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on International Finance |
| By: | Campbell, Rachel; Koedijk, Kees; Lothian, James R; Mahieu, Ronald J |
| Abstract: | We review Irving Fisher’s seminal work on UIP and on the closely related equation linking interest rates and inflation. Like Fisher, we find that the failures of UIP are connected to individual episodes in which errors surrounding exchange rate expectations are persistent, but eventually transitory. We find considerable commonality in deviations from UIP and PPP, suggesting that both of these deviations are driven by a common factor. Using a dynamic latent factor model, we find that deviations from UIP are almost entirely due to forecasting errors in exchange rates, a result consistent with those reported by Fisher a century ago. |
| Keywords: | Expectations formation; Irving Fisher; small-sample problems; UIP |
| JEL: | F31 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6294&r=ifn |
| By: | Cristina Arellano; Jonathan Heathcote |
| Abstract: | How does a country’s choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets. We compare a floating regime to full dollarization. We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen incentives to maintain access to debt markets. Given stronger repayment incentives, more borrowing can be supported, and thus dollarization can increase international financial integration. This prediction of theory is consistent with the experiences of El Salvador and Ecuador, which recently dollarized, as well as with that of highly-indebted countries like Italy which adopted the Euro as part of Economic and Monetary Union. In each case, spreads on foreign currency government debt declined substantially around the time of regime change. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:890&r=ifn |
| By: | Zsolt Darvas (Department of Mathematical Economics and Economic Analysis, Corvinus University of Budapest); Zoltán Schepp (University of Pécs) |
| Abstract: | This paper shows that error correction models assuming that long-maturity forward rates are stationary outperform the random walk in out of sample forecasting at forecasting horizons mostly above one year, for US dollar exchange rates against nine industrial countries’ currencies, using the 1990-2006 period for evaluating the out of sample forecasts. The improvement in forecast accuracy of our models is economically significant for most of the exchange rate series, and statistically significant according to a bootstrap test. Our results are robust to the specification of the error correction model and to the underlying data frequency. |
| Keywords: | bootstrap, forecasting performance, out of sample, random walk, VECM |
| JEL: | E43 F31 F47 |
| Date: | 2007–05–18 |
| URL: | http://d.repec.org/n?u=RePEc:mkg:wpaper:0705&r=ifn |
| By: | Jeffrey A. Frankel; Shang-Jin Wei |
| Abstract: | This paper examines two related issues: (a) the implicit methodology used by the U.S. Treasury in determining whether China and America's 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 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 - but also some 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, adding 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 suggest that they have different policy implications. |
| JEL: | F3 F59 O1 |
| Date: | 2007–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13100&r=ifn |
| By: | Moura, Marcelo L. & Lima, Adauto R. S. |
| Date: | 2007–10 |
| URL: | http://d.repec.org/n?u=RePEc:ibm:ibmecp:wpe_85&r=ifn |