nep-ifn New Economics Papers
on International Finance
Issue of 2008‒07‒14
seven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Getting PPP Right: Identifying Mean-Reverting Real Exchange Rates in Panels By Georgios Chortareas; George Kapetanios
  2. Random Walk or A Run: Market Microstructure Analysis of the Foreign Exchange Rate Movements based on Conditional Probability By Yuko Hashimoto; Takatoshi Ito; Takaaki Ohnishi; Misako Takayasu; Hideki Takayasu; Tsutomu Watanabe
  3. How Much Intraregional Exchange Rate Variability Could a Currency Union Remove? The Case of ASEAN+3 By Duo Qin; Tao Tan
  4. The Rise and Fall of the Dollar, or When Did the Dollar Replace Sterling as the Leading International Currency? By Barry Eichengreen; Marc Flandreau
  5. Pitfalls in Measuring Exchange Rate Misalignment: The Yuan and Other Currencies By Yin-Wong Cheung; Menzie D. Chinn; Eiji Fujii
  6. Skill Upgrading and the Real Exchange Rate By Roberto Alvarez; Ricardo Lopez
  7. Common Risk Factors in Currency Markets By Hanno Lustig; Nikolai Roussanov; Adrien Verdelhan

  1. By: Georgios Chortareas (University of Athens); George Kapetanios (Queen Mary, University of London)
    Abstract: Recent advances in testing for the validity of Purchasing Power Parity (PPP) focus on the time series properties of real exchange rates in panel frameworks. One weakness of such tests, however, is that they fail to inform the researcher as to which cross-section units are stationary. As a consequence, a reservation for PPP analyses based on such tests is that a small number of real exchange rates in a given panel may drive the results. In this paper we examine the PPP hypothesis focusing on the stationarity of the real exchange rates in up to 25 OECD countries. We introduce a methodology that when applied to a set of established panel-unit-root tests, allows the identification of the real exchange rates that are stationary. We apply procedures that account for cross-sectional dependence. Our results reveal evidence of mean-reversion that is significantly stronger as compared to that obtained by the existing literature, strengthening the case for PPP. Moreover, our approach can be used to provide half-lives estimates for the mean-reverting real exchange rates. We find that the half-lives are shorter than the literature consensus and therefore that the PPP puzzle is less pronounced than initially thought.
    Keywords: PPP, Panel unit root tests, Real exchange rates, Half-lives, PPP puzzle
    JEL: C12 C15 C23 F31
    Date: 2008–07
  2. By: Yuko Hashimoto; Takatoshi Ito; Takaaki Ohnishi; Misako Takayasu; Hideki Takayasu; Tsutomu Watanabe
    Abstract: Using tick-by-tick data of the dollar-yen and euro-dollar exchange rates recorded in the actual transaction platform, a "run" -- continuous increases or decreases in deal prices for the past several ticks -- does have some predictable information on the direction of the next price movement. Deal price movements, that are consistent with order flows, tend to continue a run once it started i.e., conditional probability of deal prices tend to move in the same direction as the last several times in a row is higher than 0.5. However, quote prices do not show such tendency of a run. Hence, a random walk hypothesis is refuted in a simple test of a run using the tick by tick data. In addition, a longer continuous increase of the price tends to be followed by larger reversal. The findings suggest that those market participants who have access to real-time, tick-by-tick transaction data may have an advantage in predicting the exchange rate movement. Findings here also lend support to the momentum trading strategy.
    JEL: F31 F33 G15
    Date: 2008–07
  3. By: Duo Qin (Queen Mary, University of London); Tao Tan (Tianjin University of Finance and Economics)
    Abstract: A multilateral currency union removes the intraregional exchange rates but not the union rate variability with the rest of the world. The intraregional exchange rate variability is thus latent. A two-step procedure is developed to measure the variability. The measured variables are used to model inflation and intraregional trade growth of individual union members. The resulting models form the base for counterfactual simulations of the union impact. Application to ASEAN+3 shows that the intraregional variability consists of mainly short-run shocks, which have significantly affected the inflation and trade growth of major ASEAN+3 members, and that a union would reduce inflation and promote intraregional trade on the whole but the benefits facing each member vary and may not be significant enough to warrant a vote for the union.
    Keywords: Currency union, Latent variables, Dynamic factor model, Simulation
    JEL: F02 F40 O19 O53
    Date: 2008–07
  4. By: Barry Eichengreen; Marc Flandreau
    Abstract: We present new evidence on the currency composition of foreign exchange reserves in the 1920s and 1930s. Contrary to the presumption that the pound sterling continued to dominate the U.S. dollar in central bank reserves until after World War II, we show that the dollar first overtook sterling in the mid-1920s. This suggests that the network effects thought to lend inertia to international currency status and to create incumbency advantages for the dominant international currency do not apply in the reserve currency domain. Our new evidence is similarly incompatible with the notion that there is only room in the market for one dominant reserve currency at a point in time. Our findings have important implications for our understanding of interwar monetary history but also for the prospects of the dollar and the euro as reserve currencies.
    JEL: F0 F33 N1 N2
    Date: 2008–07
  5. By: Yin-Wong Cheung; Menzie D. Chinn; Eiji Fujii
    Abstract: We evaluate whether the Renminbi (RMB) is misaligned, relying upon conventional statistical methods of inference. A framework built around the relationship between relative price and relative output levels is used. We find that, once sampling uncertainty and serial correlation are accounted for, there is little statistical evidence that the RMB is undervalued, even though the point estimates usually indicate economically significant misalignment. The result is robust to various choices of country samples and sample periods, as well as to the inclusion of control variables. We then update the results using the latest vintage of the data to demonstrate how fragile the results are. We find that whatever misalignment we detected in our previous work disappears in this data set.
    JEL: F31 F41
    Date: 2008–07
  6. By: Roberto Alvarez (Central Bank of Chile); Ricardo Lopez (Indiana University Bloomington)
    Abstract: This paper examines the effect of changes in the real exchange rate on skill upgrading in the case of Chile. Using plant-level data from the manufacturing sector we find that a real depreciation increases the share of skilled workers in the total wage bill in exporters but not in non-exporters. This result suggests that depreciations or, more generally, increases in export profitability, may induce exporters to adopt more skilled-intensive technologies. This finding gives support to recent models of trade that highlight the possible effect of the real exchange rate on skill upgrading and wage inequality. This paper also finds that real depreciations increase the probability of exporting and the export intensity of plants that export, suggesting that these two channels may explain why changes in the real exchange rate may affect wages.
    JEL: F14 F16 O30 O54
    Date: 2008–07
  7. By: Hanno Lustig; Nikolai Roussanov; Adrien Verdelhan
    Abstract: Currency excess returns are highly predictable, more than stock returns, and about as much as bond returns. In addition, these predicted excess returns are strongly counter-cyclical. The average excess returns on low interest rate currencies are 4.8 percent per annum smaller than those on high interest rate currencies after accounting for transaction costs. We show that a single return-based factor, the return on the highest minus the return on the lowest interest rate currency portfolios, explains the cross-sectional variation in average currency excess returns from low to high interest rate currencies. This evidence suggests currency risk premia are large and time-varying. In a simple affine pricing model, we show that the high-minus-low currency return measures the component of the stochastic discount factor innovations that is common across countries. To match the carry trade returns in the data, low interest rate currencies need to load more on this common innovation when the market price of global risk is high.
    JEL: F31 G12 G15
    Date: 2008–07

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