nep-ifn New Economics Papers
on International Finance
Issue of 2007‒09‒16
fifteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Interpreting real exchange rate movements in transition countries By Broeck, Mark De; Sløk , Torsten
  2. Substituting a Substitute Currency – The Case of Estonia By Heimonen , Kari
  3. Investigating the Balassa-Samuelson hypothesis in transition: Do we understand what we see? By Égert , Balázs
  4. Adjustment of the US current account deficit By Kortelainen, Mika
  5. Econometric Analysis of Currency Substitution: A Case of Latvia By Sarajevs, Vadims
  6. Currency Crises in Emerging Markets: Capital Flows and Herding Behaviour By Komulainen , Tuomas
  7. Capturing Common Components in High-Frequency Financial Time Series: A Multivariate Stochastic Multiplicative Error Model By Nikolaus Hautsch
  8. Discrete Devaluations and Multiple Equilibria in a First Generation Model of Currency Crises By Fernando Broner
  9. Equilibrium Exchange Rates in Transition Countries: Evidence from Dynamic Heterogeneous Panel Models By Kim, Byung-Yeon; Korhonen, Iikka
  10. A forewarning indicator system for financial crises: the case of six Central and Eastern European countries By Irene Andreou; Gilles Dufrénot; Alain Sand; Aleksandra Zdzienicka-Durand
  11. Real currency appreciation in accession countries: Balassa-Samuelson and investment demand By Fischer, Christoph
  12. Managing capital flows in Estonia and Latvia By Sutela, Pekka
  13. Exchange rate regimes and nominal convergence in the CEECs By Järvinen , Marketta
  14. Dollarization in Lithuania: An Econometric Approach By Vetlov , Igor
  15. What can the data tell us about carry trades in Japanese yen? By Joseph E. Gagnon; Alain P. Chaboud

  1. By: Broeck, Mark De (BOFIT); Sløk , Torsten (BOFIT)
    Abstract: Several transition countries have experienced strong real exchange rate appreciations. This paper tests the hypothesis that these appreciations reflect underlying productivity gains in the tradable sector. Using panel data over the period 1993–98, the results show clear evidence of productivity-driven exchange rate movements in the central and eastern European and Baltic countries. Transition countries, particularly the EU accession countries that have begun to catch up, can expect to experience further productivity-driven real exchange rate appreciations. Evidence from a large cross-section of non-transition countries indicates that catching up by one percent will be associated with a 0.4 percent real appreciation.
    Keywords: real exchange rates; transition; Balassa-Samuelson effects
    JEL: F30 G14 G15 P34
    Date: 2007–09–12
  2. By: Heimonen , Kari (BOFIT)
    Abstract: This study evaluates substitution of foreign currency balances in Estonia, a transition economy neighbouring countries participating in EMU. The focus is on substitution between dollar and euro balances in the three basic functions of money - unit of account, store of value and means of payment. While traditional models for currency substitution concentrate on substitution between a domestic currency and aggregate foreign currency balances, we look for substitution between the dollar and the euro or euro-related foreign currency balances. We find substitution between dollarization and euroization to be asymmetric in the short run, which suggests that inertia, irreversibility and ratchet effects favour the euro. No significant evidence of asymmetries in the long run was detected. In general, the traditional model for currency substitution explains the dynamics of the euro and dollar as substitute foreign currencies.
    Keywords: euro; dollar; currency substitution; currency demand
    Date: 2007–09–13
  3. By: Égert , Balázs (BOFIT)
    Abstract: This paper studies the Balassa-Samuelson effect in the Czech Republic, Hungary, Poland, Slovakia and Slovenia. Time series and panel cointegration techniques are used to show that the BS effect works reasonably well in these transition economies during the period 1991:Q1 to 2001:Q2. However, productivity growth does not fully translate into price in-creases due to the structure of CPI indexes. We thus argue that productivity growth will not hinder the ability of the five EU accession candidates to meet the Maastricht criterion on inflation in the medium term. Moreover, the observed appreciation of the CPI-deflated real exchange rate is found to be systematically higher compared to the real appreciation justi-fied by the Balassa-Samuelson effect, particularly in the cases of the Czech Republic and Slovakia. This may be partly explained by the trend appreciation of the tradable-goods-price-based real exchange rate, increases in non-tradable sector prices due to price liberali-sation and demand-side pressures, and the evolution of the nominal exchange rate due to the exchange rate regime and magnitude of capital inflows.
    Keywords: Balassa-Samuelson effect; productivity; real exchange rate; transition; panel cointegration
    JEL: E31 F31 O11 P17
    Date: 2007–09–11
  4. By: Kortelainen, Mika (Bank of Finland Research)
    Abstract: We present a two country DGE model and estimate it using Bayesian techniques and euro area and US quarterly data for 1977–2004. In analysing the current accounts we find that a lower US rate of time preference or a higher dollar risk premium could render the deficit sustainable, but that these could push the interest rate to the zero bound. Secondly, we find that fiscal policy is not sufficiently effective to improve the current account although the zero bound is not hit.
    Keywords: current account; zero bound; policy coordination
    JEL: E61 F32
    Date: 2007–09–12
  5. By: Sarajevs, Vadims (BOFIT)
    Abstract: The paper provides a comprehensive econometric analysis of currency substitution for Latvia. Rather than drawing inferences on the degree of currency substitution from domestic money demand modelling, the most common approach to empirical analysis of the phenomenon, direct modelling of currency substitution ratio is ap-plied. Extensive model construction, estimation, evaluation and testing are per-formed. Methodological issues are also discussed. No simple policy recommenda-tions can be made at this stage of research, but a number of instruments are identi-fied, which can be used by the authorities to influence currency substitution behaviour.
    Keywords: currency substitution; exogeneity; unit roots; causality; cointegration; parameter constancy
    Date: 2007–09–13
  6. By: Komulainen , Tuomas (BOFIT)
    Abstract: This study shows that due to herding behaviour and possible capital outflows, emerging market countries are vulnerable to multiple equilibria situations and currency crises. It uses a model by Jeanne (1997), where currency crises can be formed by multiple equilibria and self-fulfilling expectations. We determine the country fundamentals according to balance of payments approach. In this study we introduce capital flows, which depend from crisis probability, into the model. The capital flows are further assumed to follow herding behaviour, which produces a reason and mechanism for the large capital outflows witnessed during the recent crises. The range of country fundamentals, where self-fulfilling crises are possible, is now larger than without capital flows and herding behaviour. Consequently, the country fundamentals have to be better, if the country wants to stay totally out of crises. The model further points out lender interdependence as one shortcoming in the current structure of international capital markets. An empirical application of the model to the Mexican and Asian crises shows that when the possible capital outflows are included, the fundamentals of most emerging market countries were inside the range of multiple equilibria in 1994 and 1996, and so self-fulfilling crises were possible.
    Date: 2007–09–13
  7. By: Nikolaus Hautsch (Humboldt University Berlin and CFS)
    Abstract: We introduce a multivariate multiplicative error model which is driven by componentspecific observation driven dynamics as well as a common latent autoregressive factor. The model is designed to explicitly account for (information driven) common factor dynamics as well as idiosyncratic effects in the processes of highfrequency return volatilities, trade sizes and trading intensities. The model is estimated by simulated maximum likelihood using efficient importance sampling. Analyzing five minutes data from four liquid stocks traded at the New York Stock Exchange, we find that volatilities, volumes and intensities are driven by idiosyncratic dynamics as well as a highly persistent common factor capturing most causal relations and cross-dependencies between the individual variables. This confirms economic theory and suggests more parsimonious specifications of high-dimensional trading processes. It turns out that common shocks affect the return volatility and the trading volume rather than the trading intensity.
    Keywords: Net Foreign Assets; Valuation Adjustment; International Financial Integration
    JEL: C15 C32 C52
    Date: 2007–09–04
  8. By: Fernando Broner
    Abstract: The first generation models of currency crises have often been criticized because they predict that, in the absence of very large triggering shocks, currency attacks should be predictable and lead to small devaluations. This paper shows that these features of first generation models are not robust to the inclusion of private information. In particular, this paper analyzes a generalization of the Krugman-Flood-Garber (KFG) model, which relaxes the assumption that all consumers are perfectly informed about the level of fundamentals. In this environment, the KFG equilibrium of zero devaluation is only one of many possible equilibria. In all the other equilibria, the lack of perfect information delays the attack on the currency past the point at which the shadow exchange rate equals the peg, giving rise to unpredictable and discrete devaluations.
    Keywords: Currency Crises, First Generation Models, Private Information, Discrete Devaluations, Multiple Equilibria
    JEL: D8 E58 F31 F32
    Date: 2007–01
  9. By: Kim, Byung-Yeon (BOFIT); Korhonen, Iikka (BOFIT)
    Abstract: We use a dynamic heterogeneous panel model to estimate real equilibrium exchange rates for advanced transition countries. Our method is based on out-of-sample estimations from middle-income and high-income countries, and we use a pooled mean group estimator. We find that exchange rates have converged in recent years in five transition countries (Czech Republic, Hungary, Poland, Slovakia, and Slovenia) with real equilibrium exchange rates expressed in the US dollars. However, we also find that the currencies of the transition countries studied are substantially overvalued if real effective exchange rates are used.
    Keywords: exchange rates; transition economies; dynamic heterogeneous panel estimations
    JEL: C33 F31 P27
    Date: 2007–09–12
  10. By: Irene Andreou (GATE CNRS); Gilles Dufrénot (Université Paris 12, GREQAM); Alain Sand (GATE CNRS); Aleksandra Zdzienicka-Durand (GATE CNRS)
    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
    JEL: F31 F47
    Date: 2007–04
  11. By: Fischer, Christoph (BOFIT)
    Abstract: The Balassa-Samuelson effect is usually seen as the prime explanation of the continuous real appreciation of central and east European (CEE) transition countries' currencies against their western counterparts. The response of a small country's real exchange rate to various shocks is derived in a simple model. It is shown that productivity shocks work not only through a Balassa-type supply channel but also through an investment demand channel. Therefore, empirical evidence apparently in favour of Balassa-Samuelson effects may require a re-interpretation. The model is estimated for a panel of CEE countries. The results are consistent with the model, plausibly explain the observed real appreciation and support the existence of the proposed investment demand channel.
    Keywords: real exchange rate; Balassa-Samuelson effect; transition economies; panel
    JEL: C33 F31 F41
    Date: 2007–09–11
  12. By: Sutela, Pekka (BOFIT)
    Abstract: The three Baltic countries have been able to combine, Estonia since 1992 and Latvia and Lithuania since 1994, (1) a fixed exchange rate,(2) liberalisation of the capital account before having a well-functioning and fully supervised financial system, and (3) very large current account deficits. At the same time they have gone through deep structural and institutional change, which has been even faster than in several other transition economies. How have they been able to manage such a combination of characteristics that would usually be regarded inconsistent? The answer is not in clever management or control of financial markets combined with sound fundamentals. Rather, the Baltic countries have lacked several such markets that might be sources of instability. There are hardly any inter-bank markets. Public debt is absent or relatively very small. After the boomlet of 1997, the Baltic stock exchanges have generally hibernated. Banking crises have been recurrent. Not only are these economies extremely small, their degree of monetisation is very low. There are very few assets and markets for speculative capital flows. Partially, this reflects sound fundamentals, but mostly it is an unintended consequence of policy decisions. One cannot expect the experience to be easily repeated in other countries.
    Keywords: the Baltic countries; capital flows and controls; financial crises; currency boards
    Date: 2007–09–13
  13. By: Järvinen , Marketta (BOFIT)
    Abstract: This paper examines, in the context of future EMU membership of the Central and Eastern European countries (CEECs), the interaction between fiscal policy and the price level in different exchange rate regimes. The theoretical framework is based on the Fiscal Theory of the Price Level (FTPL). The results show that a credibly fixed exchange rate is inconsistent with fiscal irresponsibility, while adopting the common currency enables the conduct of irresponsible policies with the result that a rise in the level of debt by one member country raises the common price level of the whole union.
    Keywords: exchange rate regimes; inflation; fiscal theory of the price level; transition economies
    JEL: E00 F33 O57
    Date: 2007–09–11
  14. By: Vetlov , Igor (BOFIT)
    Abstract: The paper analyses the factors driving dollarization in Lithuania during the period from December 1992 to August 2000. Starting with a brief overview of the major economic and political developments in Lithuania, the study attempts to model the process of dollarization by applying rigorous time series analysis. In particular, it investigates the long- and short-run properties of the relationship between the dollarization ratio and interest rates paid on domestic and foreign currency deposits. The study identifies a relatively stable cointegrating relationship between variables, whereby the dollarization ratio is negatively related to the interest rate spread. In the constructed vector error correction model, the deviations from the long-run relationship are found be significant for the dynamics of all three variables. Overall, the model explains the development of dollarization rather well. Simple specification of the model is possible when interest rates reflect the major economic and political events relevant to the process of dollarization.
    Keywords: dollarization; transition economy; currency board; unit roots; cointegration; vector error-correction
    JEL: C22 C51 C52
    Date: 2007–09–12
  15. By: Joseph E. Gagnon; Alain P. Chaboud
    Abstract: This paper examines the available data that may shed light on the carry trade in Japanese yen. We define an individual or a sector to be engaged in the carry trade if it has a short position in yen and a long position in other currencies. The tendency of large yen movements to be skewed toward appreciations is consistent with the existence of substantial carry positions, and other evidence from market prices provides some modest support for an effect from the carry trade. Data on bank loans and bond holdings by currency reveal a large apparent yen carry position of the Japanese official sector and modest carry positions in the Japanese and foreign banking sectors. The Japanese private non-banking sector has a large long foreign-currency position, but does not have a short yen position, and is thus not engaged in the yen carry trade in the aggregate. However, it is possible that exporters and investors in Japan use the derivatives markets to hedge some of their long foreign-currency exposure, with the private non-banking sector outside of Japan (including most hedge funds) likely to be taking on most of the associated carry exposure.
    Keywords: Foreign exchange rates ; Yen, Japanese ; Interest rates
    Date: 2007

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