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on International Finance |
| By: | Jose Olmo (Department of Economics, City University, London); Keith Pilbeam (Department of Economics, City University, London) |
| Abstract: | We argue that the forward discount puzzle is primarily a statistical phenomenon and that statistical rejections of Uncovered Interest Parity do not necessarily constitute valid rejections of market efficiency. We find by using a Taylor expansion a theoretical negative bias in existing regressions of UIP. We propose two alternative tests for market efficiency, one of which is designed to measure the degree of market inefficiency. Our results from these tests indicate that for all four of the bilateral dollar parities studied the foreign exchange market is efficient despite decisive clear rejections of UIP using the conventional regression approach. |
| Keywords: | Forward discount puzzle, Efficient Market Hypothesis, Jensen’s inequality, Taylor expansion, Uncovered Interest Parity |
| JEL: | F31 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:cty:dpaper:07/10&r=ifn |
| By: | Metodij Hadzi-Vaskov; Clemens Kool |
| Abstract: | Uncovered interest rate parity provides a crucial theoretical underpinning for many models in international finance and international monetary economics. Though theoretically sound, this concept has not been supported by the empirical evidence. Typically, econometric tests not only reject the null hypothesis, but also find significant slope coefficients with the wrong sign. Following the approach employed in Kool and Thornton (2004), we show that the empirical procedure conventionally used to test for UIP may produce biased slope coefficients if the true data-generating process slightly differs from the theoretically expected one. Using monthly data for ten industrial countries during the period W75-2004,we estimate the UIP relation for all possible bilateral country pairs for each of the six fiveyear sub-periods. The evidence supports the biasedness hypothesis: when the interest rate volatility of the anchor country is very high (very low), this estimation procedure reports significantly higher (lower) slope coefficients. |
| Keywords: | International Financial Markets, Estimation Bias, Exchange Rate Volatility |
| JEL: | F31 G15 C5 |
| Date: | 2006–10 |
| URL: | http://d.repec.org/n?u=RePEc:use:tkiwps:0616&r=ifn |
| By: | Axel Dreher (KOF Swiss Economic Institute, ETH Zurich Switzerland and CESifo, Germany); Roland Vaubel (University of Mannheim, Dept. of Economics, Mannheim, Germany,) |
| Abstract: | By combining expansionary open market operations with sales of foreign exchange, the central bank can expand the monetary base without depreciating the exchange rate. Thus, if there is a monetary political business cycle, sales of foreign exchange are especially likely before elections. Our panel data analysis for up to 146 countries in 1975-2001 supports this hypothesis. Foreign exchange reserves relative to trend GDP depend negatively on the preelection index. The relationship is significant and robust irrespective of the type of electoral variable, the choice of control variables and the estimation technique. |
| Keywords: | Foreign exchange interventions, political business cycles |
| JEL: | F31 E58 |
| Date: | 2007–04 |
| URL: | http://d.repec.org/n?u=RePEc:kof:wpskof:07-159&r=ifn |
| By: | Dees, Stephane; Holly, Sean; Pesaran, M. Hashem; Smith, L. Vanessa |
| Abstract: | This paper focuses on testing long run macroeconomic relations for interest rates, equity, prices and exchange rates within a model of the global economy. It considers a number of plausible long run relationships suggested by arbitrage in financial and goods markets, and uses the global vector autoregressive (GVAR) model developed in Dees, di Mauro, Pesaran and Smith (2007) to test for long run restrictions in each country/region conditioning on the rest of the world. Bootstrapping is used to compute both the empirical distribution of the impulse responses and the log-likelihood ratio statistic for over-identifying restrictions. The paper also examines the speed with which adjustments to the long run relations take place via the persistence profiles. We find strong evidence in favour of the uncovered interest parity and to a lesser extent the Fisher equation across a number of countries, but our results for the PPP are much weaker. Also as to be expected, the transmission of shocks and subsequent adjustments in financial markets are much faster than those in goods markets. |
| Keywords: | Global VAR, interdependencies, Fisher relationship, Uncovered Interest Rate Parity, Purchasing Power Parity, persistence profile |
| JEL: | C32 E17 F47 R11 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:ifwedp:5521&r=ifn |
| By: | Wang, Q. |
| Abstract: | This work evaluates whether or not the interest rate rules under different exchange rate regimes lead to a REE that is both locally determinate and stable under adaptive learning by private agents. I find that monetary interdependence among countries is crucial for the determinacy and learning stability of the economy in the open economy case, even without the coordination of the policymakers. Under floating exchange rate regime, both countries should follow aggressive interest rate rules simultaneously, in order to obtain determinate and learnable REE. Furthermore, the openness diminishes the regions for the determinate and learnable rules relative to its closed economy counterpart under the .oating regime, while in other exchange rate regime, the additional reaction towards the level or change of nominal exchange rate will enlarge this region. |
| Keywords: | Adaptive learning, interest rate rules, open economy, exchange rate regime, determinacy, learnability |
| JEL: | E52 E42 E31 D84 F41 F42 |
| Date: | 2006–12 |
| URL: | http://d.repec.org/n?u=RePEc:cam:camdae:0659&r=ifn |
| By: | Bask, Mikael (Bank of Finland Research); Selander, Carina (Umeå University) |
| Abstract: | The aim of this paper is threefold: (i) to investigate if there is a unique rational expectations equilibrium (REE) in the small open economy in Galí and Monacelli (2005) that is augmented with technical trading in the foreign exchange market; (ii) to investigate if the unique REE is adaptively learnable in a recursive least squares sense; and (iii) to investigate if the unique and adaptively learnable REE is desirable in an inflation rate targeting regime in the sense that a low and not too variable CPI inflation rate in equilibrium is achieved. The monetary authority is using a Taylor rule when setting the nominal interest rate, and we investigate numerically the properties of the model developed. A main conclusion is that the monetary authority should increase (decrease) the interest rate when the CPI inflation rate increases (decreases) and when the currency gets stronger (weaker) to have a desirable rule that is robust with respect to the degree of technical trading in the foreign exchange market. Thus, the value of the currency is a better response variable than the output gap in the most desirable parametrizations of the interest rate rule. |
| Keywords: | determinacy; foreign exchange; inflation rate targeting regime; interest rate rule; robust monetary policy; technical trading |
| JEL: | E52 F31 |
| Date: | 2007–05–09 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofrdp:2007_006&r=ifn |
| By: | Reitz, Stefan; Schmidt, Markus; Taylor, Mark P. |
| Abstract: | In this paper we provide evidence for Evans and Lyons' (2005b) model of an information aggregation process in FX markets using a German bank's end-user order flow from 2002 to 2003. Though customer order flow is unambiguously the vehicle incorporating non-public information into exchange rates over time, our empirical analysis does not support the widespread optimism in the market microstructure literature that customer order flow is the high-powered source of information easily exploitable for short-run speculation. Moreover, commercial customers' order flow produces negative coefficients in contemporaneous return regressions, stressing their role as liquidity providers. |
| Keywords: | Foreign exchange, market microstructure, end-user order flow |
| JEL: | F31 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp1:5559&r=ifn |
| By: | Evans, Kevin (Cardiff Business School); Speight, Alan |
| Abstract: | Investigation of the dynamic, short-run response of exchange rate returns to the information surprise of macroeconomic announcements reveals that US macroeconomic news generates far more dramatic responses in exchange rate returns and returns volatility than news on the macroeconomic performance of other countries. Eurozone, German, French and Japanese news have very little impact. However, some UK announcements are important for the EUR-GBP rate. The reaction of exchange rate returns to news is very quick and occurs within the first five minutes of the release with very little reaction in the following fifteen minutes, thus enabling us to characterise such reactions as conditional mean return jumps. These jumps show that exchange rates are strongly linked to fundamentals in the five-minute intervals immediately following the data release. Interestingly, despite causing large responses in returns volatility, the large jumps in returns following interest rate decisions do not appear to be correlated with the informational innovation surrounding their announcement. |
| Keywords: | Intraday volatility; macroeconomic announcements; exchange rates |
| JEL: | G12 E44 E32 |
| Date: | 2006–10 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:accfin:2006/4&r=ifn |
| By: | Ashton de Silva; Rob J. Hyndman; Ralph D. Snyder |
| Abstract: | The vector innovation structural time series framework is proposed as a way of modelling a set of related time series. Like all multi-series approaches, the aim is to exploit potential inter-series dependencies to improve the fit and forecasts. A key feature of the framework is that the series are decomposed into common components such as trend and seasonal effects. Equations that describe the evolution of these components through time are used as the sole way of representing the inter-temporal dependencies. The approach is illustrated on a bivariate data set comprising Australian exchange rates of the UK pound and US dollar. Its forecasting capacity is compared to other common single- and multi-series approaches in an experiment using time series from a large macroeconomic database. |
| Keywords: | Vector innovation structural time series, state space model, multivariate time series, exponential smoothing, forecast comparison, vector autoregression. |
| JEL: | C32 C51 C53 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:msh:ebswps:2007-3&r=ifn |