nep-ifn New Economics Papers
on International Finance
Issue of 2009‒01‒03
eleven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Interpreting deviations from covered interest parity during the financial market turmoil of 2007-08 By Naohiko Baba; Sahminan Frank Packer
  2. Does the law of one price hold in international financial markets? Evidence from tick data By Q. Farooq Akram; Dagfinn Rime; Lucio Sarno
  3. "Currency Manipulation" and World Trade By Robert W. Staiger; Alan O. Sykes
  4. Nonlinear Adjustment of the Real Exchange Rate Towards its Equilibrium Value: a Panel Smooth Transition Error Correction Modelling By Sophie Bereau; Antonia Lopez Villavicencio; Valerie Mignon
  5. 3-Regime symmetric STAR modeling and exchange rate reversion By Mario Cerrato; Hyunsok Kim; Ronald MacDonald
  6. Does the currency regime shape unhedged currency exposure. By Patnaik, Ila; Shah, Ajay
  7. Pre and post crisis analysis of stock price and exchange rate: Evidence from Malaysia By Baharom, A.H.; Habibullah, M.S.; R.C., Royfaizal
  8. Exchange Rate Volatility and Output Volatility: a Theoretical Approach By Maria Grydaki; Stilianos Fountas
  9. New Shocks, Exchange Rates and EquityPrices By Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
  10. Trade-imbalances networks and exchange rate adjustments: The paradox of a new Plaza By Andrea Fracasso; Stefano Schiavo
  11. Fundamentals at Odds? The U.S. Current Account Deficit and The Dollar By Gian Maria Milesi-Ferretti

  1. By: Naohiko Baba; Sahminan Frank Packer
    Abstract: This paper investigates the spillover effects of money market turbulence in 2007-08 on the short-term covered interest parity (CIP) condition between the US dollar and the euro through the foreign exchange (FX) swap market. Sharp and persistent deviations from the CIP condition observed during the turmoil are found to be significantly associated with differences in the counterparty risk between European and US financial institutions. Furthermore, evidence is found that dollar term funding auctions by the ECB, supported by dollar swap lines with the Federal Reserve, have stabilized the FX swap market by lowering the volatility of deviations from CIP.
    Keywords: FX swap, covered interest parity, financial market turmoil, counterparty risk, dollar swap lines, dollar term auction facility
    Date: 2008–12
  2. By: Q. Farooq Akram (Norges Bank (Central Bank of Norway)); Dagfinn Rime (Norges Bank (Central Bank of Norway)); Lucio Sarno (Cass Business School and CEPR)
    Abstract: This paper investigates the validity of the law of one price (LOP) in international financial markets by examining the frequency, size and duration of inter-market price di erentials for borrowing and lending services (`one-way arbitrage'). Using a unique data set for three major capital and foreign exchange markets that covers a period of more than seven months at tick frequency, we nd that the LOP holds on average, but numerous economically signi cant violations of the LOP arise. The duration of these violations is high enough to make it worth- while searching for one-way arbitrage opportunities in order to minimize borrowing costs and/or maximize earnings on given funds. We also document that such opportunities decline with the pace of the market and increase with market volatility.
    Keywords: Law of one price, One-way arbitrage, Foreign exchange microstructure
    JEL: F31 F41 G14 G15
    Date: 2008–11–03
  3. By: Robert W. Staiger; Alan O. Sykes
    Abstract: Central bank intervention in foreign exchange markets may, under some conditions, stimulate exports and retard imports. In the past few years, this issue has moved to center stage because of the foreign exchange policies of China. China has regularly intervened to prevent the RMB from appreciating relative to other currencies, and over the same period has developed large global and bilateral trade surpluses. Numerous public officials and commentators argue that China has engaged in impermissible "currency manipulation," and various proposals for stiff action against China have been advanced. This paper clarifies the theoretical relationship between exchange rate policy and international trade, and addresses the question of what content can be given to the concept of "currency manipulation" as a measure that may impair the commitments made in trade agreements. Our conclusions are at odds with much of what is currently being said by proponents of counter-measures against China. For example, it is often asserted that China's currency policies have real effects that are equivalent to an export subsidy. In fact, however, if prices are flexible the effect of exchange rate intervention parallels that of a uniform import tariff and export subsidy, which will have no real effect on trade, an implication of Lerner's symmetry theorem. With sticky prices, the real effects of exchange rate intervention and the translation of that intervention into trade-policy equivalents depend critically on how traded goods and services are priced. The real effects of China's policies are potentially quite complex, are not readily translated into trade-policy equivalents, and are dependent on the time frame over which they are evaluated (because prices are less "sticky" over a longer time frame).
    JEL: F02 F13 F31 K33
    Date: 2008–12
  4. By: Sophie Bereau; Antonia Lopez Villavicencio; Valerie Mignon
    Abstract: We study the nonlinear dynamics of the real exchange rate towards its behavioral equilibrium value (BEER) using a Panel Smooth Transition Regression model framework.We show that the real exchange rate convergence process in the long run is characterized by nonlinearities for emerging economies, whereas industrialized countries exhibit a linear pattern. Moreover, there exists an asymmetric behavior of the real exchange rate when facing an over- or an undervaluation of the domestic currency. Finally, our results suggest that the real exchange rate is unable to unwind alone global imbalances.
    Keywords: Equilibrium exchange rate; BEER model; panel smooth transition regression; panel vector error correction model
    JEL: F31 C23
    Date: 2008
  5. By: Mario Cerrato; Hyunsok Kim; Ronald MacDonald
    Abstract: The breakdown of the Bretton Woods system and the adoption of generalised floating exchange rates ushered in a new era of exchange rate volatility and uncer­tainty. This increased volatility lead economists to search or economic models able to describe observed exchange rate behavior. In the present paper we propose more general STAR transition functions which encompass both threshold nonlinearity and asymmetric effects. Our framework allows for a gradual adjustment from one regime to another, and considers threshold effects by encompassing other existing models, such as TAR models. We apply our methodology to two different exchange rate data-sets, one for developing countries, and official nominal exchange rates, and the second for emerging market economies using black market exchange rates.
    Keywords: unit root tests, threshold autoregressive models, purchasing power parity.
    JEL: C22 F31
    Date: 2008–12
  6. By: Patnaik, Ila (National Institute of Public Finance and Policy); Shah, Ajay (National Institute of Public Finance and Policy)
    Abstract: This paper examines how unhedged currency exposure of firms varies with changes in currency flexibility. A sequence of four time- periods with alternating high and low currency volatility in India provides a natural experiment in which changes in currency exposure of a panel of firms is measured, and the moral hazard versus incomplete markets hypotheses tested. We find that firms carried higher currency exposure in periods when the currency was less flexible. We also find homogeneity of views, where firms set themselves up to benefit from a rupee appreciation, in the later two periods. Our results support the moral hazard hypothesis that low currency flexibility encourages firms to hold unhedged exposure in response to implicit government guarantees.
    Keywords: Currency regime ; Currency exposure of firms ; Moral hazard ; One-way bets on exchange rates
    JEL: F31 G32
    Date: 2008–04
  7. By: Baharom, A.H.; Habibullah, M.S.; R.C., Royfaizal
    Abstract: The furore and chaos created by the Asian financial crisis have ignited many studies on numerous subjects, and it is believed that the crisis has changed the way nations being administered and policies formed and implemented especially those regarding monetary and fiscal policies. Johansen (1991) cointegration method was used and the period was divided into two sub periods, albeit pre crisis and post crisis. The results obtained are similar with a number of past literatures pointing to no long run relationship between stock price and exchange rate for both periods.
    Keywords: Stock price; exchange rate; Asian financial crisis; Cointegration.
    JEL: G14 F31
    Date: 2008–06–01
  8. By: Maria Grydaki (Department of Economics, University of Macedonia); Stilianos Fountas (Department of Economics, University of Macedonia)
    Abstract: This paper makes an attempt to determine the factors influencing exchange rate and exchange rate uncertainty, as well as, output and output variability. In the context of a small open economy under flexible exchange rates regime it is found that the level both of exchange rate and output is affected by monetary and inflationary shocks, as well as shocks in government spending, output and trade balance. Further, the uncertainty of exchange rate and output is associated positively with the uncertainty of all shocks while the contemporaneous occurrence of selected shocks imposes either a positive or negative impact on exchange rate and output volatility. Finally, it is shown that the effect of the determinants either of exchange rate volatility or output volatility is very sensitive to the parameter values.
    Keywords: Vexchange rate volatility, output volatility, open-economy models.
    JEL: E32 F31 F41
    Date: 2008–12
  9. By: Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
    Abstract: We study exchange rate and equity price dynamics, in general equilibrium, in the presence of news shocks about future productivity and monetary policy. We identify a condition under which these asset prices become more volatile without affecting the volatility of the underlying processes-a positive correlation between news and current shocks. This condition also explains why persistent underlying processes generate volatile asset prices. In addition, we show that the correlation between exchange rate and equity returns depends critically on the currency denomination of the equity return and the monetary policy reaction to productivity shocks. The model we set up does well at matching second moments of exchange rate and equity returns for major floating currencies.
    Keywords: External shocks , Exchange rates , Stock prices , Productivity , Monetary policy , Asset prices , Floating exchange rates , Economic models ,
    Date: 2008–12–10
  10. By: Andrea Fracasso; Stefano Schiavo
    Abstract: Global imbalances are not new as much as the effort to address them. In the mid 1980s the phenomenon led the most industrialised countries to orchestrate a devaluation of the US dollar so as to reduce the US trade deficit. Some economists have called for a similar "New Plaza" agreement to tackle the present situation. The feasibility of such a plan has not been thoroughly assessed so far. In this paper we apply complex network analysis to characterise the properties of the web of international bilateral trade imbalances. We study its evolution over time and the position of key players within it. We find that the complexity of the network has increased in several dimensions, and this casts doubts on the usefulness of a coordinated solution among industrialised countries only. In addition, we propose new effective exchange rate measures based on bilateral trade imbalances, and study their dynamics in the 1980s and in the 2000s. By distinguishing exchange rate movements against debtor and creditor countries we show that, so far, they have not been consistent with the simultaneous reduction in all trade bilateral imbalances. A paradox therefore emerges: the growing difficulty to orchestrate a plan involving a large number of partners is matched by the inability of so far uncoordinated exchange rate adjustments to close global imbalances.
    Keywords: Plaza agreement, exchange rates, global imbalances, network analysis
    JEL: F31 F33 F42
    Date: 2008
  11. By: Gian Maria Milesi-Ferretti
    Abstract: The real effective exchange rate of the dollar is close to its minimum level for the past 4decades (as of September 2008). At the same time, however, the U.S. trade and currentaccount deficits remain large and, absent a significant correction in coming years, wouldcontribute to a further accumulation of U.S. external liabilities. The paper discusses thetension between these two aspects of the dollar assessment, and what factors can helpreconcile them. It focuses in particular on the terms of trade, adjustment lags, andmeasurement issues related to both the real effective exchange rate and the current accountbalance.
    Keywords: Current account deficits , United States , Real effective exchange rates , Terms of trade , Current account balances , Adjustment process ,
    Date: 2008–11–20

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