nep-ifn New Economics Papers
on International Finance
Issue of 2009‒04‒05
nine papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Using Engel Curves to Estimate Purchasing Power Parity. A Case Study of the Computation of the Exchange Rate between the Norwegian krone and the U.S. dollar By Erling Røed Larsen
  2. Accounting for Incomplete Pass-Through By Nakamura, Emi; Zerom, Dawit
  3. A Model of International Cities: Implications for Real Exchange Rates By Mario J. Crucini; Hakan Yilmazkuday
  4. Dissecting the Dynamics of the US Trade Balance in an Estimated Equilibrium Model By P. JACOB; G. PEERSMAN
  5. The Law of One Price Without the Border: The Role of Distance Versus Sticky Prices By Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
  6. Compositional Analysis of Foreign Currency Reserves in the 1999-2007 Period : The Euro vs. The Dollar as Leading Reserve Currency By Aristovnik, Aleksander; Čeč, Tanja
  7. Model Misspecification, Learning and the Exchange Rate Disconnect Puzzle By V. LEWIS; A. MARKIEWICZ
  8. Une mesure financière de l’importance de la prime de risque de change dans la prime de risque boursière By Salem Boubakri
  9. Currency crashes in industrial countries: much ado about nothing? By Joseph E. Gagnon

  1. By: Erling Røed Larsen (Statistics Norway)
    Abstract: Standard practice of estimating purchasing power parities (PPP) involves using prices, in domestic currencies, of a common basket of goods and services, then calculating the price-equalizing exchange rate. In this article, I substitute observed consumer behavior for price data. On the assumption that an Engel curve for food reflects material standard of living, I estimate Engel curves for food for the United States and Norway. This allows us to calculate the exchange rate required for re-aligning the two curves, i.e. the incomes needed in the two countries to purchase the same standard of living. Since different relative prices or preferences for food can affect the position and slope of the curves, I also estimate the Engel curves of non-food, for which the effect is opposite. Not only does this provide a band of upper and lower bounds of PPP, it also improves upon the assumption of preference homogeneity underlying conventional PPP-computations. Using Consumer Expenditure (CES) data for 2001, I obtain estimated PPP-levels for the rate of the Norwegian krone (NOK) versus the U.S. dollar (USD) in the 5.38-7.90 range. The average rate 1977-2007 was 6.81 NOK per USD. The conventional estimates of PPP from the World Bank and OECD are 8.84 and 9.18 NOK per USD, respectively.
    Keywords: Engel curve; exchange rate; material standard of living; purchasing power parity
    JEL: C20 D10 E30 F31
    Date: 2009–03
  2. By: Nakamura, Emi; Zerom, Dawit
    Abstract: Recent theoretical work has suggested a number of potentially important factors in causing incomplete pass-through of exchange rates to prices, including markup adjustment, local costs and barriers to price adjustment. We empirically analyze the determinants of incomplete passthrough in the coee industry. The observed pass-through in this industry replicates key features of pass-through documented in aggregate data: prices respond sluggishly and incompletely to changes in costs. We use microdata on sales and prices to uncover the role of markup adjustment, local costs, and barriers to price adjustment in determining incomplete pass-through using a structural oligopoly model that nests all three potential factors. The implied pricing model explains the main dynamic features of short and long-run pass-through. Local costs reduce long-run pass-through by a factor of 59% relative to a CES benchmark. Markup adjustment reduces pass-through by an additional factor of 33%, where the extent of markup adjustment depends on the estimated \super-elasticity" of demand. The estimated menu costs are small (0:23% of revenue) and have a negligible eect on long-run pass-through, but are quantitatively successful in explaining the delayed response of prices to costs. We nd that delayed passthrough in the coee industry occurs almost entirely at the wholesale rather than the retail level.
    Keywords: exchange rate pass-through; menu costs; discrete choice model
    JEL: L16 L11 F10
    Date: 2008–11
  3. By: Mario J. Crucini; Hakan Yilmazkuday
    Abstract: We develop a model of cities each inhabited by two agents, one specializing in manufacturing, the other in distribution. The distribution sector represents the physical transformation of all internationally traded goods from the factory gate to the final consumer. Using a panel of micro-prices at the city level, we decompose the long-run variance of LOP deviations into the fraction due to distribution costs, trade costs and a residual. For the median good, trade costs account for 50 percent of the variance, distribution costs account for 10 percent with 40 percent of the variance unexplained. Since the sample of items in the data are heavily skewed toward traded goods, we also decompose the variance based on the median good on an expenditure-weighted basis. Now the tables turn, with distribution costs accounting for 43 percent, trade costs 36 percent and 21 percent of the variance unexplained.
    JEL: F0 F15
    Date: 2009–04
    Abstract: This paper presents empirical evidence on the stochastic driving forces of the US trade balance. In an estimated two-country DSGE model, we .find that investment- specific technology shocks have the strongest impact on the volatility of cyclical trade balance .fluctuations, especially when the shocks are domestic and considered over longer forecast-horizons. At shorter horizons, US and foreign inter-temporal shocks that generate co-movement between consumption and investment, have an impact com- parable to that of the investment-specific technology shocks. In contrast, shocks to US public spending and neutral technology - both forces traditionally used to explain trade balance fluctuations - hardly explain the volatility
    Keywords: US Trade Balance, New Open Economy Macroeconomics, Bayesian Inference, DSGE Estimation
    JEL: C11 F41
    Date: 2008–11
  5. By: Mario J. Crucini; Mototsugu Shintani; Takayuki Tsuruga
    Abstract: We examine the role of nominal price rigidities in explaining the deviations from the Law of One Price (LOP) across cities in Japan. Focusing on intra-national relative prices isolates the border effect and thus enables us to extract the pure effect of sticky prices. A two-city model with nominal rigidities and transportation costs predicts that the variation of LOP deviations is lower for goods with less frequent price adjustment after controlling for the distance separating the cities. Using retail price data for individual goods and services collected in Japanese cities, we find strong evidence supporting this prediction. Adapting the Engel and Rogers (1996) regression framework to our theoretical setting, we quantify the separate roles of nominal rigidities and trade costs (proxied by distance) in generating LOP variability. Our estimates suggest that the distance equivalent of nominal rigidities can be as large as the `width' of the border typically found in the literature on international LOP deviations. The findings point to both the utility of the regression framework in identifying qualitative effects (i.e., sign of a coefficient) and the challenges interpreting their quantitative implications.
    JEL: D4 F40 F41
    Date: 2009–04
  6. By: Aristovnik, Aleksander; Čeč, Tanja
    Abstract: Using a critical analysis of the acquired data, this article mainly aims to present the currency composition of the foreign currency reserves of central banks in selected countries in the 1999-2007 period and, on this basis, to establish whether the euro stands any real chances of dethroning the US dollar as the global currency. Among other things, the empirical results, for the most part overlapping with the theoretical and empirical expectations, confirm the hypothesis that in the near future the euro may be regarded as a global reserve currency on a par with the US dollar or it may even become the leading reserve currency. Finally, the empirical analysis also shows that the proportion of the euro in foreign currency reserves differs by the groups of countries concerned; however, in the period under scrutiny it was mainly increasing.
    Keywords: international monetary system; international currency; foreign currency reserves; dollar; euro
    JEL: F02 F31 G20
    Date: 2009–03–26
    Abstract: Rational expectations models fail to explain the disconnect between the ex-change rate and macroeconomic fundamentals. In line with survey evidence on the behaviour of foreign exchange traders, we introduce model misspecification and learning into a standard monetary model. Agents use simple forecasting rules based on a restricted information set. They learn about the parameters and performance of different models and can switch between forecasting rules. We compute the implied US-UK post-Bretton Woods exchange rate under learning. While the excess volatility of the exchange rate return can be reproduced with low values of the learning gain, the implied correlations with the fundamentals are higher than in the data
    Keywords: exchange rate, disconnect, misspecification, learning
    JEL: F31 E37 E44
    Date: 2009–03
  8. By: Salem Boubakri
    Abstract: This study tests an international extension of the Asset Pricing Model (CAPM) based on the coexistence of two risk causes. The first cause is linked to the market portfolio and the second one is required by expectations about the variation of exchange rates. Through an application to various developed and emerging countries, we show that the exchange risk premium in the ICAPM is statistically and economically significant and contribues to the formation of the total risk premium by using the conditional approach of exchange rate variations.
    Keywords: Exchange risk premium, Purchasing Power Parity, conditional International Capital Asset Pricing Model (ICAPM)
    JEL: C32 F31 G11
    Date: 2009
  9. By: Joseph E. Gagnon
    Abstract: Sharp exchange rate depreciations, or currency crashes, are associated with poor economic outcomes in industrial countries only when they are caused by inflationary macroeconomic policies. Moreover, the poor outcomes are attributable to inflationary policies in general and not the currency crashes in particular. On the other hand, crashes caused by rising unemployment or external deficits have always had good economic consequences with stable or falling inflation rates.
    Keywords: Foreign exchange rates; Exchange rate, depreciation, inflation, unemployment, current account CL HG136 A54
    Date: 2009

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