nep-ifn New Economics Papers
on International Finance
Issue of 2009‒10‒03
seven papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Capital constraints, counterparty risk, and deviations from covered interest rate parity By Niall Coffey; Warren B. Hrung; Asani Sarkar
  2. Can long-horizon forecasts beat the random walk under the Engel-West explanation? By Charles Engel; Jian Wang; Jason Wu
  3. Estimating the border effect: some new evidence By Gita Gopinath; Pierre-Olivier Gourinchas; Chang-Tai Hsieh; Nicholas Li
  4. Global rebalancing in a three-country model By Engler, Philipp
  5. Exchange rates during the crisis By Weber, Sebastian; Wyplosz, Charles
  6. Wavelet Based Volatility Clustering Estimation of Foreign Exchange Rates By A. N. Sekar Iyengar
  7. Modelling the Global Financial Crisis By Warwick J McKibbin; Andy Stoeckel

  1. By: Niall Coffey; Warren B. Hrung; Asani Sarkar
    Abstract: We provide robust evidence of a deviation in the covered interest rate parity (CIP) relation since the onset of the financial crisis in August 2007. The CIP deviation exists with respect to several different dollar-denominated interest rates and exchange rate pairings of the dollar vis-a-vis other currencies. The results show that our proxies for margin conditions and for the cost of capital are significant determinants of the CIP deviations, especially during the crisis period. The supply of dollars by the Federal Reserve to foreign central banks via reciprocal currency arrangements (swap lines) reduced CIP deviations at this time. Following the bankruptcy of Lehman Brothers, uncertainty about counterparty risk became a significant determinant of CIP deviations, and the swap lines program no longer affected the CIP deviations significantly. These results indicate a breakdown of arbitrage transactions in the international capital markets that owes partly to lack of capital and partly to heightened counterparty credit risk. Central bank interventions helped reduce the funding liquidity risk of global institutions.
    Keywords: Interest rates ; Currency substitution ; Foreign exchange rates ; Swaps (Finance) ; Banks and banking, Central
    Date: 2009
  2. By: Charles Engel; Jian Wang; Jason Wu
    Abstract: Engel and West (EW, 2005) argue that as the discount factor gets closer to one, present-value asset pricing models place greater weight on future fundamentals. Consequently, current fundamentals have very weak forecasting power and exchange rates appear to follow approximately a random walk. We connect the Engel-West explanation to the studies of exchange rates with long-horizon regressions. We find that under EW's assumption that fundamentals are I(1) and observable to the econometrician, long-horizon regressions generally do not have significant forecasting power. However, when EW's assumptions are violated in a particular way, our analytical results show that there can be substantial power improvements for long-horizon regressions, even if the power of the corresponding shorthorizon regression is low. We simulate population Rsquared for long-horizon regressions in the latter setting, using Monetary and Taylor Rule models of exchange rates calibrated to the data. Simulations show that long-horizon regression can have substantial forecasting power for exchange rates.
    Keywords: Foreign exchange rates ; Financial markets ; Asset pricing ; Forecasting ; Random walks (Mathematics) ; Regression analysis
    Date: 2009
  3. By: Gita Gopinath; Pierre-Olivier Gourinchas; Chang-Tai Hsieh; Nicholas Li
    Abstract: To what extent do national borders and national currencies impose costs that segment markets across countries? To answer this question the authors use a dataset with product-level retail prices and wholesale costs for a large grocery chain with stores in the United States and Canada. They develop a model of pricing by location and employ a regression discontinuity approach to estimate and interpret the border effect. They report three main facts: One, the median absolute retail price and wholesale cost discontinuities between adjacent stores on either side of the U.S.-Canadian border are as high as 21 percent. In contrast, within-country border discontinuity is close to 0 percent. Two, the variation in the retail price gap at the border is almost entirely driven by variation in wholesale costs, not by variation in markups. Three, the border gaps in prices and costs co-move almost one-to-one with changes in the U.S.-Canadian nominal exchange rate. They show these facts suggest that the price gaps they estimate provide only a lower bound on border costs.
    Keywords: Prices ; Price indexes ; Wholesale price indexes ; Retail trade
    Date: 2009
  4. By: Engler, Philipp
    Abstract: This paper extends the model of Engler et al. (2007) on the adjustment of the US current account to a three-country world economy. This allows an analysis of the differential impact of a reversal of the US current account on Europe and Asia. In particular, the outcomes under different exchange rate policies are analysed. The main finding is that large factor re-allocations from non-tradables to tradables will be necessary in the US. The direction of factor re-allocation in Asia depends on whether the Bretton-Woods-II regime of unilaterally fixed or manipulated exchange rates in Asia is continued. If this is the case, the tradables sector and the current account surplus will continue to grow even when the US deficit closes. The flip side of this result is that Europe will face a huge real appreciation and an enormous current account deficit. With floating exchange rates worldwide, the impact on Europe will be limited while Asia´s tradables sector will shrink.
    Keywords: Global imbalances,US current account deficit,dollar adjustment,sectoral adjustment
    JEL: E2 F32 F41
    Date: 2009
  5. By: Weber, Sebastian; Wyplosz, Charles
    Abstract: Nearly two years after the onset of the financial crises, many central banks have brought their policy interest rates down to, or close to zero. Various governments have seen their budget deficits soar. Both policies have affected exchange rates, partly through market expectations. With a majority of exchange rates officially floating, exchange rate movements do not necessarily reflect official decisions as was the case in the 1930s. Yet, also in the 2008 crisis, authorities have directly intervened in the foreign exchange market, sometimes in order to defend a falling currency but in other instances with the aim to limit appreciation pressure, akin of competitive devaluations. This paper documents the exchange rate interventions during the height of the 2008/09 financial crisis and identifies the countries which have particular high incentives to intervene in the foreign exchange market to competitively devalue their currency. While various countries had increased incentives to devalue, we find that direct exchange rate interventions have been rather limited and contagion of devaluation has been restricted to one regionally contained case. However, sharp market-driven exchange rate movements have reshaped competitive positions. It appears that these movements have so far not seriously disrupted global trade. After all, a world crisis is likely to require widespread exchange rate adjustments as different countries are affected in different ways and have different capacities to weather the shocks.
    Keywords: Currencies and Exchange Rates,Debt Markets,Emerging Markets,Economic Stabilization,Economic Theory&Research
    Date: 2009–09–01
  6. By: A. N. Sekar Iyengar
    Abstract: We have presented a novel technique of detecting intermittencies in a financial time series of the foreign exchange rate data of U.S.- Euro dollar(US/EUR) using a combination of both statistical and spectral techniques. This has been possible due to Continuous Wavelet Transform (CWT) analysis which has been popularly applied to fluctuating data in various fields science and engineering and is also being tried out in finance and economics. We have been able to qualitatively identify the presence of nonlinearity and chaos in the time series of the foreign exchange rates for US/EURO (United States dollar to Euro Dollar) and US/UK (United States dollar to United Kingdom Pound) currencies. Interestingly we find that for the US-INDIA(United States dollar to Indian Rupee) foreign exchange rates, no such chaotic dynamics is observed. This could be a result of the government control over the foreign exchange rates, instead of the market controlling them.
    Date: 2009–10
  7. By: Warwick J McKibbin; Andy Stoeckel
    Abstract: This paper models the global financial crisis as a combination of shocks to global housing markets and sharp increases in risk premia of firms, households and international investors in an intertemporal (or DSGE) global model. The model has six sectors of production and trade in 15 major economies and regions. The paper shows that a ‘switching’ of expectations about risk premia shocks in financial markets can easily generate the severe economic contraction in global trade and production currently being experienced in 2009 and subsequent events. The results show that the future of the global economy depends critically on whether the shocks to risk are expected to be permanent or temporary. The best representation of the crisis may be one where initial long lasting pessimism about risk is unexpectedly revised to a more moderate scenario. This suggests a rapid recovery in countries not experiencing a balance sheet adjustment problem.
    Date: 2009–09

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