nep-ifn New Economics Papers
on International Finance
Issue of 2009‒11‒21
eight papers chosen by
Yi-Nung Yang
Chung Yuan Christian University

  1. Exchange Rate Pass-Through into Romanian Price Indices: A VAR Approach By Florentina Manea
  2. Exchange Rate Mean Reversion within a Target Zone: Evidence from a Country on the Periphery of the ERM By António Portugal Duarte; João Sousa Andrade; Adelaide Duarte
  3. The puzzling peso By Carlos Arteta; Steven B. Kamin; Justin Vitanza
  4. How Stable Are Monetary Models of the Dollar-Euro Exchange Rate?: A Time-varying Coefficient Approach By Joscha Beckmann; Ansgar Belke; Michael Kühl
  5. Endogenous Inflows of Speculative Capital and the Optimal Currency Appreciation Path By Mei Li,; Junfeng Qiu
  6. Exchange Rate Risk: Heads or Tails By Ana-Maria Gavril
  7. The determinants of international flows of U.S. currency By Rebecca Hellerstein; William Ryan
  8. Rise of the machines: algorithmic trading in the foreign exchange market By Alain Chaboud; Benjamin Chiquoine; Erik Hjalmarsson; Clara Vega

  1. By: Florentina Manea
    Abstract: This paper investigates the exchange rate pass-through (ERPT) into import prices, producer prices and several different measures of consumer prices indices for Romanian economy. In order to determine the size, describe the dynamics and identify the asymmetries in ERPT the paper employs an array of econometric methods belonging to the VAR family. The methods range from RVARS (on different price indices and/or on a rolling window), Sign-restriction VARs (also using different consumer inflation measures), MS-VAR, TAR and SETAR, the last three methods being naturally equipped to capture various types of asymmetries. The results point to an almost complete pass-through into import prices and incomplete passthrough into producer and consumer prices. In all cases except import prices the ERPT displays a decline in magnitude over the analysed time interval. The paper also finds important asymmetries with respect to sign and size of the exchange rate, size of inflation and time period.
    Keywords: exchange rate pass-through, MS-VAR, TAR, SETAR
    Date: 2009–11
  2. By: António Portugal Duarte (Faculdade de Economia/GEMF, Universidade de Coimbra); João Sousa Andrade (Faculdade de Economia/GEMF, Universidade de Coimbra); Adelaide Duarte (Faculdade de Economia/GEMF, Universidade de Coimbra)
    Abstract: The aim of this study is to assess to what extent the Portuguese participation in the European Monetary System (EMS) has been characterized by mean reverting behaviour, as predicted by the exchange rate target zone model developed by Krugman (1991). For this purpose, a new class of mean reversion tests is introduced. The empirical analysis of mean reversion in the Portuguese exchange rate shows that most of the traditional unit root and stationarity tests point to the nonstationarity of the exchange rate within the band. However, using a set of variance-ratio tests, it was possible to detect the presence of a martingale difference sequence. This suggests that the Portuguese foreign exchange market has functioned efficiently, allowing us to conclude that the adoption of an exchange rate target zone regime has contributed decisively to the creation of the macroeconomic stability conditions necessary for the participation of Portugal in the euro area.
    Keywords: difference sequence, mean reversion, stationarity, target zones and unit roots
    JEL: C32 C51 F31 F41 G15
    Date: 2009–11
  3. By: Carlos Arteta; Steven B. Kamin; Justin Vitanza
    Abstract: In the past decade, some observers have noted an unusual aspect of the Mexican peso's behavior: During periods when the U.S. dollar has risen (fallen) against other major currencies such as the euro, the peso has risen (fallen) against the dollar. Very few other currencies display this behavior. In this paper, we attempt to explain the unusual pattern of the peso's correlation with the dollar by developing some general empirical models of exchange rate correlations. Based on a study of 29 currencies, we find that most of the cross-country variation in exchange rate correlations with the dollar and the euro can be explained by just a few variables. First, a country's currency is more likely to rise against the dollar as the dollar rises against the euro, the closer it is to the United States and the farther it is from the euro area. In this result, distance likely proxies for the role of economic integration in affecting exchange rate correlations. Second, and perhaps more surprisingly, a country's currency is more likely to exhibit this unusual pattern when its sovereign credit rating is more risky. This may reflect that currencies of riskier countries are less substitutable in investor portfolios than those of better-rated countries. All told, these factors well explain the peso's unusual behavior, as Mexico both is very close to the United States and has a lower credit rating than most industrial economies.
    Date: 2009
  4. By: Joscha Beckmann; Ansgar Belke; Michael Kühl
    Abstract: This paper examines the significance of different fundamental regimes by applying various monetary models of the exchange rate to one of the politically most important exchange rates, the exchange rate of the US dollar vis-à-vis the euro (the DM). We use monthly data from 1975:01 to 2007:12. Applying a novel time-varying coefficient estimation approach, we come up with interesting properties of our empirical models. First, there is no stable long-run equilibrium relationship among fundamentals and exchange rates since the breakdown of Bretton Woods. Second, there are no recurring regimes, i.e. across different regimes either the coefficient values for the same fundamentals differ or the significance differs. Third, there is no regime in which no fundamentals enter. Fourth, the deviations resulting from the stepwise cointegrating relationship act as a significant error-correction mechanism. In other words, we are able to show that fundamentals play an important role in determining the exchange rate although their impact differs significantly across different sub-periods.
    Keywords: Structural exchange rate models, cointegration, structural breaks, switching regression, time-varying coefficient approach
    JEL: E44 F31 G12
    Date: 2009
  5. By: Mei Li, (Department of Economics,University of Guelph); Junfeng Qiu (Central University of Finance and Economics)
    Abstract: This paper examines the optimal appreciation path of an under-valued currency in the presence of speculative capital inflows that are endogenously affected by the appreciation path. A central bank decides the optimal appreciation path based on three factors: (i) Misalignment costs associated with the gap between the actual exchange rate and the fundamental exchange rate, (ii) short-term adjustment costs due to fast appreciation, and (iii) capital losses due to speculative capital inflows. We examine two cases in which speculators do and do not face liquidity shocks. We show that, in the case without liquidity shocks, the central bank should appreciate quickly to discourage speculative capital, and should appreciate more quickly in initial periods than in later periods. In the case with liquidity shocks, the central bank should pre-commit to a slow appreciation path to discourage speculative capital. The central bank should appreciate slowest when the probability of liquidity shocks takes middle values. If the central bank cannot commit and can only take a discretionary policy, appreciation should be faster.
    Keywords: exchange rate, appreciation, capital flows
    JEL: F31 F32
    Date: 2009
  6. By: Ana-Maria Gavril
    Abstract: More than forty years ago researchers started to reconsider the behavior of financial data. Since then, stylized facts about financial returns have become common knowledge in economics. Characteristics as fat-tailedness, leptokurtosis and serial dependence have been extensively analyzed. As the financial world became focused on risk management and prudential supervision, various risk models have been developed. However, the first generation of risk models is highly dependent on rough assumptions, empirically contradicted, but embraced by practitioners as they benefit from a fairly easy implementation. In the context of market risk, such a proxy was developed under the name of Value at Risk, which rapidly became a standard measure for both risk managers and supervisors. The current state of affairs brings us one step closer to the death of VaR. The need for a new approach is imperative. This paper aims to bring new evidence to the limited performance of Value at Risk and test the fit of Extreme Value Theory as a complementary risk management tool for stressed market conditions, in the context of exchange rate risk. We use exchange rate returns of four currencies against the Euro and analyze the relative performance of several VaR models and Extreme Value Theory, respectively. We show that in extreme market conditions, extreme measures are required, and that no single measure can perform proper for both the centre and the tails of an exchange rate distribution.
    Keywords: Extreme Value Theory, VaR
    Date: 2009–11
  7. By: Rebecca Hellerstein; William Ryan
    Abstract: This paper examines the determinants of cross-border flows of U.S. dollar banknotes, using a new panel data set of bilateral flows between the United States and 103 countries from 1990 to 2007. We show that a gravity model explains international flows of currency as well as it explains international flows of goods and financial assets. We find important roles for market size and transaction costs, consistent with the traditional gravity framework, as well as roles for financial depth, the behavior of the nominal exchange rate, the size of the informal sector, the amount of remittance credits, the degree of competition with the euro, and the history of macroeconomic instability over the previous generation. We find no role for official trade flows of goods. Our results thus confirm several hypotheses about the determinants of using a secondary currency.
    Keywords: Flow of funds ; Dollar, American ; Currency substitution
    Date: 2009
  8. By: Alain Chaboud; Benjamin Chiquoine; Erik Hjalmarsson; Clara Vega
    Abstract: We study the impact that algorithmic trading, computers directly interfacing at high frequency with trading platforms, has had on price discovery and volatility in the foreign exchange market. Our dataset represents a majority of global interdealer trading in three major currency pairs in 2006 and 2007. Importantly, it contains precise observations of the size and the direction of the computer-generated and human-generated trades each minute. The empirical analysis provides several important insights. First, we find evidence that algorithmic trades tend to be correlated, suggesting that the algorithmic strategies used in the market are not as diverse as those used by non-algorithmic traders. Second, we find that, despite the apparent correlation of algorithmic trades, there is no evident causal relationship between algorithmic trading and increased exchange rate volatility. If anything, the presence of more algorithmic trading is associated with lower volatility. Third, we show that even though some algorithmic traders appear to restrict their activity in the minute following macroeconomic data releases, algorithmic traders increase their provision of liquidity over the hour following each release. Fourth, we find that non-algorithmic order flow accounts for a larger share of the variance in exchange rate returns than does algorithmic order flow. Fifth, we find evidence that supports the recent literature that proposes to depart from the prevalent assumption that liquidity providers in limit order books are passive.
    Date: 2009

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