nep-ifn New Economics Papers
on International Finance
Issue of 2009‒06‒17
six papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Tacit On the Unstable Relationship between Exchange Rates and Macroeconomic Fundamentals By Philippe Bacchetta; Eric van Wincoop
  2. Crash Risk in Currency Markets By Emmanuel Farhi; Samuel Paul Fraiberger; Xavier Gabaix; Romain Ranciere; Adrien Verdelhan
  3. Cointegration and asymmetric adjustment: Some new evidence concerning the behaviour of the US current account By Mark J. Holmes; Theodore Panagiotidis
  4. Linear and nonlinear monetary approaches to the exchange rate of the Philippines peso-Japanese yen By Liew, Venus Khim-Sen
  5. Financial Intermediation and the Role of Price Discrimination in a Two-Tier Market By Reitz, Stefan; Schmidt, Markus; Taylor , Mark P.
  6. Evaluarea expunerii firmelor la riscul valutar; consideratii generale (General remarks on the assessment of foreign exchange risk exposure of firms) By Arnaldo MAURI; Claudia Gabriela BAICU

  1. By: Philippe Bacchetta; Eric van Wincoop
    Abstract: It is well known from anecdotal, survey and econometric evidence that the relationship between the exchange rate and macro fundamentals is highly unstable. This could be explained when structural parameters are known and very volatile, neither of which seems plausible. Instead we argue that large and frequent variations in the relationship between the exchange rate and macro fundamentals naturally develop when structural parameters in the economy are unknown and change very slowly. We show that the reduced form relationship between exchange rates and fundamentals is driven not by the structural parameters themselves, but rather by expectations of these parameters. These expectations can be highly unstable as a result of perfectly rational "scapegoat" effects. This happens when parameters can potentially change much more in the long run than the short run. This generates substantial uncertainty about the level of parameters, even though monthly or annual changes are small. This mechanism can also be relevant in other contexts of forward looking variables and could explain the widespread evidence of parameter instability found in macroeconomic and financial data. Finally, we show that parameter instability has remarkably little effect on the volatility of exchange rates, the in-sample explanatory power of macro fundamentals and the ability to forecast out of sample.
    Keywords: exchange rate and time-varying coefficients
    JEL: F31 F37 F41
    Date: 2009–05
  2. By: Emmanuel Farhi; Samuel Paul Fraiberger; Xavier Gabaix; Romain Ranciere; Adrien Verdelhan
    Abstract: How much of carry trade excess returns can be explained by the presence of disaster risk? To answer this question, we propose a simple structural model that includes both Gaussian and disaster risk premia and can be estimated even in samples that do not contain disasters. The model points to a novel estimation procedure based on currency options with potentially different strikes. We implement this procedure on a large set of countries over the 1996--2008 period, forming portfolios of hedged and unhedged carry trade excess returns by sorting currencies based on their forward discounts. We find that disaster risk premia account for about 25% of expected carry trade excess returns in advanced countries.
    JEL: E44 F31
    Date: 2009–06
  3. By: Mark J. Holmes (Department of Economics, Waikato University); Theodore Panagiotidis (Department of Economics, University of Macedonia)
    Abstract: This study conducts an investigation into the extent of cointegration between imports and exports and asymmetries in the adjustment of the US current account over the study period 1960Q4-2007Q2. We find evidence in favour of cointegration through the application of the standard Johansen methodology. Employing the Trace test procedure recursively, two distinct regimes are identified according to whether or not imports and exports are cointegrated. We also consider the Breitung (2002) and Breitung and Taylor (2003) nonparametric cointegration test procedures that do not assume linear short-run dynamics. Further analysis of the asymmetric short-run dynamics reveals that adjustment towards long-run equilibrium is primarily driven by US exports responding to current account deficits.
    Keywords: US Current Account, Sustainability, Cointegration, structural changes, nonparametric cointegration, recursive Trace test statistic, recursive betas, asymmetric error correction..
    JEL: C5 F1 F4
    Date: 2009–05
  4. By: Liew, Venus Khim-Sen
    Abstract: This study provides evidence of nonlinear long-run relationship between peso-yen exchange rate and its monetary determinants implied by the reduced-form flexible-price monetary model for the Philippines, using Breitung’s (2001) nonlinear cointegration testing procedures. The existence of such relationship is probably resulted from the strong and consistent bilateral trade relationship between the Philippines and Japan. Results from various monetary restrictions tests suggest that other forms of the related monetary model are not suitable in the determination of the peso-yen exchange rate.
    Keywords: Exchange Rate; Monetary Model; Nonlinear; Cointegration; the Philippines
    JEL: C32 F31
    Date: 2009
  5. By: Reitz, Stefan; Schmidt, Markus; Taylor , Mark P.
    Abstract: Though unambiguously outperforming all other financial markets in terms of liquidity, foreign exchange trading is still performed in opaque and decentralized markets. In particular, the two-tier market structure consisting of a customer segment and an interdealer segment to which only market makers have access gives rise to the possibility of price discrimination. We provide a theoretical foreign exchange pricing model that accounts for market power considerations and analyze a database of the trades of a German market maker and his cross section of end-user customers. We find that the market maker generally exerts low bargaining power vis-á-vis his customers. The dealer earns lower average spreads on trades with financial customers than commercial customers, even though the former are perceived to convey exchange-rate-relevant information. From this perspective, it appears that market makers provide interdealer market liquidity to end-user customers with cross-sectionally differing spreads.
    Keywords: foreign exchange; market microstructure; pricing behavior
    JEL: F31
    Date: 2009–05–30
  6. By: Arnaldo MAURI; Claudia Gabriela BAICU
    Abstract: The paper deals firstly with the assessment of nonfinancial firm’s risk exposure which has been deeply affected in the last two decades by the trend of market globalization and increased competition. In this new scenario we can note the weakening of the traditional separation between risks voluntary accepted by the firm as a chance to improve its profitability and risks which unavoidably lay on the overall business activity of the firm itself and have to be adequately covered by means of risk management. Secondly, within the frame of financial risks, particular attention is given to exchange rate fluctuations and to issues dealing with measurement and analysis of qualitative as well as quantitative aspects of foreign exchange risks affecting nonfinancial firms and chiefly those extensively involved in international activities. The focus then shifts to the assessment of foreign currency risk exposure by the firm as well as to managing foreign eschange risks and to the intruments and techniques involved.
    Keywords: Risk, financial risk, foreign exchange risk,foreign exchange exposure, risk management
    JEL: G30 G28 G32
    Date: 2008–02–01

This nep-ifn issue is ©2009 by Yi-Nung Yang. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.