nep-ifn New Economics Papers
on International Finance
Issue of 2008‒02‒16
ten papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. The dynamic interaction of order flows and the CAD/USD exchange rate By Nikola Gradojevic; Christopher J. Neely
  2. CAN EXCHANGE RATES FORECAST COMMODITY PRICES? By Chen, Yu-chin; Rogoff, Kenneth; Rossi, Barbara
  3. Exchange Rate Policies: Fact or Fiction in the Rise of High Performance Asian Economies By Turan Subasat
  4. Rare Disasters and Exchange Rates By Emmanuel Farhi; Xavier Gabaix
  5. Exchange Rate Economics By John Williamson
  6. A Note on Long Horizon Forecasts of Nonlinear Models of Real Exchange Rates: Comments on Rapach and Wohar (2006) By Daniel Buncic
  7. Short-Run Adjustment in a Global Model of Current Account Imbalances By Rudiger von Arnim
  8. Preventing financial instability and currency crises By Horst Siebert
  9. A Long Term Perspective on the Euro By Michael D. Bordo; Harold James
  10. A Modern Reconsideration of the Theory of Optimal Currency Areas By Giancarlo Corsetti

  1. By: Nikola Gradojevic; Christopher J. Neely
    Abstract: We explore the relationship between disaggregated order flow, the Canada/U.S. dollar (CAD/USD) market and U.S. macroeconomic announcements. Three types of CAD order flow and the CAD/USD are cointegrated. Financial order flow appears to contemporaneously drive the CAD/USD while commercial order flow seems to contemporaneously respond to exchange rate movements. Past order flow and lagged exchange rates strongly explain most types of order flow. Despite this predictability and the contemporaneous correlation of order flow with exchange rate returns, exchange rate returns are not predictable by either statistical or economic criteria (trading rule). This negative finding contrasts with that of Rime et al (2007), who use a different data set. There is strong evidence of structural breaks in the order-flow-exchange rate systems in 1994, 1996-1997 and 1999-2000.
    Keywords: Foreign exchange rates
    Date: 2008
  2. By: Chen, Yu-chin; Rogoff, Kenneth; Rossi, Barbara
    Abstract: This paper studies the dynamic relationship between exchange rate fluctuations and world commodity price movements. Taking into account parameter instability, we demonstrate surprisingly robust evidence that exchange rates predict world commodity price movements, both in-sample and out-of-sample. Because commodity prices are exogenous to the exchange rates we consider, we are able to overcome the identification problems that plague the existing empirical exchange rate literature. Because our finding that exchange rates predict future commodity prices can be given a true causal interpretation, it provides the most concrete support yet for the importance of selected macroeconomic fundamentals in determining exchange rates. As an important by-product of our analysis, we show that exchange rate-based forecasts may be a viable alternative for predicting future commodity price movements.
    Keywords: Exchange rates, forecasting, commodity prices, random walk
    JEL: C52 C53 F31 F47
    Date: 2008
  3. By: Turan Subasat (Department of Economics, Izmir University of Economics)
    Abstract: Many economists believe that the nature of exchange rate management was an important reason for rapid economic growth in East Asia. In this view, Asian countries avoided extreme exchange rate appreciations and kept their nominal exchange rates close to market clearing levels. In contrast, the inappropriate exchange rate policies pursued by many Latin American and African countries in the late 1970s and 1980s contributed a great deal towards their poor economic performance. This paper challenges the above views on the type of exchange rate policies adopted by the East Asian, Latin American and African countries. The empirical evidence fails to prove that the exchange rate policies of the East Asian economies were significantly different from those of other developing countries.
    Keywords: Exchange rate policy, Trade policy, East Asian Miracle, exports growth, economic growth
    JEL: F1 O24
    Date: 2008–02
  4. By: Emmanuel Farhi; Xavier Gabaix
    Abstract: We propose a new model of exchange rates, which yields a theory of the forward premium puzzle. Our explanation combines two ingredients: the possibility of rare economic disasters, and an asset view of the exchange rate. Our model is frictionless, has complete markets, and works for an arbitrary number of countries. In the model, rare worldwide disasters can occur and affect each country's productivity. Each country's exposure to disaster risk varies over time according to a mean-reverting process. Risky countries command high risk premia: they feature a depreciated exchange rate and a high interest rate. As their risk premium mean reverts, their exchange rate appreciates. Therefore, currencies of high interest rate countries appreciate on average. To make the notion of disaster risk more implementable, we show how options prices might in principle uncover latent disaster risk, and help forecast exchange rate movements. We then extend the framework to incorporate two factors: a disaster risk factor, and a business cycle factor. We calibrate the model and obtain quantitatively realistic values for the volatility of the exchange rate, the forward premium puzzle regression coefficients, and near-random walk exchange rate dynamics. Finally, we solve a model of stock markets across countries, which yields a series of predictions about the joint behavior of exchange rates, bonds, options and stocks across countries. The evidence from the options market appears to be supportive of the model.
    JEL: E43 E44 F31 G12 G15
    Date: 2008–02
  5. By: John Williamson (Peterson Institute for International Economics)
    Abstract: The paper summarizes the current theory of how a floating exchange rate is determined, dividing the subject into what determines the steady state and what determines the transition to steady state. The inadequacies of this model are examined, and an alternative “behavioral” model, which recognizes that the foreign exchange market is populated by both fundamentalists and chartists is presented. It is argued that the main importance of understanding the foreign exchange market for development strategy is to permit a correct appraisal of the dangers of Dutch disease. Empirically it seems that from the standpoint of promoting development it is preferable to have a mildly undervalued rate. The paper concludes by examining implications for exchange rate regimes.
    Keywords: Exchange rates; behavioral model; Dutch disease
    JEL: F31 F43 O24
    Date: 2008–02
  6. By: Daniel Buncic (School of Economics, The University of New South Wales)
    Abstract: We show that long horizon forecasts from the nonlinear models that are considered in the study by Rapach and Wohar (2006) cannot generate any forecast gains over a simple AR(1) specification. This is contrary to the findings reported in Rapach and Wohar (2006). Moreover, we illustrate graphically that the nonlinearity in the forecasts from the ESTAR model is the strongest when forecasting one step-ahead and that it diminishes as the forecast horizon increases. There exists, therefore, no potential whatsoever for the considered nonlinear models to outperform linear ones when forecasting far ahead. We also illustrate graphically why one step-ahead forecasts from the nonlinear ESTAR model fail to yield superior predictions to a simple AR(1).
    Keywords: PPP; regime modelling; nonlinear real exchange rate models; ESTAR; forecast evaluation
    JEL: C22 C52 C53 F31 F47
    Date: 2008–02
  7. By: Rudiger von Arnim (New School for Social Research, New York, NY)
    Keywords: short-run adjustment; current account; imbalances
    Date: 2007–05–31
  8. By: Horst Siebert
    Abstract: Financial crises can have a severe impact on the real side of the economy with countries losing up to 20 percent of GDP. The paper studies rules that prevent financial instability and currency crises. These include institutional arrangements for a solid banking system, prudent regulations and appropriate principles of monetary policy. The paper studies the role of the IMF in light of the past experience in preventing currency crises and a systemic breakdown of the world’s financial system and points out necessary IMF reforms. It discusses how the IMF should adjust to the structural changes in the world economy.
    Keywords: Financial instability, rules for monetary stability, hedge funds, exchange rate crises, IMF, IMF quotas
    JEL: E5 F33 G2 P00
    Date: 2008–02
  9. By: Michael D. Bordo; Harold James
    Abstract: This study grounds the establishment of EMU and the euro in the context of the history of international monetary cooperation and of monetary unions, above all in the U.S., Germany and Italy. The purpose of national monetary unions was to reduce transactions costs of multiple currencies and thereby facilitate commerce; to reduce exchange rate volatility; and to prevent wasteful competition for seigniorage. By contrast, supranational unions, such as the Latin Monetary Union or the Scandinavian Currency Union were conducted in the broader setting of an international monetary order, the gold standard. There are closer parallels between EMU and national monetary unions. Historical monetary unions also were associated with fiscal unions (fiscal federalism). Both fiscal and monetary unions were an important part of the process of political unification. In the past, central banks, and the currencies they managed, have been discredited or put under severe strain as a result of: severe or endemic fiscal problems creating pressures for the monetization of public debt; low economic growth may produce demands for central banks to pursue more expansionary policies; regional strains producing a demand for different monetary policies to adjust to particular regional pressures; severe crises of the financial system; and tensions between the international and the domestic role of a leading currency. In particular, there is the possibility for the EMU that low rates of growth will produce direct challenges to the management of the currency, and a demand for a more politically controlled and for a more expansive monetary policy. Such demands might arise in some parts or regions or countries of the euro area, but not in others and would lead to a politically highly difficult discussion of monetary governance.
    JEL: F02 F33 N20
    Date: 2008–02
  10. By: Giancarlo Corsetti
    Abstract: What can be learnt from revisiting the Optimal Currency Areas (OCA) theory 50 years from its birth, in light of recent advances in open economy macro and monetary theory? This paper presents a stylized micro-founded model of the costs of adopting a common currency, relative to an ideal benchmark in which domestic monetary authorities pursue country-specific efficient stabilization. Costs from (a) limiting monetary autonomy and (b) giving up exchange rate flexibility are examined in turn. These costs will generally be of the same magnitude as the costs of the business cycle. However, to the extent that exchange rates do not perform the stabilizing role envisioned by traditional OCA theory, a common monetary policy can be as efficient as nationally differentiated policies, even when shocks are strongly asymmetric, provided that the composition of aggregate spending tends to be symmetric at unionwide level. Convergence in consumption (and spending) patterns thus emerges as a possible novel attribute of countries participating in an efficient currency area.
    Keywords: Optimum Currency Area, optimal monetary policy, costs of business cycle, exchange rate regime, international policy cooperation, New Open Economy Macroeconomics
    JEL: E31
    Date: 2008

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