nep-ifn New Economics Papers
on International Finance
Issue of 2008‒02‒09
seven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Consumption growth, uncovered equity parity and the cross-section of returns on foreign currencies By Thomas Nitschka
  2. What Determines the Forward Exchange Rate of the Euro? By Costas Karfakis
  4. On the determinants of currency crises: The role of model uncertainty By Jesus Crespo Cuaresma; Tomas Slacik
  5. Understanding Asian equity flows, market returns and exchange rates By Chayawadee Chai-Anant; Corinna Ho
  6. The Consumption - Real Exchange Rate Anomaly: an Asset Pricing Perspective By Mathias Hoffmann; Thomas Nitschka
  7. The Impact of Return Nonnormality on Exchange Options By Li, Minqiang

  1. By: Thomas Nitschka
    Abstract: Lagged foreign stock returns in excess of the U.S. stock market return are informative about quarterly exchange rate movements. A past high foreign stock return relative to the U.S. signals a foreign currency depreciation and hence low returns on the foreign currency. Conditional on stock return differentials, the consumption-based CAPM (CCAPM) explains the cross-sectional dispersion in U.S. dollar exchange rates. The CCAPM captures more than 40 percent of the variation in foreign currency returns scaled with the respective stock return differential on a country-by-country basis.
    Keywords: Consumption-based CAPM, foreign currency return, uncovered equity parity
    JEL: F31 G12
    Date: 2007–11
  2. By: Costas Karfakis (Department of Economics, University of Macedonia)
    Abstract: This study examines the determinants of the forward exchange rate of the euro in the context of the “modern approach” for five currency combinations. The co-integration analysis suggests that speculation has played a minor role and arbitrage played a major role in determining the forward exchange rate of the euro.
    Keywords: Euro, Forward Exchange Rate, Arbitrage, Speculation, Co-integration
    JEL: F31 F37
    Date: 2008–02
  3. By: Nwaobi, Godwin
    Abstract: Indeed, the specification of equilibrium in the world economy depends on the exchange rate regime and thus, the early contributions to the postwar literature on exchange rate economics are to a large extent concerened with the role of speculation in foreign exchange markets. However, the world has known several exchange rate systems beginning with the fixed-gold standard, the adjustable-peg system, adjustable-parity system and the flexible exchange rate system. Yet, in 1997, when foreign exchange was deregulated, independent traders finally had access to the biggest trading market of the world; and these forex traders attempt to make money from the simultaneous buying and selling of foreign currencies. And within the forex market, many types of instruments can be used:futures market,spot market, and forward market.However, the degree of volatility tends to increase with the frequency with which observations are sampled and this can be seen clearly as one moves from monthly to daily observations on exchange rates. Thus the basic thrust of the paper is to analyse the forecasting accuracy of the full vector autoregressive(FVAR), mixed vector autoregressive(MVAR) and Bayesian vector autoregressive(BVAR) models of the selected currency pairs(based on the monetary/asset model of exchange rate determination).
    Keywords: exchange rate; foreign exchange; forex; forecasting; vector autoregression; regimes; volatility; world;future markets; spotmarket;futures; options; assets; portfolio balance; brettonwood; IMF; Fixed rate; Floating rate; adjustable peg; purchasing power parity(PPP); Uncovered interest rate parity(UIP); internal balance; external balance; devaluation; overvaluation; pips; currency pairs; trading platform; forex allocation; parallel(black) market; banks; brokers; misalignment
    JEL: F00 F37 G1 C53 E42 G15 E44 F31
    Date: 2008–02–01
  4. By: Jesus Crespo Cuaresma; Tomas Slacik
    Abstract: We tackle explicitly the issue of model uncertainty in the framework of binary variable models of currency crises. Using Bayesian model averaging techniques, we assess the robustness of the explanatory variables proposed in the recent literature for both static and dynamic models. Our results indicate that the variables belonging to the set of macroeconomic fundamentals proposed by the literature are very fragile determinants of the occurrence of currency crises. The results improve if the crisis index identifies a crisis period (defined as the period up to a year before a crisis) instead of a crisis occurrence. In this setting, the extent of real exchange rate misalignment and financial market indicators appear as robust determinants of crisis periods.
    Keywords: Forecasting, model averaging, Bayesian econometrics, exchange rates.
    JEL: F31 F34 E43
  5. By: Chayawadee Chai-Anant; Corinna Ho
    Abstract: This paper examines from various angles foreign investors' daily transactions in six emerging Asian equity markets and their relationship with local market returns and exchange rate changes over the period 1999-2006. Confirming much of the literature, we find that equity market returns matter for net equity purchases, and vice versa. In addition, we find that while currency returns tend to show little influence over foreign investors' demand for Asian equities, net equity purchases do have some explanatory power over near-term exchange rate changes. Moreover, we find that foreign investors do quite often move in or out of multiple Asian markets simultaneously - but more so on the way in than on the way out. Nonetheless, during specific events of heightened market volatility, we observe some interesting deviations from the full-sample average relationships.
    Keywords: Asian equity markets, foreign investor, market returns, currency returns, exchange rate
    Date: 2008–02
  6. By: Mathias Hoffmann; Thomas Nitschka
    Abstract: Idiosyncratic consumption risk explains more than 60 percent of the cross-sectional variation in quarterly exchange rate changes and currency returns. Our results are obtained from data of 13 industrialized countries and are based on an international version of the consumption capital asset pricing model (CCAPM) in which we account for international consumption heterogeneity. We use this framework to dissect the consumption-exchange rate anomaly, the empirical fact that international variation in purchasing power alone does not appear to account for differences in consumption growth rates across countries. As an explanation for this phenomenon, we explore the presence of currency risk premia that also lead to departures from uncovered interest parity (UIP). We decompose the cross-sectional variation in consumption into one component that is due to cross-country differences in inflation rates and a second component that is due to international variation in nominal interest rates. We interpret these factors as indicators of goods and financial market segmentation respectively. We find that both help account to virtually equal parts for the cross-section of exchange rate changes. Interestingly, the price of aggregate consumption risk has declined over the 1990s, in line with a growing literature that documents a growing internationalisation of country portfolios over this period.
    Keywords: Uncovered interest rate parity, consumption CAPM, international financial integration, consumption risk sharing
    JEL: E21 F30 G12
    Date: 2007–09
  7. By: Li, Minqiang
    Abstract: The Margrabe formula is used extensively by theorists and practitioners not only on exchange options, but also on executive compensation schemes, real options, weather and commodity derivatives, etc. However, the crucial assumption of a bivariate normal distribution is not fully satisfied in almost all applications. The impact of nonnormality on exchange options is studied by using a bivariate Gram-Charlier approximation. For near-the-money exchange options, skewness and coskewness induce price corrections which are linear in moneyness, while kurtosis and cokurtosis induce quadratic price corrections. The nonnormality helps to explain the implied correlation smile observed in practice.
    JEL: C00 G13
    Date: 2007

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