nep-ifn New Economics Papers
on International Finance
Issue of 2008‒11‒25
seven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Can Exchange Rates Forecast Commodity Prices? By Yu-chin Chen; Kenneth Rogoff; Barbara Rossi
  2. Demand for International Reserves: A Quantile Regression Approach By Sula, Ozan
  3. Does Real Exchange Rate Volatility Affect Sectoral Trade Flows?. By Mustafa Caglayan; Jing Di
  4. The Role of Foreign Exchange Dealers in Providing Overnight Liquidity By Chris D'Souza
  5. Impact of exchange rate shock on prices of imports and exports By Duasa, Jarita
  6. Assessing Spill-Over Effects of U.S. Monetary Policy and Macroeconomic Announcements on Financial Markets in Argentina By Bernd Hayo; Matthias Neuenkirch
  7. Imbalances in China and U.S. Capital Flows By Tatom, John

  1. By: Yu-chin Chen (University of Washington); Kenneth Rogoff (Harvard University); Barbara Rossi (Duke University)
    Abstract: This paper demonstrates that “commodity currency” exchange rates have remarkably robust power in predicting future global commodity prices, both in-sample and out-of-sample. A critical element of our in-sample approach is to allow for structural breaks, endemic to empirical exchange rate models, by implementing the approach of Rossi (2005b). Aside from its practical implications, our forecasting results provide perhaps the most convincing evidence to date that the exchange rate depends on the present value of identifiable exogenous fundamentals. We also find that the reverse relationship holds; that is, that commodity prices Granger-cause exchange rates. However, consistent with the vast post-Meese-Rogoff (1983a,b) literature on forecasting exchange rates, we find that the reverse forecasting regression does not survive out-of-sample testing. We argue, however, that it is quite plausible that exchange rates will be better predictors of exogenous commodity prices than vice-versa, because the exchange rate is fundamentally forward looking. Therefore, following Campbell and Shiller (1987) and Engel and West (2005), the exchange rate is likely to embody important information about future commodity price movements well beyond what econometricians can capture with simple time series models. In contrast, prices for most commodities are extremely sensitive to small shocks to current demand and supply, and are therefore likely to be less forward looking. J.E.L. Codes: C52, C53, F31, F47. Key words: Exchange rates, forecasting, commodity prices, random walk. Acknowledgements. We would like to thank C. Burnside, C. Engel, M. McCracken, R. Startz, V. Stavreklava, A. Tarozzi, M. Yogo and seminar participants at the University of Washington for comments. We are also grateful to various staff members of the Reserve Bank of Australia, the Bank of Canada, the Reserve Bank of New Zealand, and the IMF for helpful discussions and for providing some of the data used in this paper.
    Date: 2008–02
  2. By: Sula, Ozan
    Abstract: I estimate the determinants of the demand for international reserves using quantile regressions. Employing a dataset of 96 developing nations over the period of 1980-1996, I find considerable differences at different points of the conditional distribution of reserves. The ordinary least squares estimates of elasticities that were found to be insignificant in previous studies become statistically significant at various quantiles of the reserve holding distribution. In particular, I find that the coefficients of interest rate differential and volatility of export receipts are significant and have the signs predicted by the traditional reserve models, but only for those nations that hold the highest amount of reserves. In contrast, the flexibility of the exchange rate does not seem to be an important factor for the nations that are located at the tails of the distribution.
    Keywords: International reserves; Quantile regression; Demand for reserves; Reserve policy
    JEL: F30
    Date: 2008
  3. By: Mustafa Caglayan; Jing Di (Department of Economics, The University of Sheffield)
    Abstract: This paper investigates empirically the effect of real exchange rate volatility on sectoral bilateral trade flows between the US and her top thirteen trading countries. Our investigation also considers those effects on trade flows which may arise through changes in income volatility and the interaction between income and exchange rate volatilities. We provide evidence that exchange rate volatility mainly affects sectoral trade flows of developing but not that of developed countries. We also find that the effect of the interaction term on trade flows is opposite that of exchange rate volatility yet there is little impact arising from income volatility.
    Keywords: exchange rates, volatility, trade flows.
    JEL: F17 F31 C22
    Date: 2008–09
  4. By: Chris D'Souza
    Abstract: This paper illustrates that dealers in foreign exchange markets not only provide intraday liquidity, they are key participants in the provision of overnight liquidity. Dealing institutions receive compensation for holding undesired inventory balances in part from the information they receive in customer trades. These flows can be used to forecast future movements in the exchange rate. Findings suggest that Canadian dealers, as a group and individually, are more likely to provide interday liquidity to foreign rather than Canadian financial customers. Financial institutions operating in multiple price-correlated markets manage their risky positions across markets. An interdependent relationship is revealed between the supply of liquidity provided by non-financial firms and dealing institutions across time, and across markets.
    Keywords: Exchange rates; Market structure and pricing; Financial markets
    JEL: F31 G21 D82
    Date: 2008
  5. By: Duasa, Jarita
    Abstract: This study examines the significant impact of exchange rate shock on prices of Malaysian imports and exports. In methodology, the study adopts vector error correction (VECM) model using monthly data of nominal exchange rates, money supply, prices of imports and prices of exports covering the period of M1:1999 to M12:2006. For further analysis, we adopt an innovation accounting by simulating variance decompositions (VDC) and impulse response functions (IRF). VDC and IRF serve as tools for evaluating the dynamic interactions and strength of causal relations among variables in the system. In fact, IRF is used to calculate the exchange rate pass-through on import prices and export prices. The findings indicate that, while the exchange rate shock is significantly affect the fluctuation of import prices, the degree of pass-through is incomplete.
    Keywords: Import prices; Export prices; VECM; Impulse Response; Variance Decomposition.
    JEL: E30 C22 F31
    Date: 2008
  6. By: Bernd Hayo (Faculty of Business Administration and Economics, Philipps Universitaet Marburg); Matthias Neuenkirch (Faculty of Business Administration and Economics, Philipps Universitaet Marburg)
    Abstract: We study the effects of U.S. monetary policy and macroeconomic announcements on Argentine money, stock and foreign exchange markets’ returns and volatility over the period 1998 to 2006 using a GARCH model. Firstly, we show that both types of news have a significant impact on all markets. Secondly, we conclude that the Argentine markets have become less dependent on U.S. news after the abandonment of the currency board. Thirdly, we find that U.S. dollar-denominated assets react less to news which suggests that the currency board was not completely credible. Fourthly, we discover that financial markets react stronger during the financial crisis. Fifthly, in the case of peso-denominated assets, U.S. central bank communication helps to reduce money market volatility during the financial crisis in Argentina.
    Keywords: Argentina, Financial Markets, U.S. Monetary Policy, Federal Reserve Bank, Central Bank Communication, Macroeconomic Announcements
    JEL: E52 F33 G14 G15
    Date: 2008
  7. By: Tatom, John
    Abstract: China’s major imbalances include trade and capital account surpluses and a large annual build-up of international reserves. China has a capital account surplus reinforcing the accumulation of foreign exchange reserves, mainly U.S. dollar-denominated assets. Usually, a sustainable fixed or floating exchange rate system requires that a country with a large current account surplus run a capital account deficit. The U.S. is widely criticized for having a comparable trade deficit that mirrors, to a large extent, China’s surplus and for its dependence on large capital inflows including from China. There is political pressure for protectionism and for China to implement wasteful economic policies to reduce the surplus. Negative consequences of China’s imbalances include the build-up of large, low-return foreign exchange, leading to rapid growth in money and credit and to a sharp acceleration in inflation. Moreover, efforts to offset money growth and inflation have deepened inefficiencies in the financial system, which China had hoped to remedy by its efforts to recapitalize and list its banks’ equities on stock exchanges. China could eliminate these imbalances by policies that would reduce growth. One solution is to lift restrictions on capital outflows, allowing households and business to diversify their wealth holdings and realize higher returns and/or less volatility in their income and wealth. This would transform future asset growth to holdings of higher return, lower risk assets abroad and also would eliminate pressures on the People’s Bank of China, allowing for more rapid deregulation of banks, slower money and credit growth and lower inflation. The U.S. is already adjusting to these imbalances as the current account deficit began to decline in 2005 and the dollar has fallen dramatically. Unfortunately, such adverse developments are coming from political pressures to raise taxes, especially on capital resources income, and from protectionist policies, both of which are slowing growth in the U.S.
    Keywords: Capital account imbalance; capital controls and banking inefficiencies; capital outflows and financial development; exchange rate management; banking regulation
    JEL: F42 E58 G15
    Date: 2008–09

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