nep-ifn New Economics Papers
on International Finance
Issue of 2007‒05‒12
eleven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. A New Approach to Forecasting Exchange Rates By Kenneth W Clements; Yihui Lan
  2. Parametric and Non-parametric Approaches to Exits from Fixed Exchange Rate Regimes By Ahmet Atil Asici
  3. Another Look at the Null of Stationary RealExchange Rates. Panel Data with Structural Breaks and Cross-section Dependence By Syed A. Basher; Josep Lluís Carrion-i-Silvestre
  4. An Evaluation of the Exchange Rate Forecasting Performance of the New Keynesian Model By Vitek, Francis
  5. Persistent Appreciations and Overshooting: A Normative Analysis By Ricardo J. Caballero; Guido Lorenzoni
  6. Ability of the New EU Member States to Fulfill the Exchange Rate Stability Convergence Criterion By Stavarek, Daniel
  7. Exchange Rate Cooperation in East Asia – Why a Basket Approach may be best By Peter Wilson
  8. The Timing and Magnitude of Exchange Rate Overshooting By Niklas J. Westelius; Mathias Hoffmann; Jens Sondergaard
  9. Why are Switzerland's foreign assets so low? The growing financial exposure of a small open economy By Nicolas Stoffels; Cédric Tille
  10. Conference Report on the Economics of Commodity Prices and Exchange Rates By Kenneth W. Clements; Mei Han; Inga Kristoffersen
  11. Consumption Persistence and the Equity Premium Puzzle: A Resolution or Not? (Job Market Paper) By Jun Ma

  1. By: Kenneth W Clements (UWA Business School, The University of Western Australia); Yihui Lan (UWA Business School, The University of Western Australia)
    Abstract: Building on purchasing power parity theory, this paper proposes a new approach to forecasting exchange rates using the Big Mac data from The Economist magazine. Our approach is attractive in three aspects. Firstly, it uses easily-available Big Mac prices as input. These prices avoid several serious problems associated with broad price indexes, such as the CPI, that are used in conventional PPP studies. Secondly, this approach provides real-time exchange-rate forecasts at any forecast horizon. Such real-time forecasts can be made on a day-to-day basis if required, so that the forecasts are based on the most up-to-date information set. These high-frequency forecasts could be particularly appealing to decision makers who want up-to-date forecasts of exchange rates. Finally, as our forecasts are obtained through Monte Carlo simulation, estimation uncertainty is made explicit in our framework which provides the entire distribution of exchange rates, not just a single point estimate. A comparison of our forecasts with the random walk model shows that although the random walk is superior for very short horizons, our approach tends to dominate over the medium to longer term.
    Keywords: Exchange-rate forecasting, Bic Mac prices, purchasing power parity, Monte Carlo simulation
    JEL: F30 C53
    Date: 2006
  2. By: Ahmet Atil Asici (IUHEI, The Graduate Institute of International Studies, Geneva)
    Abstract: Following the demise of the Bretton-Woods increasing number of countries has been opting for flexible exchange rate regimes. Exiting from fixed regimes however is not without costs. Regime transitions have often been occurred in the midst of a crisis which has considerable economic costs in terms of output contraction and exchange rate depreciation. Given the big number of countries having still fixed regimes and financial markets that are fairly close and expected to be liberalized sooner or later, issue of exiting a peg without incurring crisis is a real challenge confronting these countries. The aim of this paper is to determine the conditions under which orderly exit is possible. The paper employs Binary Recursive Tree and standard regression frameworks. Analysis shows that countries with higher output gap and overvalued real exchange rate, among others, are doomed to exit in a disorderly way. Following their exit output collapses and exchange rate depreciates considerably. The ill-managed financial liberalization and macroeconomic stabilization programs seem to lay the seeds of instability. An interesting finding is that the conventional strengths of parametric regression analysis can be dramatically improved by utilizing findings of non-parametric BRT technology. Sample contains all countries depending on the data availability, and covers 1975-2004 period.
    Keywords: Exchange rate regime choice, Exiting, Non-parametric Binary Recursive Tree Methodology
    JEL: C14 C34 F30 F31 F41
    Date: 2007–03–15
  3. By: Syed A. Basher (Department of Economics. York University.); Josep Lluís Carrion-i-Silvestre (Faculty of Economics, University of Barcelona.)
    Abstract: This paper re-examines the null of stationary of real exchange rate for a panel of seventeen OECD developed countries during the post-Bretton Woods era. Our analysis simultaneously considers both the presence of cross-section dependence and multiple structural breaks that have not received much attention in previous panel methods of long-run PPP. Empirical results indicate that there is little evidence in favor of PPP hypothesis when the analysis does not account for structural breaks. This conclusion is reversed when structural breaks are considered in computation of the panel statistics. We also compute point estimates of half-life separately for idiosyncratic and common factor components and find that it is always below one year.
    Keywords: Purchasing power parity, Half-lives, Panel unit roottests, Multiple structural breaks, Cross-section dependence.
    JEL: C32 C33 E31
    Date: 2007–05
  4. By: Vitek, Francis
    Abstract: This paper evaluates the dynamic out of sample nominal exchange rate forecasting performance of the canonical New Keynesian model of a small open economy. A novel Bayesian procedure for jointly estimating the hyperparameters and trend components of a state space representation of an approximate linear panel unobserved components representation of this New Keynesian model, conditional on prior information concerning the values of hyperparameters and trend components, is developed and applied for this purpose. In agreement with the existing empirical literature, we find that nominal exchange rate movements are difficult to forecast, with a random walk generally dominating the canonical New Keynesian model of a small open economy in terms of predictive accuracy at all horizons. Nevertheless, we find empirical support for the common practice in the theoretical open economy macroeconomics literature of imposing deterministic equality restrictions on deep structural parameters across economies, both in sample and out of sample.
    Keywords: Exchange rate forecasting; New Keynesian model; Small open economy
    JEL: C13 C11 F41 F47 C33
    Date: 2007–04–17
  5. By: Ricardo J. Caballero; Guido Lorenzoni
    Abstract: Most economies experience episodes of persistent real exchange rate appreciations, when the question arises whether there is a need for intervention to protect the export sector. In this paper we present a model of irreversible destruction where exchange rate intervention may be justified if the export sector is financially constrained. However the criterion for intervention is not whether there are bankruptcies or not, but whether these can cause a large exchange rate overshooting once the factors behind the appreciation subside. The optimal policy includes ex-ante and ex-post interventions. Ex-ante (i.e., during the appreciation phase) interventions have limited effects if the financial resources in the export sector are relatively abundant. In this case the bulk of the intervention takes place ex-post, and is concentrated in the first period of the depreciation phase. In contrast, if the financial constraint in the export sector is tight, the policy is shifted toward ex-ante intervention and it is optimal to lean against the appreciation. On the methodological front, we develop a framework to study optimal dynamic interventions in economies with financially constrained agents.
    JEL: E0 E2 F0 F4 H2
    Date: 2007–05
  6. By: Stavarek, Daniel
    Abstract: This paper assesses exchange rate development and volatility in six new EU member states (Cyprus, Czech Republic, Hungary, Poland, Slovakia, and Slovenia) during the period November 1996 - April 2006. The study is motivated by the unavoidable participation of the new member states’ currencies in the Exchange Rate Mechanism II and fulfillment of the exchange rate stability convergence criterion. The development of exchange rates is examined by the calculation of various rates of return and the exchange rate volatility is analyzed using moving average standard deviations of the annualized daily returns of the nominal bilateral exchange rates. The results suggest that the dilemma of “participation or non-participation in ERM II” have been solved properly so far by all countries analyzed. The three ERM II participating currencies (SIT, CYP, SKK) entered into the mechanism at the optimal time of stable exchange rate development and low volatility. On the other hand, the admissible fluctuation band ± 2.25 % seems to be still too narrow for the remaining three currencies (CZK, HUF, PLN), thus the currencies should remain out of ERM II for some time.
    Keywords: exchange rates; rate of return; volatility; ERM II; exchange rate stability criterion; new EU Member States
    JEL: F31
    Date: 2006–05
  7. By: Peter Wilson (Department of Economics, National University of Singapore)
  8. By: Niklas J. Westelius (Hunter College); Mathias Hoffmann (University of Cologne); Jens Sondergaard (Johns Hopkins University, Department of International Economics (SAIS))
    Abstract: Empirical evidence suggests that a monetary shock induces the exchange rate to over-shoot its long-run level. The estimated magnitude and timing of the overshooting, however, varies across studies. This paper generates delayed overshooting in a New Keynesian model of a small open economy by incorporating incomplete information about the true nature of the monetary shock. The framework allows for a sensitivity analysis of the overshooting result to underlying structural parameters. It is shown that policy objectives and measures of the economy?s sensitivity to exchange rate dynamic a¤ect the timing and magnitude of the overshooting in a predictable manner, suggesting a possible rationale for the cross-study variation of the delayed overshooting phenomenon.
    Keywords: Exchange rate overshooting, Partial information, Learning.
    JEL: F41 F31 E31
    Date: 2007
  9. By: Nicolas Stoffels; Cédric Tille
    Abstract: Switzerland's international investment position shows a puzzling feature since 1999: Large and persistent current account surpluses have failed to boost the value of Swiss foreign assets. In this paper, we link this pattern to the substantial increase in the leveraging of Switzerland?s international assets and liabilities over the last twenty years, which we document in detail. We estimate the impact of exchange rate and asset prices movements on Swiss net foreign assets, and show that they led to substantial valuations losses since 1999, accounting for between one-quarter and one-half of the gap between the net foreign assets and cumulated current account flows. We show how these adverse valuation effects have erased Switzerland?s advantage in terms of the yield on its net foreign asset position.
    Keywords: Capital movements ; International finance ; International economic integration ; Switzerland ; Assets (Accounting)
    Date: 2007
  10. By: Kenneth W. Clements (UWA Business School, The University of Western Australia); Mei Han (UWA Business School, The University of Western Australia); Inga Kristoffersen (UWA Business School, The University of Western Australia)
    Abstract: This report contains information about the sessions, papers, speakers and participants in the conference on the Economics of Commodity Prices and Exchange Rates held at the University Club at UWA on 9 June, 2006.
    Date: 2006
  11. By: Jun Ma
    Abstract: As first pointed out by Mehra and Prescott (1985), the excess return of equities over the risk-free rate, roughly 6%, is too high to be readily reconciled with a standard intertemporal model. Recently, Bansal and Yaron (2000, 2004) have demonstrated a resolution of the equity premium puzzle when high persistence in the consumption growth process is combined with the Generalized Expected Utility (GEU) specification of Epstein and Zin (1989, 1991). However, Nelson and Startz (2006) and Ma, Nelson, and Startz (2006) have shown that standard estimates of persistence are generally spurious in time series models that are weakly identified. This motivates the re-examination of the evidence for resolution of the equity premium puzzle in this paper. Using the valid Anderson-Rubin type test proposed by Ma and Nelson (2006) I show that weak identification may account for the apparent resolution and valid confidence regions and tests reject high persistence in consumption growth. Also, the possibility of integrated expectations is examined using the Median Unbiased Estimator of Stock and Watson (1998) and little supporting evidence is found. Evidently, the equity premium puzzle remains just that.
    Date: 2006–11

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