nep-ifn New Economics Papers
on International Finance
Issue of 2008‒07‒20
fourteen papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Bond risk premia, macroeconomic fundamentals and the exchange rate By Taboga, Marco; Pericoli, Marcello
  3. Exchange Rate and Interest Rate Volatility in a Target Zone: The Portuguese Case By António Portugal Duarte; João Sousa Andrade; Adelaide Duarte
  4. The Country Risk and the nominal exchange rate between Peru and the United States. An approach through a model of asset markets for determining the exchange rate. (1998:12 - 2007:12) By Salazar, Eduardo
  5. ARE FINANCIAL CRISES ALIKE? By MArdi Dungey; Renee Fry; Brenda Gonzales-Hermosillo; Vance L. Martin; Chrismin Tang
  6. The US dollar and the Euro: The Deus Ex-Machina By Lorca-Susino, Maria
  7. Optimal Exchange Rate Stabilization in a Dollarized Economy with Inflation Targets By Nicoletta Batini; Paul Levine; Joseph Pearlman
  8. Evaluating Foreign Exchange Market Intervention: Self-selection, Counterfactuals and Average Treatment Effects By Rasmus Fatum; Michael M. Hutchison
  9. The Relative Size of New Zealand Exchange Rate and Interest Rate Responses to News By Andrew Coleman; Özer Karagedikli
  10. Does FOMC News Increase Global FX Trading? By Fischer, Andreas M.; Ranaldo, Angelo
  11. Macro Wine in Financial Skins: The Oil-FX Interdependence By Enzo Weber
  12. Density forecast evaluation and the effect of risk-neutral central moments on the currency risk premium: tests based on EUR/HUF option-implied densities By Csaba Csávás
  13. Hoarding of International Reserves: A Comparison of the Asian and Latin American Experiences By Yin-wong Cheung; Hiro Ito
  14. Too Much for Self-Insurance? Asian Foreign Reserves By Yuko Hashimoto

  1. By: Taboga, Marco; Pericoli, Marcello
    Abstract: We introduce a two-country no-arbitrage term-structure model to analyse the joint dynamics of bond yields, macroeconomic variables and the exchange rate. The model allows to understand how exogenous shocks to the exchange rate affect the yield curves, how bond yields co-move in different countries and how the exchange rate is influenced by the interactions between macroeconomic variables and time-varying bond risk premia. Estimating the model with US and German data, we obtain an excellent fit of the yield curves and we are able to account for up to 75 per cent of the variability of the exchange rate. We find that time-varying risk premia play a non-negligible role in exchange rate fluctuations, due to the fact that a currency tends to appreciate when risk premia on long-term bonds denominated in that currency rise. A number of other novel empirical findings emerge.
    Keywords: Bond risk premia;exchange rate;no-arbitrage
    JEL: E43 C01
    Date: 2008–06
  2. By: Genberg, Hans; He, Dong; Leung, Frank
    Abstract: This paper reviews the performance of the Hong Kong dollar Linked Exchange Rate system since the introduction of the three refinements to it in May 2005. It presents an analytical framework which argues that, in a fully credible exchange rate target zone regime, the spot exchange rate normally stays inside the band but does not have a natural tendency to converge towards the centre of the zone. While a certain level of interest rate differential between the Hong Kong dollar and the US dollar may persist, it should not grow significantly larger than what is implied by the width of the Convertibility Zone. Judged against this framework, the developments since May 2005 point to increased credibility of the refined Linked Exchange Rate system.
    Keywords: Hong Kong dollar linked exchange rate system
    JEL: E58 F31
    Date: 2007–06
  3. By: António Portugal Duarte (GEMF and Faculdade de Economia, Universidade de Coimbra); João Sousa Andrade (GEMF and Faculty of Economics of the University of Coimbra); Adelaide Duarte (GEMF and Faculty of Economics of the University of Coimbra)
    Abstract: This work examines the participation of the Portuguese economy in the ERM of the EMS based on some of the main predictions of the target zone literature. The exchange rate distribution reveals that the majority of the observations lie close to the central parity, thus rejecting one of the key predictions of the Krugman (1991) model. Using a M-GARCH model however we confirm that there is a trade-off between exchange rate volatility and interest rates differential volatility. These results express the increased credibility of the Portuguese monetary policy, due manly to the modernisation of the banking and financial system and to the progress made in terms of the disinflation process under an exchange rate target zone policy. In accordance to these results we can say that the participation of the Portuguese escudo in an exchange rate target zone was crucial to create the conditions of stability, credibility and confidence necessary for the adoption of a single currency.
    Keywords: Credibility, Exchange rate stability, M-GARCH, ERM, EMS, Volatility and target zones
    JEL: C32 C51 F31 F41 G15
    Date: 2008
  4. By: Salazar, Eduardo
    Abstract: This paper tries to explain, using a model that includes asset market risk country, the behavior of nominal exchange rate, as well as determine the impact of this risk in determining the exchange rate, also seeks to establish whether the exchange rate is below the level predicted by their bases to determine whether they have to take steps to bring its level of long-term. The econometric methodology used is that of the ordinary least squares, the results are consistent with the logic and economic theory, it shows that among the country risk and exchange rate there is a direct relationship, namely that reductions of country risk generate currency appreciations, also shows evidence that the nominal exchange rate is below its equilibrium level.
    Keywords: Riesgo país; Tipo de Cambio Nomina; Modelos de mercado de activos; Tipo de cambio de equilibrio
    JEL: F42 F41 C22 F31
    Date: 2008–04–14
  5. By: MArdi Dungey; Renee Fry; Brenda Gonzales-Hermosillo; Vance L. Martin; Chrismin Tang
    Abstract: This paper investigates whether fi?nancial crises are alike by considering whether a single modelling framework can fi?t multiple distinct crises in which contagion effects link markets across national borders and asset classes. The crises con- sidered are Russia and LTCM in the second half of 1998, Brazil in early 1999, dot-com in 2000, Argentina in 2001-2005, and the recent U.S. subprime mortgage and credit crisis in 2007. Using daily stock and bond returns on emerging and developed markets from 1998 to 2007, the empirical results show that fi?nancial crises are indeed alike, as all linkages are statistically important across all crises. However, the strength of these linkages does vary across crises. Contagion chan- nels are widespread during the Russian/LTCM crisis, are less important during subsequent crises until the subprime crisis, where again the transmission of con- tagion becomes rampant.
    JEL: C51 G15
    Date: 2008–06
  6. By: Lorca-Susino, Maria
    Abstract: Until the 19th and mid-20th centuries, economic theory explained that the economic status of a country was represented by the strength of its currency.2 This strength is measured by the exchange rate of one currency vis-á-vis another currency, a “zero-sum” game in which one currency gains what the other loses. In fact, during the 19th century, the strength of the Pound Sterling facilitated Britain’s global hegemonic political and economic power known as the Pax Britanica. During the 20th century, the strength of the US dollar represented both the economic and political hegemony of the US around the world known as the Pax Americana. Nowadays, the weakness of the US dollar is making specialists wonder if we are witnessing the end of Pax Americana and the beginning of something else, possibly a Pax Europea, led by the strength of the euro. This is the argument surrounding the current behaviour of the US$-€ exchange rate and its effect on the economic performance of these two economic blocs. While the current exchange rate between the US dollar and the euro has been considered a blessing for the US, it has become a matter of concern for most Eurozone countries. In fact, we are witnessing an unprecedented scenario where the country with a weak currency is actually pleased and the group of countries with a strong currency is worried. The strength of the euro is becoming irritating for the Eurozone and, nevertheless, the weakness of the US dollar is also pushing it to the brink of losing its status as a global currency. This exchange rate debate is accompanied by another debate concerning how the latest monetary policy actions taken by the US and Eurozone monetary authorities3, aimed at solving current economic imbalances, are affecting the US$-€ exchange rate. Scholars, economists, and politicians argue that these monetary policies seem unable to solve today’s economic problems in the EU as well as in the Eurozone, but are having a tremendous impact on the US$-€ exchange rate. This paper will explain in layman’s terms the relationship (or lack thereof) between two of today’s most important economic issues: the US dollar and euro exchange rate, and the monetary policy behind it.
    Keywords: US dolla; euro; Monetary Policy; INTOR
    JEL: E5 A10
    Date: 2008–04
  7. By: Nicoletta Batini (International Monetary Fund); Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University)
    Abstract: We build a small open-economy model with partial dollarization–households hold wealth in domestic currency and a foreign currency as in Felices and Tuesta (2006). The degree of dollarization is endogenous to the extent of exchange rate stabilization by the central bank. We identify the optimal monetary policy response under com-mitment and discretion and assess the optimal degree of exchange rate stabilization inthis set up, drawing policy implications for countries that target inflation in economies of this kind.
    Keywords: dollarized economies, optimal monetary policy, managed exchange rates, inflation-forecast-based rules
    JEL: E52 E37 E58
    Date: 2008–02
  8. By: Rasmus Fatum (University of Alberta); Michael M. Hutchison (University of California, Santa Cruz, Hong Kong Institute for Monetary Research)
    Abstract: Estimating the effect of official foreign exchange market intervention is complicated by the fact that intervention at any point entails a self-selection choice made by the authorities and that no counterfactual is observed. To address these issues, we estimate the counterfactual exchange rate movement in the absence of intervention by introducing the method of propensity score matching to estimate the average treatment effect (ATE) of intervention. To derive the propensity scores we introduce a new intervention reaction function that includes the difference between market expectations and official announcements of macroeconomic developments that can influence the decision to intervene. We estimate the ATE for daily official intervention in Japan over the January 1999 to March 2004 period. This sample encompasses a remarkable variation in intervention frequencies as well as unprecedented frequent intervention towards the latter part of the period. We find that the effects of intervention vary dramatically and inversely with the frequency of intervention: Intervention is effective over the 1999 to 2002 period and ineffective (or possibly counterproductive) during 2003 and 2004. These results hold up to a variety of robustness tests. Only sporadic and relatively infrequent intervention appears to be effective.
    Keywords: Foreign Exchange Intervention, Bank of Japan, Self-Selection, Matching Methods
    JEL: E58 F31 G15
    Date: 2008–02
  9. By: Andrew Coleman (Motu Economic and Public Policy Research); Özer Karagedikli (Bank of England)
    Abstract: This paper examines the relative size of the effects of New Zealand monetary policy and macroeconomic data surprises on the spot exchange rate, 2 and 5 year swap rate differentials, and the synthetic forward exchange rate schedule. We find that the spot exchange rate and 5 year swap rates respond by a similar magnitude to monetary surprises, implying there is little response of the forward exchange rate to this type of news. In contrast, the spot exchange rate responds by nearly three times as much as 5 year interest rates to CPI and GDP surprises, implying that forward rates appreciate to higher than expected CPI or GDP news. This is in contrast to standard theoretical models and US evidence. Lastly, we show that exchange rates but not interest rates respond to current account news. The implications of these results for monetary policy are considered.
    Keywords: New Zealand, interest rates, exchange rates, news
    Date: 2008–06
  10. By: Fischer, Andreas M. (Swiss National Bank); Ranaldo, Angelo (Swiss National Bank)
    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: Trading volume; FOMC; Global linkages
    JEL: F31 G12
    Date: 2008–03–01
  11. By: Enzo Weber
    Abstract: This paper analyses mutual causalities between crude oil price and euro / US dollar exchange rate. Instead of focusing on long-run macroeconomic linkages like the bulk of the relevant literature, the present approach takes a financial markets perspective using daily data. The fast-running simultaneous impacts are identified through heteroscedasticity by specifying multivariate EGARCH processes for the structural variances. While for the decade after 1986 no significance is found, thereafter oil price changes cause inverse reactions of the dollar price and affect its volatility. Reversely, dollar appreciation asymmetrically increases the oil price.
    Keywords: Crude Oil Price, Foreign Exchange, Identification
    JEL: C32 F31 Q43
    Date: 2008–07
  12. By: Csaba Csávás (Magyar Nemzeti Bank)
    Abstract: In this paper we estimate risk-neutral probability density functions from EUR/HUF currency options using the Malz (1997) method. First, we compare different option-based indicators. We present so-called 'shortcut' indicators, i.e. indicators that can be calculated directly, without the estimation of RNDs, but which show strong co-movement with the central moments of estimated densities. We also find that it is possible to construct probability-based indicators, which again exhibit strong correlation with the central moments. We present evidence that risk-neutral densities do not provide accurate forecasts for the distribution of the historical EUR/HUF exchange rate. The higher moments of risk-neutral densities are responsible for the rejection of forecasting ability. Our interpretation is that the standard deviation, the skewness and the kurtosis of the risk-neutral densities are significantly higher than the central moments of subjective densities. Finally, we show that the higher moments of risk-neutral densities are able to explain a significant part of the variability in the estimated risk premium. These latter results suggest that risk-neutral standard deviation and skewness can be used as proxy variables for the respective central moments of subjective densities.
    Keywords: currency option, implied risk-neutral density function, density forecasting, risk premium, GMM.
    JEL: F31 G13 C53
    Date: 2008
  13. By: Yin-wong Cheung (University of California, Santa Cruz, USA, Hong Kong Institute for Monetary Research); Hiro Ito (Portland State University, Portland, USA)
    Abstract: We examine the empirical determinants of the demand for international reserves and compare the experiences of some Asian and Latin American economies. Our empirical results indicate that different vintages of the model of international reserves give different inferences about the appropriate level of international reserves. The developed and developing economies have equations of the demand for international reserves that are quite different from each other. Further, the Asian economies and the Latin American economies have different empirical determinants of the demand for international reserves. Our results highlight the complexity of evaluating whether an economy is holding an excessive or deficient level of international reserves ¨C the inference can be heavily dependent on the choice of a benchmark model. A direct comparison affirms the perception that the Asian economies tend to hold more international reserves than the Latin American economies.
    Keywords: Foreign Exchange Reserves, Macro Determinants, Financial Factors, Institutional Variables, Excessive Hoarding of International Reserves
    JEL: F31 F33 F34 F36
    Date: 2008–07
  14. By: Yuko Hashimoto (Toyo University, International Monetary Fund, Hong Kong Institute for Monetary Research)
    Abstract: This paper attempts to identify whether the recent foreign reserve accumulation in Asian economies has been too extraordinary to recover the moderate level of reserves which depleted at the time of the currency crisis in 1997-1998. First of all, the level of reserves numerated by various economic fundamentals such as broad money, imports and short-term external debt in Asian economies was examined in order to judge whether the level was high enough to weather speculative pressures at the onset of the crisis in 1997. The analysis is based on a Brownian motion model with an absorbing barrier. Although most Asian economies appeared to have larger reserves (reserve indicators) than the estimated threshold at the time of the crisis of 1997, reserves in terms of short-term external debt were apparently not sufficient to avoid speculative attacks. Then, based on the estimated threshold of reserve indicators, the likelihood of a 25% devaluation within three months ahead is calculated. Probabilities of currency devaluation vary from time to time, among countries, and among reserve indicators. The devaluation likelihood was modest in the mid 1990s, but then it showed a big jump in 1997 in Indonesia, Thailand, Korea, and Philippines.
    Keywords: foreign reserves, accumulation, Asia, threshold, currency crisis
    Date: 2008–06

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