nep-ifn New Economics Papers
on International Finance
Issue of 2008‒04‒21
eight papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. The dynamics of ex-ante risk premia in the foreign exchange market: Evidence from the yen/usd exchange rate Using survey data By Georges Prat; Remzi Uctum
  2. Circular Aspects of Exchange Rates and Market Structure By Yunus Aksoy; Hanno Lustig
  3. Oil Price Shocks and Exchange Rate Management: The Implications of Consumer Durables for the Small Open Economy By Michael Plante
  4. Asymmetric News Effects on Volatility: Good vs. Bad News in Good vs. Bad Times By Laakkonen, Helinä; Lanne, Markku
  5. Balance Sheet Effects in Currency Crises: Evidence from Brazil By Marcio M. Janot; Marcio G. P. Garcia; Walter Novaes
  6. Optimal Monetary Policy and the Sources of Local-Currency Price Stability By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
  7. "Fourier Transform Method with an Asymptotic Expansion Approach: an Application to Currency Options" By Akihiko Takahashi; Kohta Takehara
  8. New Open Economy Macroeconomics By Giancarlo Corsetti

  1. By: Georges Prat; Remzi Uctum
    Abstract: Using financial experts’ Yen/USD exchange rate expectations provided by Consensus Forecasts surveys (London), this paper aims to model the 3 and 12-month ahead ex-ante risk premia measured as the difference between the expected and forward exchange rates. According to a two-country portfolio asset pricing model, the risk premium is modeled as the product of three factors: a constant risk aversion coefficient, the expected variance of the rate of change in the real exchange rate, and the spread between domestic agent’s market position in foreign assets and foreign agent’s market position in domestic assets (net market position). When the returns are partially predictable, the expected variance is horizondependent and this is a sufficient condition for agents not to require at any time a unique risk premium for all maturities but a set of premia scaled by the time horizon of the investment. For each horizon the expected variance is assumed to depend on the historical values of the variance and on the unobservable maturity-dependent net market positions which have been estimated through a state space model using the Kalman filter methodology. We find that the model explains satisfactorily both the common and the non-random specific time-patterns of the 3- and 12-month ex-ante premia.
    Keywords: risk premium, foreign exchange market, international asset pricing model
    JEL: D84 E44 G14
    Date: 2008
  2. By: Yunus Aksoy; Hanno Lustig
    Abstract: This modified version of Salop's (1979) spatial competition model yields clear-cut predictions about the effects of exchange rate shocks on market structure and pass-through. Shocks within the band of inaction do not affect market structure. The upper bound of this range rises as the industry ratio of sunk to fixed costs increases. As fixed costs and product heterogeneity jointly increase, the lower bound drops. Outside of the range, depreciations cause one or several of those foreign brands closest to the home brand to leave. This decreases the overall responsiveness of prices to exchange rate shocks. Large appreciations induce entry and increase the elasticity of prices. This asymmetry implies larger positive than negative PPP deviations. When accounting for price changes in foreign markets, strategic pricing behavior is no longer sufficient to generate real exchange rate variability. Incomplete pass-through obtains if and only if the domestic firms have a smaller market share abroad. With large nominal exchange rate shocks hysteresis result obtains if and only if sunk costs are non-zero.
    Date: 2008–03
  3. By: Michael Plante (Indiana University Bloomington)
    Abstract: This paper examines exchange rate management issues when a small open economy is hit by an exogenous oil price shock. In this model consumer durables play an important role in the demand for oil and oil based products as opposed to the traditional role of oil as a factor of production. When prices are sticky, oil price shocks lead to reduced output, lower inflation, and real exchange rate deprecation. These recessionary effects occur whether or not oil is in the production function because of the close relationship between consumer durables and oil. Tentative results suggest that flexible exchange rates produce smaller output losses and less volatile inflation in the non-tradables sector than fixed exchange rates but at the cost of front-loading real exchange rate movements.
    Keywords: oil, durables, exchange rates
    JEL: E31 F41 E52
    Date: 2008–04
  4. By: Laakkonen, Helinä; Lanne, Markku
    Abstract: We study the impact of positive and negative macroeconomic US and European news announcements in different phases of the business cycle on the highfrequency volatility of the EUR/USD exchange rate. The results suggest that in general bad news increases volatility more than good news. The news effects also depend on the state of the economy: bad news increases volatility more in good times than in bad times, while there is no difference between the volatility effects of good news in bad and good times.
    Keywords: Volatility; News; Nonlinearity; Smooth Transition Models
    JEL: C32 G15 F31
    Date: 2008
  5. By: Marcio M. Janot (Central Bank of Brasil); Marcio G. P. Garcia (Department of Economics, PUC-Rio); Walter Novaes (Department of Economics, PUC-Rio)
    Abstract: In third generation currency crises models, balance sheet losses from currency depreciations propagate the crises into the real sector of the economy. To test these models, we built a firmlevel database that allowed us to measure currency mismatches around the 2002 Brazilian currency crisis. We found that between 2001 and 2003, firms with large currency mismatches just before the crisis reduced their investment rates 8.1 percentage points more than other publicly held firms. We also showed that the currency depreciation increased exporters revenue, but those with currency mismatches reduced investments 12.5 percentage points more than other exporters. These estimated reductions in investment are economically very significant, underscoring the importance of negative balance sheet effects in currency crises. Jel Codes:F32; F34; G31; G32
    Keywords: Investment; Balance sheets; Currency crises; Hedge; Financial constraints.
    Date: 2008–04
  6. By: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
    Abstract: We analyze the policy trade-offs generated by local currency price stability of imports in economies where upstream producers strategically interact with downstream firms selling the final goods to consumers. We study the effects of staggered price setting at the downstream level on the optimal price (and markup) chosen by upstream producers and show that downstream price movements affect the desired markup of upstream producers, magnifying their price response to shocks. We revisit the international dimensions of optimal monetary policy, unveiling an argument in favour of consumer price stability as the main prescription for monetary policy. Since stable consumer prices feed back into a low volatility of markups among upstream producers, this contains inefficient deviations from the law of one price at the border. However, efficient stabilization of different CPI components will not generally result into perfect stabilization of headline inflation. National policies optimally respond to the same shocks in a similar way, thus containing volatility of the terms of trade, but not necessarily of the real exchange rate. The latter will be more volatile, among other things, the larger the home bias in expenditure and the content of local inputs in consumer goods.
    Keywords: optimal monetary policy, price discrimination, price dispersion, exchange rate pass through, real exchange rates
    JEL: F31 F33 F41
    Date: 2007–11–09
  7. By: Akihiko Takahashi (Faculty of Economics, University of Tokyo); Kohta Takehara (Graduate School of Economics, University of Tokyo)
    Abstract: This paper develops a Fourier transform method with an asymptotic expansion approach for option pricing. The method is applied to European currency options with a libor market model of interest rates and jump-diffusion stochastic volatility models of spot exchange rates. In particular, we derive closed-form approximation formulas of the characteristic functions of log-prices of the underlying assets and the prices of currency options based on a third order asymptotic expansion scheme; we use a jump-diffusion model with a mean-reverting stochastic variance process such as in Heston [1993] / Bates [1996] and log-normal market models for domestic and foreign interest rates. Finally, the validity of our method is confirmed through numerical examples.
    Date: 2008–01
  8. By: Giancarlo Corsetti
    Abstract: The New Open Economy Macroeconomics refers to a vast body of literature embracing a new theoretical framework for policy analysis in open economy, with the goal of overcoming the limitations of the Mundell-Fleming model, while preserving the empirical wisdom and policy friendliness of traditional analysis. Starting in the early 1990s, NOEM contributions have developed general equilibrium models with imperfect competition and nominal rigidities, to reconsider conventional views on the transmission of monetary and exchange rate shocks; they have contributed to the design of optimal stabilization policies, identifying international dimensions of optimal monetary policy; they have raised issues in the desirability of international policy coordination.
    Keywords: Open economy models; exchange rates; stabilization policy; Mundell-Fleming
    Date: 2007–11–09

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