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on International Finance |
| By: | Tatsuyoshi Okimoto (Yokohama National University); Katsumi Shimotsu (Queen's University) |
| Abstract: | Purchasing power parity (PPP) is one of the most important, but empirically controversial theories in international macroeconomics. Although many researchers believe that some variant of PPP holds in the long run, there are diverse empirical results regarding the PPP hypothesis. We examine the PPP hypothesis from an alternate point of view: We investigate the possibility of financial market integration, and world economic stabilization toward PPP, by examining the change in the persistence of PPP deviations during the last three decades. We employ a fractional integration framework, which provides a powerful tool to detect changes in the persistence for highly persistent time series. First, we test the null hypothesis of no decline in the persistence of PPP deviations. The test rejects the null at the 10% significance level for 11 out of 17 countries, thus providing strong support for financial market integration and world economic stabilization toward PPP. Second, we examine the dynamics of the persistence of PPP deviations during the last three decades through rolling-window estimation. Our results show that the persistence of PPP deviations has decreased gradually, and that many real exchange rates have experienced a sharp drop in their persistence once samples starting in the mid-1980s are used. Interestingly, this timing almost coincides with the timing of U.S./world economic stabilization reported by other studies. We also examine the relation between the persistence of PPP deviations and de facto measures of financial integration by Lane and Milesi-Ferretti (2006). We confirm that they are strongly correlated for all countries. This finding suggests that the recent promotion of financial integration is one of the main sources of the decline in the persistence of PPP deviations. |
| Keywords: | fractional integration, PPP, real exchange rate, financial integration |
| JEL: | C14 C22 F31 F36 |
| Date: | 2007–10 |
| URL: | http://d.repec.org/n?u=RePEc:qed:wpaper:1138&r=ifn |
| By: | Ivo J.M. Arnold; Ronald MacDonald; Casper G. de Vries |
| Abstract: | A widely held notion is that freely floating exchange rates are excessively volatile when moving from fixed to floating exchange rates. We re-examine the data and conclude that the disparity between the fundamentals and exchange rate volatility is more apparent than real, especially when the Deutsche Mark, rather than the dollar, is chosen as the numeraire currency. We argue and demonstrate that in inter-regime comparisons one has to account for certain ‘missing variables’ which compensate for the fundamental variables’ volatility under fixed exchange rates. We show that IMF credit support is a crucial compensating variable. |
| Keywords: | Exchange rates; Exchange rate regimes; Excess volatility; IMF credit |
| JEL: | F31 |
| Date: | 2007–06 |
| URL: | http://d.repec.org/n?u=RePEc:gla:glaewp:2007_37&r=ifn |
| By: | Matthieu Bussiere (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.) |
| Abstract: | A standard assumption in the empirical literature is that exchange rate pass-through is both linear and symmetric, implying that (a) large and small exchange rate changes and (b) appreciations and depreciations have an effect of the same magnitude, proportionally. This paper tests these assumptions for export and import prices in the G7 economies. It focuses on non-linearities in the reaction of profit margins to exchange rate movements, which may arise from the presence of price rigidities and switching costs. To this end, nonlinearities are characterised by augmenting a standard linear model with polynomial functions of the exchange rate and with interactive dummy variables. The presence of such non-linearities is confirmed by formal statistical tests. Overall, the results suggest that non-linearities and asymmetries in the exchange rate pass-through cannot be ignored, especially on the export side, although their magnitude varies noticeably across countries. JEL Classification: C22, C51, F14, F31. |
| Keywords: | Exchange Rate Pass-Through, Non-linear Model, Trade Prices. |
| Date: | 2007–10 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070822&r=ifn |
| By: | Chris D'Souza |
| Abstract: | Trades in foreign exchange markets are initiated around the world and around the clock. This study illustrates that trades are more informative when initiated in a local country or in major foreign exchange centers like London and New York. Evidence suggests that informational asymmetries based on geography arise from the market making capacity of dealers and the customer order flow that dealers capture during regional business hours. Findings also show that market orders initiated in price-correlated FX markets are not informative. Transparency in quotes on electronic trading platforms may prevent informed participants from exploiting information across FX markets. Overall, these results are robust across different market conditions. |
| Keywords: | Market structure and pricing; Exchange rates; Financial markets |
| JEL: | F31 G15 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:07-52&r=ifn |
| By: | Michael D. Bordo; Ali Dib; Lawrence Schembri |
| Abstract: | This paper revisits Canada's pioneering experience with floating exchange rate over the period 1950-1962. It examines whether the floating rate was the best option for Canada in the 1950s by developing and estimating a New Keynesian small open economy model of the Canadian economy. The model is then used to conduct a counterfactual analysis of the impact of different monetary policies and exchange rate regimes. The main finding indicates that the flexible exchange rate helped reduce the volatility of key macro-economic variables. The Canadian monetary authorities, however, clearly did not understand all of the implications of conducting monetary policy under a flexible exchange rate and a high degree of capital mobility. The paper confirms that monetary policy was more volatile in the post-1957 period and Canada's macroeconomic performance suffered as a result. |
| JEL: | E32 E37 F31 F32 N01 |
| Date: | 2007–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13605&r=ifn |
| By: | Wei Dong |
| Abstract: | The author investigates the quantitative importance of the expenditure-switching effect by developing and estimating a structural sticky-price model nesting both producer currency pricing (PCP) and local currency pricing (LCP) settings. The author aims to provide empirical evidence of the magnitude of the benefits to be gained from exchange rate flexibility in terms of expenditure switching, and to contribute to the ongoing debate regarding the optimal exchange rate regime. In the author's model, the size of the expenditure-switching effect is determined by the degree of price stickiness, the fraction of firms employing PCP versus LCP, the distribution margin, and the elasticity of substitution between domestic and foreign tradable goods. The model is estimated for three small open economies: Australia, Canada, and the United Kingdom. The empirical results suggest that, among the three countries, the magnitude of the expenditure switching by domestic agents is relatively small for the United Kingdom, and comparatively large for Canada; the distribution margin in the United Kingdom is exceptionally high, which limits the degree of domestic expenditure switching initiated by nominal exchange rate movements. Moreover, expenditure switching by foreign distributors is comparatively small for Australia and Canada, since a larger fraction of Australian and Canadian firms adopt LCP for their export pricesetting. |
| Keywords: | Exchange rate regimes; International topics |
| JEL: | F3 F4 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:07-54&r=ifn |
| By: | Marques, Luis B |
| Abstract: | This paper measures the welfare cost to consumers of the bloc of Central and Eastern European Countries (CEEC), plus Malta and Cyprus, of choosing a de- preciated conversion rate when joining the European Monetary Union. For this, I present and solve an appropriately calibrated small open economy model where a euro-denominated bond and the equity on a traded goods sector are traded internationally. I show that the cost of depreciating the domestic currency against the euro by 20%, at the time of joining the European Monetary Union, entails a cost of approximately 1.65% in terms of lost lifetime utility (measured in equivalent units of consumption). |
| Keywords: | trade effect; valuation effect; wealth effect; exchange rate. |
| JEL: | F41 F47 F31 |
| Date: | 2007–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:5723&r=ifn |
| By: | Funke, Michael (BOFIT); Gronwald, Marc (BOFIT) |
| Abstract: | On 21 July 2005 China adopted an undisclosed basket exchange rate regime. We formally assess and envisage the gradual evolution of the renminbi over time. We utilize nonlinear dependencies in the renminbi exchange rate and describe the smooth transition of the renminbi/U.S. dollar (RMB/USD) exchange rate using the family of time-varying autoregressive (TV-AR) models. Specifically, the nonlinear models allow for a smooth transition from one optimal level to another. Our estimation results imply that the RMB/USD exchange rate will likely be about 7.42 RMB/USD in summer/autumn 2008. |
| Keywords: | China; renminbi; de facto exchange rate regime; TV-AR model; TV-AR-GARCH mode |
| JEL: | C22 F31 F37 |
| Date: | 2007–11–06 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofitp:2007_020&r=ifn |
| By: | Antonio Diez de los Rios; Enrique Sentana |
| Abstract: | Nowadays researchers can choose the sampling frequency of exchange rates and interest rates. If the number of observations per contract period is large relative to the sample size, standard GMM asymptotic theory provides unreliable inferences in UIP regression tests. We specify a bivariate continuous-time model for exchange rates and forward premia robust to temporal aggregation, unlike the discrete time models in the literature. We obtain the UIP restrictions on the continuous-time model parameters, which we estimate efficiently, and propose a novel specification test that compares estimators at different frequencies. Our empirical results based on correctly specified models reject UIP. |
| Keywords: | Exchange rates; Econometric and statistical methods |
| JEL: | F31 G15 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:07-53&r=ifn |
| By: | Edward J. O'Brien (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Derek Bond (University of Ulster, Cromore Road, Coleraine, Co.Londonderry, BT52 1SA, United Kingdom.); Michael J. Harrison (School of Economics, University College Dublin, Belfield, Dublin 4, Ireland.) |
| Abstract: | This paper attempts to model the nominal and real exchange rate for Ireland, relative to Germany and the UK from 1975 to 2003. It offers an overview of the theory of purchasing power parity (Ppp), focusing particularly on likely sources of nonlinearity. Potential difficulties in placing the analysis in the standard I(1)/I(0)framework are highlighted and comparisons with previous Irish studies are made. Tests for fractional integration and nonlinearity, including random field regressions, are discussed and applied. The results obtained highlight the likely inadequacies of the standard cointegration and Star approaches to modelling, and point instead to multiple structural changes models. Using this approach, both bilateral nominal exchange rates are effectively modelled, and in the case of Ireland and Germany, Ppp is found to be valid not only in the long run, but also in the medium term. JEL Classification: C22, C51, F31, F41. |
| Keywords: | Purchasing power parity, fractional Dickey-Fuller tests, smooth transition, autoregression, random field regression, multiple structural changes models. |
| Date: | 2007–10 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070823&r=ifn |
| By: | Albert Makochekanwa (Department of Economics, University of Pretoria) |
| Abstract: | This paper looks into the changes of the black market premium for foreign exchange in Zimbabwe. Generally, the black market for foreign exchange arises as a direct consequence of the adoption of exchange rate controls in many developing economies facing substantial macroeconomic imbalances. Despite its negative impact on Zimbabwe’s economy, this market has not, so far, attracted the attention of researchers. The research attempts to describe the functioning of the black market and find out the determinants of the parallel premium based on a stock-flow model as well as to investigate whether inflation Granger causes the parallel exchange rate. Estimated results reveal that the determinants of the black market premium are international foreign reserves, real exchange rate, lagged values of the black market premium, expected rate of devaluation, money supply and inflation. On the other hand, inflation and black market are found to Granger-cause each other during the period under consideration. |
| Keywords: | Black Market Exchange Rate, Black Market Premium, Foreign Exchange Controls, Cointegration, Granger Causality |
| JEL: | F31 C23 |
| Date: | 2007–07 |
| URL: | http://d.repec.org/n?u=RePEc:pre:wpaper:200713&r=ifn |
| By: | Marques, Luis B |
| Abstract: | This paper measures the welfare implications of a depreciation of the US dollar against the euro using a dynamic equilibrium model. I calibrate a simple two country stochastic endowment economy with trade in goods and financial assets and exogenous variations in the exchange rate. The model displays both a trade channel effect and an asset channel effect after a change in the value of the exchange rate. The welfare loss coming from the trade channel translates into the relatively higher price that consumers have to pay for imports. The asset channel effect arises from three sources. One is the traditional valuation effect associated with US debt being denominated mostly in dollars. The other two novel effects are: (1) the dollar value of investors net worth, mostly denominated in local currency, increases more in Europe than in the US; (2) asset prices change, causing a portfolio rebalancing effect which results in a fall in the share of world assets owned by the US. I show that a dollar depreciation has potentially large negative welfare effects as measured by the net present value of future consumption. After a temporary 10% depreciation of the dollar, with a half-life of one year, I calculate a 0.25% decrease in lifetime aggregate consumption for the US consumer. |
| Keywords: | trade effect; valuation effect; wealth effect; exchange rate; dynamic equilibrium model; welfare. |
| JEL: | F41 F47 F31 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:5721&r=ifn |