nep-ifn New Economics Papers
on International Finance
Issue of 2007‒09‒09
eight papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange Market Pressure and Monetary Policy: Evidence from Pakistan By M. Idrees Khawaja
  2. Order Flows, News, and Exchange Rate Volatility By M. FRÖMMEL; A. MENDE; L. MENKHOFF
  3. What drives financial crises in emerging markets? By Komulainen, Tuomas; Lukkarila, Johanna
  4. Optimum currency area theory: A selective review By Horvath , Julius
  5. Bilaterial equilibrium exchange rates of EU accession countries against the euro By Rahn , Jörg
  6. Valuing Foreign Currency Options with a Mean-Reverting Process: A Study of Hong Kong Dollar By Cho-hoi Hui; Vincent Yeung; Laurence Fung; Chi-Fai Lo
  7. Economic Integration and the Foreign Exchange By Weber, Enzo
  8. The monetary approach to exchange rates in the CEECs By Crespo-Cuaresma, Jesús; Fidrmuc, Jarko; McDonald , Ronald

  1. By: M. Idrees Khawaja (Pakistan Institute of Development Economics, Islamabad.)
    Abstract: The study employs Girton and Roper (1977) measure of exchange market pressure—sum of exchange rate depreciation and foreign reserves outflow, to examine the interaction between exchange market pressure and monetary variables, viz. domestic credit (Reserve Money) and interest rate. Evidence from impulse response functions suggests that domestic credit has remained the dominant tool of monetary policy for managing exchange market pressure. The increase in domestic credit upon increase in exchange market pressure (during 1991–98) is imprudent. The result suggests that fiscal needs/growth objective might have dominated the external account considerations during the span. Post 9/11 there is evidence of sterilised intervention in forex market. Interest rate has also weakly served as the tool of monetary policy during the hay days of foreign currency deposits (1991–98). The finding implies that for interest rate to work as tool of monetary policy vis-a-vis exchange market pressure a reasonable degree of capital mobility is called for.
    Keywords: Monetary Policy, Foreign Exchange
    JEL: E52 F31
    Date: 2007
    Abstract: This paper examines the roles of order flow (reflecting private information) and news (reflecting public information) in explaining exchange rate volatility. Analyzing four months of a bank’s high frequency US dollar-euro trading, three different kinds of order flow are used in addition to seasonal patterns in explaining volatility. We find that only larger sized order flows from financial customers and banks – indicating informed trading – contribute to explaining volatility, whereas flows from commercial customers do not. The result is robust when we control for news and other measures of market activity. This strengthens the view that exchange rate volatility reflects information processing.
    Keywords: exchange rate, market microstructure, order flow, financial customer orders, volatility patterns
    JEL: F G15
    Date: 2007–06
  3. By: Komulainen, Tuomas (BOFIT); Lukkarila, Johanna (BOFIT)
    Abstract: The study examines the reasons for financial crises in 31 emerging market countries during 1980-2001. It estimates a probit model using 23 macroeconomic and financial sector variables. Traditional variables such as unemployment and inflation, as well as several indicators of indebtedness such as private sector liabilities and the foreign liabilities of banks explain currency crises rather well, and it appears currency crises occur in tandem with banking crises. Indeed, in emerging market countries vulnerability to crisis is exacerbated by situations involving large liabilities that permit sudden capital outflows. Increases in indebtedness followed the liberalisation of capital flows and domestic financial sectors.
    Keywords: currency crises; banking crises; emerging markets; liberalisation; probit model
    JEL: F31 F32 F41 F47
    Date: 2007–09–05
  4. By: Horvath , Julius (BOFIT)
    Abstract: The first part of this paper is a review of significant papers in the vast literature on optimum currency area (OCA) theory. The author focuses on the main classical contributions, then considers modern treatment of OCA theory. The second part considers empirical literature on the types of geographical areas that might constitute optimum currency areas, particularly with respect to asymmetry and symmetry of shocks.
    JEL: E42 F33
    Date: 2007–09–06
  5. By: Rahn , Jörg (BOFIT)
    Abstract: We apply BEER and PEER approaches to calculate real equilibrium exchange rates for five EU accession countries in central and east Europe. Bilateral nominal equilibrium exchange rates against the euro are obtained through algebraic transformation of the results. Panel cointegration techniques are used to check the adequacy of the empirical model. The results reveal substantial overvaluations of the real exchange rate in several EU accession countries. Overvaluation is even higher when these exchange rates are expressed in nominal terms against the euro.
    Keywords: real exchange rates; equilibrium exchange rates; transition economies; panel cointeg
    JEL: C23 F31 F41
    Date: 2007–09–06
  6. By: Cho-hoi Hui (Research Department, Hong Kong Monetary Authority); Vincent Yeung (Research Department, Hong Kong Monetary Authority); Laurence Fung (Research Department, Hong Kong Monetary Authority); Chi-Fai Lo (Research Department, Hong Kong Monetary Authority)
    Abstract: The theoretical prediction of target exchange rates expects mean reversion of the exchange rates. This paper presents a model for valuing European foreign exchange options, in which the forward foreign exchange rate follows a mean-reverting lognormal process. The mean-reverting process has material impact on the foreign exchange rate option values and their hedge parameters. The numerical results using the forward exchange rates of the Hong Kong dollar and market data of their options show such impact. As the dynamics of target exchange rates may not follow the standard lognormal process as described by the Black-Scholes model, the mean-reverting option-pricing model may be considered for valuation of options and estimation of associated hedge parameters on target exchange rates.
    Keywords: Target foreign exchange rates, currency options, mean-reverting process
    JEL: F13 G13
    Date: 2007–05
  7. By: Weber, Enzo
    Abstract: This paper demonstrates effects of economic convergence processes on the foreign exchange behaviour in a monetary modelling approach. Since the exchange rate represents the relative price of two currencies, commonness of stochastic trends between the fundamental determinants of supply and demand of the underlying monies restricts exchange rate movements to transitory fluctuations. In the spirit of optimal currency areas, this has the potential to serve as a criterion for an all-round integration of two economies. Empirically, such a constellation is found between Australia and New Zealand, whereas diverging trends in money and interest rates characterise the relation of Australia towards the US.
    Keywords: Monetary Exchange Rate Model; Convergence; Stationarity; Australia
    JEL: C32 F31 F41
    Date: 2007–06
  8. By: Crespo-Cuaresma, Jesús (BOFIT); Fidrmuc, Jarko (BOFIT); McDonald , Ronald (BOFIT)
    Abstract: A panel data set for six Central and Eastern European countries (the Czech Republic, Hungary, Poland, Romania, Slovakia and Slovenia) is used to estimate the monetary exchange rate model with panel cointegration methods, including the Pooled Mean Group estimator, the Fully Modified Least Square estimator and the Dynamic Least Square estimator. The monetary model is able to convincingly explain the long-run dynamics of exchange rates in CEECs, particularly when this is supplemented by a Balassa-Samuelson effect. We then use our long-run monetary estimates to compute equilibrium exchange rates. Finally, we discuss the implications for the accession of selected countries to the European Economic and Monetary Union.
    Keywords: exchange rates; monetary model; panel unit root tests; panel cointegration; EMU
    JEL: C33 F31 F36
    Date: 2007–09–06

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