nep-ifn New Economics Papers
on International Finance
Issue of 2009‒09‒26
twelve papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. The Forward Market in Emerging Currencies: Less Biased Than in Major Currencies By Frankel, Jeffrey; Poonawala, Jumana
  2. Dynamical Clustering of Exchange Rates By Daniel J. Fenn; Mason A. Porter; Peter J. Mucha; Mark McDonald; Stacy Williams; Neil F. Johnson; Nick S. Jones
  3. Exchange-Rate Pass Through, Openness, Inflation, and the Sacrifice Ratio By Joseph P. Daniels; David D. VanHoose
  4. The Mechanics of Central Bank Intervention in Foreign Exchange Markets By Basu, Kaushik
  5. Sources of exchange rate fluctuations: are they real or nominal? By Luciana Juvenal
  6. A Century of Purchasing Power Parity Confirmed: The Role of Nonlinearity By Kim, Hyeongwoo; Moh, Young-Kyu
  7. Optimal intervention in the foreign exchange market when interventions affect market dynamics By Alec N. Kercheval; Juan F. Moreno
  8. What Makes Currencies Volatile? An Empirical Investigation By Michael Bleaney; Manuela Francisco
  9. "Exchange Rate and Industrial Commodity Volatility Transmissions and Hedging Strategies" By Shawkat M. Hammoudeh; Yuan Yuan; Michael McAleer
  10. Commodity prices, commodity currencies, and global economic developments By Jan J. J. Groen; Paolo A. Pesenti
  11. Structure and evolution of the foreign exchange networks By Jaroslaw Kwapien; Sylwia Gworek; Stanislaw Drozdz
  12. Analysis of a network structure of the foreign currency exchange market By Jaroslaw Kwapien; Sylwia Gworek; Stanislaw Drozdz; Andrzej Gorski

  1. By: Frankel, Jeffrey (Harvard University); Poonawala, Jumana (Harvard University)
    Abstract: Many studies have replicated the finding that the forward rate is a biased predictor of the future change in the spot exchange rate. Usually the forward discount actually points in the wrong direction. But, at least until recently, those studies applied only to advanced economies and major currencies. We apply the same tests to a sample of 14 emerging market currencies. We find a smaller bias than for advanced country currencies. The coefficient is on average positive, i.e., the forward discount at least points in the right direction. It is never significantly less than zero. To us this suggests that a time-varying exchange risk premium may not be the explanation for traditional findings of bias. The reasoning is that emerging markets are probably riskier; yet we find that the bias in their forward rates is smaller. Emerging market currencies probably have more easily-identified trends of depreciation than currencies of advanced countries.
    JEL: F31
    Date: 2009–07
  2. By: Daniel J. Fenn; Mason A. Porter; Peter J. Mucha; Mark McDonald; Stacy Williams; Neil F. Johnson; Nick S. Jones
    Abstract: We use techniques from network science to study correlations in the foreign exchange (FX) market over the period 1991--2008. We consider an FX market network in which each node represents an exchange rate and each weighted edge represents a time-dependent correlation between the rates. To provide insights into the clustering of the exchange rate time series, we investigate dynamic communities in the network. We show that there is a relationship between an exchange rate's functional role within the market and its position within its community and use a node-centric community analysis to track the time dynamics of this role. This reveals which exchange rates dominate the market at particular times and also identifies exchange rates that experienced significant changes in market role. We also use the community dynamics to uncover major structural changes that occurred in the FX market. Our techniques are general and will be similarly useful for investigating correlations in other markets.
    Date: 2009–05
  3. By: Joseph P. Daniels (Center for Global and Economic Studies, Marquette University); David D. VanHoose (Hanmaker School of Business, Baylor University)
    Abstract: Considerable recent work has reached mixed conclusions about whether and how globalization affects the inflation-output trade-off and realized inflation rates. In this paper, we utilize cross-country data to provide evidence of interacting effects between a greater extent of exchange-rate pass through and openness to international trade as factors that we find both contribute to lower inflation. The interplay between the inflation effects of pass through and openness suggest that both factors may influence the terms of the output-inflation trade-off. We develop a simple theoretical model showing how both pass through and openness can interact to influence the sacrifice ratio, and we empirically explore the nature of the interplay between the two variables as factors influencing the sacrifice ratio. Our results indicate that a greater extent of pass through depresses the sacrifice ratio and that once the extent of pass through is taken into account alongside other factors that affect the sacrifice ratio, the degree of openness to international trade exerts an empirically ambiguous effect on the sacrifice ratio.
    Keywords: Pass Through, Openness, Sacrifice Ratio
    JEL: F40 F41 F43
    Date: 2009–09
  4. By: Basu, Kaushik (Cornell University)
    Abstract: Central banks in developing countries, wanting to devalue the domestic currency, usually intervene in the foreign exchange market by buying up foreign currency using domestic money--often backing this up with sterilization to counter inflationary pressures. Such interventions are usually effective in devaluing the currency but lead to a build up of foreign exchange reserves beyond what the central bank may need. The present paper analyzes the 'mechanics' of such central bank interventions and, using techniques of industrial organization theory, proposes new kinds of interventions which have the same desired effect on the exchange rate, without causing a build up of reserves.
    JEL: D43 F31 G20 L31
    Date: 2009–01
  5. By: Luciana Juvenal
    Abstract: I analyze the role of real and monetary shocks on the exchange rate behavior using a structural vector autoregressive model of the US vis-à-vis the rest of the world. The shocks are identified using sign restrictions on the responses of the variables to orthogonal disturbances. These restrictions are derived from the predictions of a two-country DSGE model. I find that monetary shocks are unimportant in explaining exchange rate fluctuations. By contrast, demand shocks explain between 23% and 38% of exchange rate variance at 4-quarter and 20-quarter horizons, respectively. The contribution of demand shocks plays an important role but not of the order of magnitude sometimes found in earlier studies. My results, however, support the recent focus of the literature on real shocks to match the empirical properties of real exchange rates.
    Keywords: Foreign exchange rates ; Vector autoregression
    Date: 2009
  6. By: Kim, Hyeongwoo; Moh, Young-Kyu
    Abstract: Taylor (2002) claims that Purchasing Power Parity (PPP) has held over the 20th century based on strong evidence of stationarity for century-long real exchange rates for 20 countries. Lopez et al. (2005), however, found much weaker evidence of PPP with alternative lag selection methods. We reevaluate Taylor’s claim by implementing a recently developed nonlinear unit root test by Park and Shintani (2005). We find strong evidence of nonlinear mean-reversion in real exchange rates that confirms Taylor’s claim. We also find a possible misspecification problem in using the ESTAR model that may not be detected with Taylor-approximation based tests.
    Keywords: Purchasing Power Parity; Transition Autoregressive Process; inf-t Unit Root Test
    JEL: C22 F31
    Date: 2009–01
  7. By: Alec N. Kercheval; Juan F. Moreno
    Abstract: We address the problem of optimal Central Bank intervention in the exchange rate market when interventions create feedback in the rate dynamics. In particular, we extend the work done on optimal impulse control by Cadenillas and Zapatero to incorporate temporary market reactions, of random duration and level, to Bank interventions, and to establish results for more general rate processes. We obtain new explicit optimal impulse control strategies that account for these market reactions, and show that they cannot be obtained simply by adjusting the intervention cost in a model without market reactions.
    Date: 2009–09
  8. By: Michael Bleaney (School of Economics, University of Nottingham, Nottingham); Manuela Francisco (Universidade do Minho - NIPE)
    Abstract: Real effective exchange rate volatility is examined for 90 countries using monthly data from January 1990 to June 2006. Volatility decreases with openness to international trade and per capita GDP, and increases with inflation, particularly under a horizontal peg or band, and with terms - of - trade volatility. The choice of exchange rate regime matters. After controlling for these effects, and independent float adds at least 45% to the standard deviation of the real effective exchange rate, relative to a conventional peg, but must other regimes make little difference. The results are robust to alternative volatility measures and to sample selection bias.
    Keywords: Exchange rate regimes; Inflation; Volatility
    JEL: F31
    Date: 2009
  9. By: Shawkat M. Hammoudeh (Lebow College of Business, Drexel University); Yuan Yuan (Lebow College of Business, Drexel University); Michael McAleer (Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo)
    Abstract: This paper examines the inclusion of the dollar/euro exchange rate together with important commodities in two different BEKK, or multivariate conditional covariance, models. Such inclusion increases the significant direct and indirect past shock and volatility effects on future volatility between the commodities, as compared with their effects in the all-commodity basic model (Model 1), which includes the highly-traded aluminum, copper, gold and oil. Model 2, which includes copper, gold, oil and exchange rate, displays more direct and indirect transmission than does Model 3, which replaces the business cycle-sensitive copper with the highly energy-intensive aluminum. Optimal portfolios should have more Euro than commodities, and more copper and gold than oil. The multivariate conditional volatility models reveal greater volatility spillovers than their univariate counterparts.
    Date: 2009–09
  10. By: Jan J. J. Groen; Paolo A. Pesenti
    Abstract: In this paper, we seek to produce forecasts of commodity price movements that can systematically improve on naive statistical benchmarks. We revisit how well changes in commodity currencies perform as potential efficient predictors of commodity prices, a view emphasized in the recent literature. In addition, we consider different types of factor-augmented models that use information from a large data set containing a variety of indicators of supply and demand conditions across major developed and developing countries. These factor-augmented models use either standard principal components or the more novel partial least squares (PLS) regression to extract dynamic factors from the data set. Our forecasting analysis considers ten alternative indices and sub-indices of spot prices for three different commodity classes across different periods. We find that, of all the approaches, the exchange-rate-based model and the PLS factor-augmented model are more likely to outperform the naive statistical benchmarks, although PLS factor-augmented models usually have a slight edge over the exchange-rate-based approach. However, across our range of commodity price indices we are not able to generate out-of-sample forecasts that, on average, are systematically more accurate than predictions based on a random walk or autoregressive specifications.
    Keywords: Commodity exchanges ; Foreign exchange rates ; Commodity futures ; Regression analysis ; Forecasting
    Date: 2009
  11. By: Jaroslaw Kwapien; Sylwia Gworek; Stanislaw Drozdz
    Abstract: We investigate topology and temporal evolution of the foreign currency exchange market viewed from a weighted network perspective. Based on exchange rates for a set of 46 currencies (including precious metals), we construct different representations of the FX network depending on a choice of the base currency. Our results show that the network structure is not stable in time, but there are main clusters of currencies, which persist for a long period of time despite the fact that their size and content are variable. We find a long-term trend in the network's evolution which affects the USD and EUR nodes. In all the network representations, the USD node gradually loses its centrality, while, on contrary, the EUR node has become slightly more central than it used to be in its early years. Despite this directional trend, the overall evolution of the network is noisy.
    Date: 2009–01
  12. By: Jaroslaw Kwapien; Sylwia Gworek; Stanislaw Drozdz; Andrzej Gorski
    Abstract: We analyze structure of the world foreign currency exchange (FX) market viewed as a network of interacting currencies. We analyze daily time series of FX data for a set of 63 currencies, including gold, silver and platinum. We group together all the exchange rates with a common base currency and study each group separately. By applying the methods of filtered correlation matrix we identify clusters of closely related currencies. The clusters are formed typically according to the economical and geographical factors. We also study topology of weighted minimal spanning trees for different network representations (i.e., for different base currencies) and find that in a majority of representations the network has a hierarchical scale-free structure. In addition, we analyze the temporal evolution of the network and detect that its structure is not stable over time. A medium-term trend can be identified which affects the USD node by decreasing its centrality. Our analysis shows also an increasing role of euro in the world's currency market.
    Date: 2009–06

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.