nep-ifn New Economics Papers
on International Finance
Issue of 2008‒01‒05
eleven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Investor Overconfidence and the Forward Discount Puzzle By Han, Bing; Hirshleifer, David; Wang, Tracy
  2. The PPP Puzzle: What the Data Tell when Allowed to Speak Freely By Katarina Juselius
  3. An Economic Evaluation of Empirical Exchange Rate Models By Della Corte, Pasquale; Sarno, Lucio; Tsiakas, Ilias
  4. Dollarization of Debt Contracts: Evidence from Chilean Firms. By Miguel Fuentes
  5. Demand for Foreign Exchange Derivatives in Brazil: Hedge or Speculation By Fernando N. de Oliveira; Walter Novaesk
  6. Three methods of forecasting currency crises: Which made the run in signaling the South African currency crisis of June 2006? By Tobias Knedlik; Rolf Scheufele
  8. Are there oil currencies? The real exchange rate of oil exporting countries By Maurizio Michael Habib; Margarita Manolova Kalamova
  9. Exchange Rate Volatility and First-Time Entry by Multinational Firms By Katheryn Niles Russ
  10. Testing Hypotheses in an I(2) Model with Applications to the Persistent Long Swings in the Dmk/$ Rate By Søren Johansen; Katarina Juselius; Roman Frydman; Michael Goldberg
  11. Exchange rate policy and export performance of WAMZ countries By Balogun, Emmanuel Dele

  1. By: Han, Bing; Hirshleifer, David; Wang, Tracy
    Abstract: This paper offers an explanation for the forward discount puzzle in foreign exchange markets based upon investor overconfidence. In our model, overconfident individuals overreact to their information about future inflation differential. The spot and the forward exchange rates differentially reflect such overreaction; as a result, the forward discount forecasts reversal in the spot rate. With plausible parameter values, the model explains the magnitude of the forward discount puzzle and stylized facts about how the forward discount bias varies with time horizon and time-series versus cross-sectional test method. Furthermore, the model generates new empirical predictions about the relation between the forward discount bias to foreign exchange trading volume, exchange rate volatility and predictability, as well as the degree of violation of the relative Purchasing Power Parity.
    Keywords: Uncovered Interest Parity; forward discount puzzle; inflation differential; investor overconfidence; exchange rate overshooting; market efficiency; Purchasing Power Parity.
    JEL: G14 G12 G15 F31
    Date: 2005–06
  2. By: Katarina Juselius (Department of Economics, University of Copenhagen)
    Abstract: The persistent movements away from long-run benchmark values in real exchange rates, dubbed the PPP puzzle, observed in many real exchange rates during periods of currency float have been subject to much empirical research without resolving the puzzle. The paper demonstrates how the cointegrated VAR approach by grouping together components of similar persistence can be used to uncover structures in the data that ultimately may help to explain theoretically the forces underlying such puzzling movements. The charaterization of the data into components which are empirically I(0), I(1), and I(2) is shown to be a powerful organizing principle allowing us to structure the data in long-run, medium-run, and short-run behavior. Its main advantage is the ability to associate persistent movements away from fundamental benchmark values in one variable/relation with similar persistent movements somewhere else in the economy.
    Keywords: cointegrated VAR, I(2); deterministic componenets; persistent movements
    JEL: C32 C50 F41
    Date: 2007–10
  3. By: Della Corte, Pasquale; Sarno, Lucio; Tsiakas, Ilias
    Abstract: This paper provides a comprehensive evaluation of the short-horizon predictive ability of economic fundamentals and forward premia on monthly exchange rate returns in a framework that allows for volatility timing. We implement Bayesian methods for estimation and ranking of a set of empirical exchange rate models, and construct combined forecasts based on Bayesian Model Averaging. More importantly, we assess the economic value of the in-sample and out-of-sample forecasting power of the empirical models, and find two key results: (i) a risk averse investor will pay a high performance fee to switch from a dynamic portfolio strategy based on the random walk model to one which conditions on the forward premium with stochastic volatility innovations; and (ii) strategies based on combined forecasts yield large economic gains over the random walk benchmark. These two results are robust to reasonably high transaction costs.
    Keywords: Bayesian MCMC Estimation; Bayesian Model Averaging; Economic Value; Exchange Rates; Forward Premium; Monetary Fundamentals; Volatility
    JEL: F31 F37 G11
    Date: 2007–12
  4. By: Miguel Fuentes (Instituto de Economía. Pontificia Universidad Católica de Chile.)
    Abstract: This paper uses a new data set to estimate the causes and consequences of foreign currency debt in rms' balance sheet. The vidence from this sample of Chilean firms indicates that dollar-denominated debt is more used by larger firms and those more exposed to foreign competition. We find evidence that dollar denominated debt combines with exchange rate movements to produce a negative balance-sheet effect that reduces firm's investment in periods of strong exchange rate depreciation. This negative balance-sheet effect is associated with long term debt and appears to be non-linear in the amount of real exchange rate depreciation.
    Keywords: Balance Sheet Effects, Currency Mismatches, Dollarization, Macroeconomics of Developing Countries
    JEL: F31 F49
    Date: 2007
  5. By: Fernando N. de Oliveira; Walter Novaesk
    Abstract: This paper examines empirically the demand of foreign exchange derivatives by Brazilian corporations. We build an original database of 25,457 contracts of foreign exchange swaps between firms and financial institutions open at the end of 2002. From these contracts we identify 53 corporations that hedge in the foreign exchange derivatives market and 40 corporations that speculate. The data show that the existence of external debt and the size of the company affect positively the probability of hedging, whereas revenues from exports affect positively the probability of speculation. These results suggest that during periods of great volatility of the exchange rate – such as in 2002 – the corporations’ demand for foreign exchange derivatives is strongly related to speculative motives.
    Date: 2007–12
  6. By: Tobias Knedlik; Rolf Scheufele
    Abstract: In this paper we test the ability of three of the most popular methods to forecast the South African currency crisis of June 2006. In particular we are interested in the out-ofsample performance of these methods. Thus, we choose the latest crisis to conduct an out-of-sample experiment. In sum, the signals approach was not able to forecast the outof- sample crisis of correctly; the probit approach was able to predict the crisis but just with models, that were based on raw data. Employing a Markov-regime-switching approach also allows to predict the out-of-sample crisis. The answer to the question of which method made the run in forecasting the June 2006 currency crisis is: the Markovswitching approach, since it called most of the pre-crisis periods correctly. However, the “victory” is not straightforward. In-sample, the probit models perform remarkably well and it is also able to detect, at least to some extent, out-of-sample currency crises before their occurrence. It can, therefore, not be recommended to focus on one approach only when evaluating the risk for currency crises.
    Date: 2007–12
  7. By: Horobet , Alexandra; Ilie, Livia
    Abstract: The theoretical linkages between exchange rates and stock prices are microeconomic as well as macroeconomic in nature and may be observed on the short- and long-run. The paper examines the interactions between the exchange rates and stock prices in Romania, after 1997, taking into account the change in the monetary regime occurred in 2005 – the shift towards inflation targeting. The analysis uses bivariate cointegration and Granger causality tests, applied on daily and monthly exchange rates and stock prices data collected over the 1999 to 2007 period. Three types of exchange rates are used: the nominal effective exchange rates of the Romanian leu, the bilateral nominal exchange rates of the leu against the US dollar and the euro, and the real effective exchange rates of the leu. In terms of stock prices, the BET and BET-C indices of the Bucharest Stock Exchange are used, denominated in the local currency.
    Keywords: exchange rates; stock exchange; cointegration; Granger causality
    JEL: F30 G10
    Date: 2007–10
  8. By: Maurizio Michael Habib (European Central Bank, Directorate General International and European Relations, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Margarita Manolova Kalamova (Social Science Research Center Berlin (WZB), Reichpietschufer 50, D-10178 Berlin, Germany.)
    Abstract: This paper investigates whether the real oil price has an impact on the real exchange rates of three main oil-exporting countries: Norway, Russia and Saudi Arabia. We create our measure of the real effective exchange rates for Norway and Saudi Arabia (1980-2006) and for Russia (1995-2006), testing if real oil prices and productivity differentials against 15 OECD countries influence exchange rates. In the case of Russia it is possible to establish a positive long-run relationship between the real oil price and the real exchange rate. However, we find virtually no impact of the real oil price on the real exchange rates of Norway and Saudi Arabia. The diverse exchange rate regimes cannot help in explaining the different empirical results on the impact of oil prices across countries, which instead may be due to other policy responses, namely the accumulation of net foreign assets and their sterilisation, and specific institutional characteristics. JEL Classification: F31, C22.
    Keywords: Real exchange rate, oil price, purchasing power parity, terms of trade, oil exporting countries.
    Date: 2007–12
  9. By: Katheryn Niles Russ
    Abstract: Using a model with upfront sunk costs, heterogeneous firms, and endogenous exchange rates, this paper demonstrates theoretically that volatility in fundamental variables such as the nominal interest rate that drive exchange rate volatility can simultaneously impact the entry behavior of multinational firms through a relative price channel unrelated to exchange rate risk. It then provides an empirical illustration of the bias this endogeneity can cause when regressing measures of foreign direct investment on exchange rate volatility. It is the first paper to provide empirical evidence that interest rate volatility may influence the behavior of multinational firms.
    JEL: F1 F2 F4
    Date: 2007–11
  10. By: Søren Johansen (Department of Economics, University of Copenhagen); Katarina Juselius (Department of Economics, University of Copenhagen); Roman Frydman (New York University); Michael Goldberg (University of New Hampshire)
    Abstract: This paper discusses a number of likelihood ratio tests on long-run relations and common trends in the I(2) model and provide new results on the test of overidentifying restrictions on β’xt and the asymptotic variance for the stochastic trends parameters, α⊥1: How to specify deterministic components in the I(2) model is discussed at some length. Model specification and tests are illustrated with an empirical analysis of long and persistent swings in the foreign exchange market between Germany and USA. The data analyzed consist of nominal exchange rates, relative prices, US inflation rate, two long-term interest rates and two short-term interest rates over the 1975-1999 period. One important aim of the paper is to demonstrate that by structuring the data with the help of the I(2) model one can achieve a better understanding of the empirical regularities underlying the persistent swings in nominal exchange rates, typical in periods of floating exchange rates
    Keywords: PPP puzzle; forward premium puzzle; cointegrated VAR; likelihood inference
    JEL: C32 C52 F41
    Date: 2007–12
  11. By: Balogun, Emmanuel Dele
    Abstract: This study examines the effect of independent exchange rate policy, relative to other determinants, on global export performance of WAMZ countries. The regression results show that exports originating from the Zone to the rest of the world are influenced positively by domestic output, export prices and exchange rate devaluations, but negatively by import price and economic performance of the major global trading partner, proxied by the US GDP. This result is not universal as the Gambia, Ghana and Guinea total exports functions show that exchange rate policy penalized exports contrary to the Nigerian case in which the coefficient estimate is significant and positive. The study infers that these results are consistent with theoretical expectation given the ironical divergence in export basket. Although they are all primary commodity exporters, Nigeria’s exports is mainly crude oil, and a priori expectation is that rapid economic growth or booms in the US should lead to increased demand for energy (healthy competitions). In conclusion, the study infers that since independent flexible exchange rate policy makes no difference to the Zonal export performance ex ante, but have great potential for global exports collectively, they could explore an OCA to enhance both intra- and global inter-regional export trade.
    Keywords: Exchange rate policy; export trade; panel data regression model; WAMZ
    JEL: F42 F1 F31
    Date: 2007–12–17

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