (1998), analyzing each indicator and calculating each threshold separately. We depart from this approach in that each country is also analyzed separately, permitting the creation of a more “custom-made” early warning system for each one.
    Keywords: composite indicator ; currency crisis ; early warning system
    Date: 2007–04–19
  6. By: Antonio Diez de los Rios
    Abstract: This paper presents a multifactor asset pricing model for currency, bond, and stock returns for ten emerging markets to investigate the effect of the exchange rate regime on the cost of capital and the integration of emerging financial markets. Since there is evidence that a fixed exchange rate regime reduces the currency risk premia demanded by foreign investors, the tentative conclusion is that a fixed exchange rate regime system can help reduce the cost of capital in emerging markets.
    Keywords: Exchange rate regimes; Development economics
    JEL: F30 F33 G15
    Date: 2007
  7. By: Celso Brunetti; Roberto S. Mariano; Chiara Scotti; Augustine H.H. Tan
    Abstract: This paper analyzes exchange rate turmoil with a Markov Switching GARCH model. We distinguish between two different regimes in both the conditional mean and the conditional variance: "ordinary" regime, characterized by low exchange rate changes and low volatility, and "turbulent" regime, characterized by high exchange rate movements and high volatility. We also allow the transition probabilities to vary over time as functions of economic and financial indicators. We find that real effective exchange rates, money supply relative to reserves, stock index returns, and bank stock index returns and volatility contain valuable information for identifying turbulence and ordinary periods.
    Date: 2007
  8. By: Jean-Pierre Allegret (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Alain Sand-Zantman (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines])
    Abstract: This paper studies to what extent the diversity of exchange rate regimes within Mercosur exerts an influence on the feasibility of a monetary union in this area. A semi-structural VAR model is built for each country, including a set of international and domestic variables. Based on impulse response functions and forecast error decomposition, we conclude that differences of exchange rate regime explain significantly the divergences of economic dynamics triggered by foreign or domestic shocks. Second, we decompose the structural innovations generated by each country model into unobservable common and idiosyncratic components, using a state-space model. This last exercise, intended to assess the degree of policy coordination between the Mercosur members, did not disclose any common component for the structural innovations generated by the three national models.
    Keywords: co-movement ; Cycles ; Mercosur ; optimum currency area ; unobserved components model
    Date: 2007–04–19
  9. By: Korhonen, Iikka (BOFIT); Juurikkala, Tuuli (BOFIT)
    Abstract: We assess the determinants of equilibrium real exchange rates in a sample of oil-dependent countries. Our basic data cover OPEC countries from 1975 to 2005. We also include three oil-producing Commonwealth of Independent States (CIS) countries in our robustness analysis. Utilising several estimation techniques, including pooled mean group and mean group estimators, we find that the price of oil has a clear, statistically significant effect on real exchange rates in our group of oil-producing countries. Higher oil price lead to appreciation of the real exchange rate. Elasticity of the real exchange rate with respect to the oil price is typically between 0.4 and 0.5, but may be larger depending on the specification. Real per capita GDP, on the other hand, does not appear to have a clear effect on real exchange rate. This latter result contrasts starkly with the consensus view of real exchange rates determinants, emphasising the unique position of oil-dependent countries.
    Keywords: equilibrium exchange rate; pooled mean group estimator; resource dependency
    JEL: F31 F41 P24 Q43
    Date: 2007–04–20
  10. By: Ingmar Nolte (University of Konstanz); Sandra Lechner (University of Konstanz)
    Abstract: This paper analyzes the relationship between currency price changes and their expectations. Currency price change expectations are derived with the help of different order flow measures, from the trading behavior of investors on OANDA FXTrade, which is an internet trading platform in the foreign exchange market. We investigate whether forecasts of intra-day price changes on different sampling frequencies can be improved with the information contained in the flow of our investors’ orders. Moreover, we verify several hypotheses on the trading behavior and the preference structure of our investors by investigating how past price changes affect future order flow.
    Keywords: Customer Dataset, Order Flow, Price Changes, Foreign Exchange Market
    JEL: G10 F31 C32
    Date: 2007–03–15
  11. By: Jeffrey Frankel
    Abstract: This paper is an econometric investigation of the determinants of the real value of the South African rand over the period 1984-2006. The results show a relatively good fit. As so often with exchange rate equations, there is substantial weight on the lagged exchange rate, which can be attributed to a momentum component. Nevertheless, economic fundamentals are significant and important. This is especially true of an index of the real prices of South African mineral commodities, which even drives out real income as a significant determinant of the rand's value. An implication is that the 2003-2006 real appreciation can be attributed to the Dutch Disease. In other respects, the rand behaves like currencies of industrialized countries with well-developed financial markets. In particular, high South African interest rates raise international demand for the rand and lead to real appreciation, controlling for a forward-looking measure of expected inflation and a measure of default risk or country risk. It is in the latter respects, in particular, that the paper hopes to have improved on earlier studies of the rand.
    JEL: F31
    Date: 2007–04
  12. By: Bussolo, Maurizio; Molina, Luis; Lopez, Humberto
    Abstract: Existing empirical eviden ce indicates that remittances have a positive impact on a good number of development indicators of recipient countries. Yet when flows are too large relative to the size of the recipient economies, as those observed in a number of Latin American countries, they may also bring a number of undesired problems. Among those probably the most feared in this context is the Dutch Disease. This paper explores the empirical evidence regarding the impact of remittances on the real exchange rate. The findings suggest that remittances indeed appear to lead to a significant real exchange rate appreciation. The paper also explores policy options that may somewhat offset the observed effect.
    Keywords: Economic Stabilization,Macroeconomic Management,Economic Theory & Research,Remittances,Pro-Poor Growth and Inequality
    Date: 2007–04–01

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