nep-ifn New Economics Papers
on International Finance
Issue of 2008‒04‒12
eleven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange Rates and Fundamentals: Footloose or Evolving Relationship? By Sarno, Lucio; Valente, Giorgio
  2. International Dynamic Asset Allocation and the Effect of the Exchange Rate By Kristien Smedts
  3. Choice of Exchange Rate Regime in Central and Eastern European Countries: an Empirical Analysis By Agnieszka Markiewicz
  4. Non-linear adjustment of import prices in the European Union By Campa, Jose M.; Gonzalez, Jose M.; Sebastia, Maria
  5. Does FOMC News Increase Global FX Trading? By Fischer, Andreas M; Ranaldo, Angelo
  6. Dispersion of Beliefs in the Foreign Exchange Market By Jongen, Ron; Verschoor, Willem F C; Wolff, Christian C; Zwinkels, Remco C.J.
  7. Are Capital Controls in the Foreign Exchange Market Effective? By Straetmans, Stefan; Versteeg, Roald; Wolff, Christian C
  8. A Modern Reconsideration of the Theory of Optimal Currency Areas By Corsetti, Giancarlo
  9. Financial Stability, the Trilemma, and International Reserves By Obstfeld, Maurice; Shambaugh, Jay C; Taylor, Alan M
  10. Widening Deviation among East Asian Currencies By OGAWA Eiji; YOSHIMI Taiyo
  11. Pricing of Currency Options in Credible Exchange Rate Target Zones: an Extension and an Alternative Valuation Approach. By Dirk Veestraeten

  1. By: Sarno, Lucio; Valente, Giorgio
    Abstract: Using novel real-time data on a broad set of economic fundamentals for five major US dollar exchange rates over the recent float, we employ a predictive procedure that allows the relationship between exchange rates and fundamentals to evolve over time in a very general fashion. Our key findings are that: (i) the well-documented weak out-of-sample predictive ability of exchange rate models may be caused by poor performance of model-selection criteria, rather than lack of information content in the fundamentals; (ii) the difficulty of selecting the best predictive model is largely due to frequent shifts in the set of fundamentals driving exchange rates, which can be interpreted as reflecting swings in market expectations over time. However, the strength of the link between exchange rates and fundamentals is different across currencies.
    Keywords: economic fundamentals; exchange rates; forecasting
    JEL: F31 G10
    Date: 2008–01
  2. By: Kristien Smedts
    Abstract: This paper analyzes a stylized theoretical framework to examine optimal portfolio selection in an international context with an explicit focus on the effect of the exchange rate. More specifically, we study how the elimination of the exchange rate induces shifts in the optimal international portfolio. We show that the effect of the elimination of the exchange rate on the optimal portfolio is twofold. First, the volatility of the international portfolio changes (volatility effect of the exchange rate), and second, the national market prices of risk converge to common international market prices of risk (price effect of the exchange rate). This induces important shifts in the optimal international portfolio.
    Keywords: International Financial Markets, Portfolio Diversification, Foreign Exchange.
    JEL: G11 G15 F31 F21
    Date: 2008–03
  3. By: Agnieszka Markiewicz
    Abstract: This paper identifies the sources of divergences between current exchange rate policies in Central and Eastern European countries (CEECs). We use an ordered logit model for the official (de jure) and the actual (de facto) exchange rate classifications. We find that the differences of the exchange rate strategies among CEECs cannot be explained by these classifications. Financial and trade openness are the major determinants of divergences among exchange rate strategies in CEECs. More financially and trade integrated countries switch to more rigid regimes.
    Date: 2008–03
  4. By: Campa, Jose M. (IESE Business School); Gonzalez, Jose M. (Banco de España); Sebastia, Maria (Bank of England)
    Abstract: This paper focuses on the non-linear adjustment of import prices in national currency to shocks in exchange rates and foreign prices measured in the exporters' currency of products originating outside the euro area and imported into European Union countries (EU-15). The paper looks at three different types of non-linearities: a) non-proportional adjustment (the size of the adjustment grows more than proportionally with the size of the misalignments); b) asymmetric adjustment to cost-increasing and cost-decreasing shocks, and c) the existence of thresholds in the size of misalignments below which no adjustment takes place. There is evidence of more than proportional adjustment towards long-run equilibrium in manufacturing industries. In these industries, the adjustment is faster the further away current import prices are from their implied long-run equilibrium. In contrast, a proportional linear adjustment cannot be rejected for some other imports (especially within agricultural and commodity imports). There is also strong evidence of asymmetry in the adjustment to long-run equilibrium. Deviations from long-run equilibrium due to exchange rate appreciations of the home currency result in a faster adjustment than those caused by a home currency depreciation. Finally, we also find that adjustment takes place in the industries in our sample only when deviations are above certain thresholds and that these thresholds tend to be somewhat smaller for manufacturing industries than for commodities.
    Keywords: exchange rate adjustment; monetary union;
    JEL: F31 F36 F42
    Date: 2008–02–09
  5. By: Fischer, Andreas M; Ranaldo, Angelo
    Abstract: Does global currency volume increase on days when the Federal Open Market Committee (FOMC) meets? To test the hypothesis of excess currency volume on FOMC days, we use a novel data set from the Continuous Linked Settlement (CLS) Bank. The CLS measure captures roughly half of the global trading volume in foreign exchange (FX) markets. We find strong evidence that trading volume increases in the order of 5% across currency areas on FOMC days during 2003 to 2007. This result holds irrespective of the size of price changes in currency markets and FOMC policy shocks. The new evidence of excess FX trading on FOMC days is inconsistent with standard models of the asset market approach with homogenous agents.
    Keywords: FOMC; Global linkages; Trading volume
    JEL: F31 G12
    Date: 2008–03
  6. By: Jongen, Ron; Verschoor, Willem F C; Wolff, Christian C; Zwinkels, Remco C.J.
    Abstract: This paper analyzes the sources of the differential beliefs of market participants in the foreign exchange market and their relative role in forming exchange rate expectations. We find that there are distinct periods of high and low dispersion and document that dispersion arises because of a combined effect of market participants holding individual information and attach different weights to some elements of the common information set. In addition to these two effect, we also document evidence of the existence of different types of agents and find that chartist rules are predominantly used at the shorter spectrum of the forecast horizon and fundamentalist rules are predominantly used at the longer spectrum of the forecast horizon. Finally, our evidence suggests that the relationship between market volatility and trader dispersion tends to be significant and positive for different measures of both trader heterogeneity and market volatility.
    Keywords: exchange rates; expectations; heterogeneity; survey data
    JEL: F31
    Date: 2008–03
  7. By: Straetmans, Stefan; Versteeg, Roald; Wolff, Christian C
    Abstract: One of the reasons for governments to use capital controls is to obtain some degree of monetary independence. This paper investigates the link between capital controls and interest differentials/ forward premia. This to test whether they can indeed give governments the power to drive exchange rates away from parity conditions. Two capital control variables are constructed in addition to the standard IMF capital control dummy. These variables are used to determine the date of capital account liberalization in a panel of Western European as well as emerging countries. Results show that capital controls do not give governments extra monetary freedom. There is even some evidence that capital controls decrease the level of monetary freedom governments enjoy for a number of countries.
    Keywords: Capital controls; Exchange Rates; Forward premia; Interest differentials; Monetary freedom
    JEL: E42 F21 F31 G15
    Date: 2008–02
  8. By: Corsetti, Giancarlo
    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 union-wide level. Convergence in consumption (and spending) patterns thus emerges as a possible novel attribute of countries participating in an efficient currency area.
    Keywords: Exchange Rate Regime; International Policy Coordination; New Open Macro Macroeconomics; Optimal Monetary Policy; Optimum Currency Area
    JEL: E31
    Date: 2008–02
  9. By: Obstfeld, Maurice; Shambaugh, Jay C; Taylor, Alan M
    Abstract: The rapid growth of international reserves---a development concentrated in the emerging markets---remains a puzzle. In this paper we suggest that a model based on financial stability and financial openness goes far toward explaining reserve holdings in the modern era of globalized capital markets. The size of domestic financial liabilities that could potentially be converted into foreign currency (M2), financial openness, the ability to access foreign currency through debt markets, and exchange rate policy are all significant predictors of reserve stocks. Our empirical financial-stability model seems to outperform both traditional models and recent explanations based on external short-term debt.
    Keywords: banking crises; capital flight; central banks; exchange rate regimes; financial development; foreign exchange; global imbalances; Guidotti-Greenspan rule; international liquidity; intervention; lender of last resort; net foreign assets; sterilization; sudden stop
    JEL: E44 E58 F21 F31 F36 F41 N10 O24
    Date: 2008–02
  10. By: OGAWA Eiji; YOSHIMI Taiyo
    Abstract: This paper investigates recent diverging trends among East Asian currencies as well as recent movements of the weighted average value of East Asian currencies (Asian Monetary Unit: AMU) and deviations (AMU Deviation Indicators) of the East Asian currencies from the average values. Our empirical analysis shows that linkages with the US dollar have been weakening since 2001 or 2002 for some of the East Asian countries. On the other hand, the monetary authority of China continues stabilizing the exchange rate of the Chinese yuan against the US dollar even though it announced its adoption of a currency basket system. It is found that the weighted average of East Asian currencies has been appreciating against the US dollar in recent years while depreciating against the currency basket of the US dollar and the euro. Also, deviations among the East Asian currencies have been widening in recent years, reflecting the fact that these countriesf monetary authorities are adopting a variety of exchange rate systems. In other words, a coordination failure in adopting exchange rate systems among these monetary authorities increases volatility and misalignment of intra-regional exchange rates in East Asia.
    Date: 2008–03
  11. By: Dirk Veestraeten
    Abstract: The paper examines pricing of options on target zone exchange rates. The pricing model of Dumas, Jennergren and Näslund (1993) is extended to asymmetric burden sharing in the defence of the target zone. This extension is relevant for various realistic set-ups, such as unilateral target zones. The paper also introduces an alternative pricing model that, in the tradition of Black and Scholes (1973), starts from geometric Brownian motion in which, however, the target zone limits are explicitly taken account of. This approach has a strong appeal from the practical point of view as it is less demanding in terms of required pricing inputs. This, however, goes at the cost of ignoring target zone nonlinearities. Simulations show that the simpler alternative model in most relevant cases moderately underprices by 1% to 3%.
    Date: 2008–03

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