nep-ifn New Economics Papers
on International Finance
Issue of 2010‒03‒06
fifteen papers chosen by
Ajay Shah
National Institute of Public Finance and Policy

  1. Does the uncovered interest parity hold in short horizons? By Levent, Korap
  2. What Determines European Real Exchange Rates? By Martin Berka; Michael B. Devereux
  3. Is the Chinese currency substantially misaligned to warrant further appreciation? By Qin, Duo; He, Xinhua
  4. Risk premium shocks, monetary policy and exchange rate pass-through in the Czech Republic, Hungary and Poland By Balázs Vonnák
  5. Real exchange rate misalignments and economic performance for the G20 countries By Audrey Sallenave
  7. Pricing to market when quality matters By Roberto Basile; Sergio de Nardis; Alessandro Girardi
  8. Central Bank Dollar Swap Lines and Overseas Dollar Funding Costs By Linda S. Goldberg; Craig Kennedy; Jason Miu
  9. Interbank Offered Rate: Effects of the financial crisis on the information content of the fixing By Vincent Brousseau; Alexandre Chailloux; Alain Durré
  10. Debt Management in Latin America How Safe Is the New Debt Composition? By Eduardo Cavallo
  11. Price Formation on the EuroMTS Platform By Guglielmo Maria Caporale; Alessandro Girardi
  12. On Dividend Restrictions and the Collapse of the Interbank Market By Dimitrios Tsomocos; Charles Goodhart; M.U. Peiris; Alexandros Vardoulakis
  13. The Great Recession versus the Great Depression: stylized facts on siblings that were given different foster parents By Aiginger, Karl
  14. Default Risk and Risk Averse International Investors By Lizarazo, Sandra
  15. When Bad Things Happen to Good Sovereign Debt Contracts: The Case of Ecuador By Porzecanski, Arturo C.

  1. By: Levent, Korap
    Abstract: In this article, one of the contemporaneous monetary theories of exchange rate determination, namely uncovered interest parity (UIP), is examined. The UIP hypothesis assumes that if capital is perfectly mobile, then investors around the world will be indifferent between holding their portfolios in domestic or foreign securities, because they obtain the same return from these assets. Based on a theoretical formulation, our ex post estimation results employing four developed countries exchange rates vis-á-vis US dollar indicate the failure of the UIP hypothesis using short-horizon interest differential and future spot exchange rate data, in line with most empirical papers in the economics literature.
    Keywords: Uncovered interest parity; GMM estimator
    JEL: F41 F31
    Date: 2010
  2. By: Martin Berka; Michael B. Devereux
    Abstract: We study a newly constructed panel data set of relative prices of a large number of consumer goods among 31 European countries. We find that there is a substantial and non-diminishing deviation from PPP at all levels of aggregation, even among eurozone members. However, real exchange rates are very closely tied to relative GDP per capita within Europe, both across countries and over time. This relationship is highly robust at all levels of aggregation. We construct a simple two-sector endowment economy model of real exchange rate determination. Simulating the model using the historical relative GDP per capita for each country, we find that for most (but not all) countries there is a very close fit between the actual and simulated real exchange rate.
    JEL: F31 F41
    Date: 2010–02
  3. By: Qin, Duo; He, Xinhua
    Abstract: This study provides quarterly time-series estimates of the misalignment in the REER of the Renminbi (RMB). The estimation is based on a commonly used economic approach, but with a wider and more up-to-date coverage of data and a more extensive use of econometric modelling techniques. Our estimates corroborate and explain most of the previous estimates. More importantly, our estimates demonstrate that there is no significant undervaluation in the REER of the RMB though downward misalignment exists in the trilateral rates between the RMB, US$ and euro. The finding refutes the claim that RMB appreciation is the primary and necessary solution to the current global trade imbalance. --
    Keywords: Real exchange rate misalignment
    JEL: F31 F41
    Date: 2010
  4. By: Balázs Vonnák (Magyar Nemzeti Bank)
    Abstract: This paper investigates the role of monetary policy in a small open economy, where exchange rate shocks are important. VAR models are estimated for the Czech Republic, Hungary and Poland. Contemporaneous and sign restrictions are imposed in order to identify the effect of monetary policy and risk premium shocks. Estimates from the same model for Canada, Sweden and the UK are used as benchmark for developed economies with low inflation. The results suggest that the typical size a of risk premium shock renders it almost impossible for the interest rate policy to smooth the exchange rate with the aim of minimising inflationary consequences. On the other hand, low inflation may decrease the exchange rate pass-through, which helps the monetary policy ignore exchange rate shocks.
    Keywords: monetary policy, risk premium shocks, exchange rate pass-through, structural VAR, sign restriction.
    JEL: E31 E52 F31
    Date: 2010
  5. By: Audrey Sallenave
    Abstract: We evaluate the growth effects of real effective exchange rate misalignments for the G20 countries over the period 1980-2006. To this end, we first estimate real effective equilibrium exchange rates relying on the behavioral approach BEER, from which misalignments are derived. Second, we estimate a dynamic panel growth model in which among the traditional determinants of growth, our measure of misalignments is included. Our findings put forward some important differences between developed and emerging economies. The magnitude of the misalignments is more pronounced in the case of emerging countries, and the speed of convergence towards the estimated equilibrium exchange rate is slower for industrialized ones. Turning to our growth regression analysis, we find that misalignments have a negative effect on the economic growth. As a consequence, an appropriate exchange rate policy would close the gap between real exchange rates and their equilibrium level.
    Keywords: Equilibrium Real Effective Exchange Rate, Group of Twenty, Growth, Misalignments, Panel Cointegration
    JEL: C23 F31 O47
    Date: 2010
  6. By: Patrick Honohan; Gavin Murphy (Institute for International Integration Studies, Trinity College Dublin)
    Abstract: Ireland had been considering a break in the long-standing currency link with sterling for some time when the ideal opportunity of a new exchange rate regime – potentially retaining the sterling link while stabilizing other exchange rates – seemed to offer itself in the form of the “zone of monetary stability in Europe” proposed by France and Germany in April 1978. Based on newly released archives, this paper reviews the evolving attitude of Irish officials and the Irish Government over the following months as the decision gradually shifted to one of breaking the sterling link and rejoining what was little more than an expanded “Snake” arrangement; the UK having decided to stay out. While financial issues were to the fore in the discussions, the final decision to join was based on a strategic vision that Ireland’s economic and political future lay with Europe rather than with the former colonial power.
    Date: 2010–02
  7. By: Roberto Basile (ISAE - Institute for Studies and Economic Analyses); Sergio de Nardis (ISAE - Institute for Studies and Economic Analyses); Alessandro Girardi (ISAE - Institute for Studies and Economic Analyses)
    Abstract: We build a model of price differentiation with firm heterogeneity, which allows for imperfect competition and market segmentation in the presence of flexible exchange rates as well as horizontal and vertical differentiation and different tastes of consumers in destination markets. We empirically assess the main predictions of our theoretical framework by using firm-level data surveyed by ISAE. We document that export-domestic price margins are significantly affected by price and quality competitiveness even controlling for foreign demand conditions, size, export intensity, destination markets and unobservables. Finally, we provide evidence of a strong heterogeneity across firms in their reaction to price and quality competitiveness.
    Keywords: Pricing to market, qualitative choice models, firm heterogeneity.
    JEL: D21 F10 C23 C25
    Date: 2009–12
  8. By: Linda S. Goldberg; Craig Kennedy; Jason Miu
    Abstract: Following a scarcity of dollar funding available internationally to banks and financial institutions, starting in December 2007 the Federal Reserve established or expanded Temporary Reciprocal Currency Arrangements with fourteen foreign central banks. These central banks had the capacity to use these swap facilities to provide dollar liquidity to institutions in their jurisdictions. This paper presents the developments in the dollar swap facilities through the end of 2009. The facilities were a response to dollar funding shortages outside the United States during a period of market dysfunction. Formal research, as well as more descriptive accounts, suggests that the dollar swap lines among central banks were effective at reducing the dollar funding pressures abroad and stresses in money markets. The central bank dollar swap facilities are an important part of a toolbox for dealing with systemic liquidity disruptions.
    JEL: E44 F36 G32
    Date: 2010–02
  9. By: Vincent Brousseau (IESEG School of Management); Alexandre Chailloux (International Monetary Fund); Alain Durré (IESEG School of Management, LEM-CNRS (UMR 8179))
    Abstract: With the onset of the financial turmoil in August 2007, pricing references on the money market interest rates have been shocked. The segment of unsecured deposit transactions, which represent the cornerstone of capital markets, and is used as basis for the setting of money market benchmark essential to the indexing of trillions of derivative contracts and loans, has been particularly damaged by the surge in counterparty risk. The lack of confidence between traders and the growing fear of counterparty’s bankruptcies have led progressively to a drying out of the unsecured market turnover. After a relative improvement in early 2008, market activity in the unsecured market has again dried up with the reinforcement of the financial crisis following the collapse of Lehman Brothers. Although there are good reasons to think that the market activity in the cash unsecured segment of the money market has remained distorted, in particular for maturities beyond the very short-term, the OIS-LIBOR spreads have been declining extremely steadily since January 2009, both in major currencies and at various maturities, seemingly pointing to a normalization of the money market. On the basis of a simple econometric supported by statistical evidence applied to the euro area date, this paper analyses whether recent developments in the unsecured interest rates actually support a diagnosis of renewed market activity, and of normalization of the unsecured market.
    Keywords: LIBOR, EURIBOR, secured segment, fixings, market distortions, financial crisis.
    JEL: G14 C02 C32
    Date: 2009–12
  10. By: Eduardo Cavallo
    Abstract: While public debt ratios in Latin America increased in 2009 amid the global financial crisis, they remain below levels reached following the Asian and Russian crises of the late 1990s. Moreover, debt composition has continued to shift towards -safer- debt (domestic debt with a higher prevalence of domestic currency liabilities). However, the current debt structure poses risks and policy challenges that should not be overlooked. Reviewing the latest available data on debt levels and composition for the region`s largest countries, this brief concludes that debt managers should avoid complacency in thinking that the region is completely redeemed from old sins. Particularly overlooked is that there does not yet exist in the region a large investor base for debt denominated in domestic currency at fixed nominal rates and reasonably long maturities.
    Keywords: Debt management, Public debt, Living with debt
    JEL: H63
    Date: 2010–02
  11. By: Guglielmo Maria Caporale; Alessandro Girardi
    Abstract: This paper examines the process of price discovery in the MTS system, which builds on the parallel quoting of euro-denominated government securities on a number of (relatively large) domestic markets and on a (relatively small) European marketplace (EuroMTS). Using twenty-seven months of daily data for 107 pairs of bonds, we present unambiguous evidence that trades on EuroMTS have a sizeable informational content.
    Keywords: MTS system, price discovery
    JEL: C32 G10
    Date: 2010
  12. By: Dimitrios Tsomocos; Charles Goodhart; M.U. Peiris; Alexandros Vardoulakis
    Abstract: Until recently, financial services regulation remained largely segmented along national lines. The integration of financial markets, however, calls for a systematic and coherent approach to regulation. This paper studies the effect of market based regulation on the proper functioning of the interbank market. Specifically, we argue that restrictions on the payout of dividends by banks can reduce their expected default on (interbank) loans, stimulate trade in this market and improve the welfare of consumers.
    Date: 2010–02
  13. By: Aiginger, Karl
    Abstract: This paper compares the depth of the Recent Crisis and the Great Depression. We use a new data set to compare the drop in activity in the industrialized countries for seven activity indicators. This is done under the assumption that the Recent Crisis leveled off in mid-2009 for production and will do so for unemployment in 2010. Our data indicate that the Recent Crisis indeed had the potential to be another Great Depression, as shown by the speed and simultaneity of the decline in the first nine months. However, if we assume that a large second dip can be avoided, the drop in all indicators overall will have been smaller than during the Great Depression. This holds true specifically for GDP, employment and priced, and least for manufacturing output. The difference in the depth in the crises concurs with differences in policy reaction. This time monetary policy and fiscal policy were applied courageously, speedily and partly internationally coordinated. During the Great Depression for several years fiscal policy tried to stabilize budgets instead of aggregate demand, and either monetary policy was not applied or was rather ineffective insofar as deflation turned lower nominal interest rates into higher real rates. Only future research will be able to prove the exact impact of economic policy, but the current tentative conclusion is that economic policy prevented the Recent Crisis from developing into a second Great Depression. This is also a partial vindication for economists. The majority of them might not have been able to predict the crisis, but it shows that the science did learn its lesson from the Great Depression and was able to give decent policy advice to at least limit the depth of the Recent Crisis. --
    Keywords: Financial crisis,business cycle,stabilisation policy,resilience
    JEL: E20 E30 E32 E44 E60 G18 G28
    Date: 2010
  14. By: Lizarazo, Sandra
    Abstract: This paper develops a model of debt and default for small open economies that interact with risk averse international investors. The model developed here extends the recent work on the analysis of endogenous default risk to the case in which international investors are risk averse agents with decreasing absolute risk aversion (DARA). By incorporating risk averse investors who trade with a single emerging economy, the present model offers two main improvements over the standard case of risk neutral investors: i.) the model exhibits a better fit of debt-to-output ratio and ii.) the model explains a larger proportion and volatility of the spread between sovereign bonds and riskless assets. The paper shows that if investors have DARA preferences, then the emerging economy's default risk, capital flows, bond prices and consumption are a function not only of the fundamentals of the economy---as in the case of risk neutral investors---but also of the level of financial wealth and risk aversion of the international investors. In particular, as investors become wealthier or less risk averse, the emerging economy becomes less credit constrained. As a result, the emerging economy's default risk is lower, and its bond prices and capital inflows are higher. Additionally, with risk averse investors, the risk premium in the asset prices of the sovereign countries can be decomposed into two components: a base premium that compensates the investors for the probability of default (as in the risk neutral base) and an ``excess'' premium that compensates them for taking the risk of default.
    Keywords: default; sovereign debt; international investors; risk premium; sovereign spreads
    JEL: F34 E44 F41
    Date: 2010–01–24
  15. By: Porzecanski, Arturo C.
    Abstract: The lesson from abundant history is that, despite decades of constructive innovations in international loan and bond contracts involving sovereign financial obligations, lawyers, bankers, analysts and investors are best advised to operate under no illusions: Sovereigns are indeed sovereign. To those who harbored the hope that Argentina’s bad behavior as a sovereign debtor was a major exception that would not soon be repeated, the case of Ecuador’s latest default on shaky claims of the “illegitimacy” of some of its obligations demonstrates that while the absence of sovereign willingness to pay remains rare, it is not rare enough. These rogue sovereign debtors can be effectively restrained only by the forceful actions of other sovereigns, bilaterally or multilaterally, but in this case, in a repetition of attitudes shown toward Argentina since 2002, the international official community not only failed to condemn Ecuador’s actions, but actually expressed verbal and provided financial support. The government in Quito gathered no plaudits from the many national and international NGOs that have been campaigning for the massive forgiveness of developing-country debt, but at least this attitude is understandable: the case of Ecuador did not lend itself to arguments in favor of repudiation on “odious debt” or any related grounds. Above all, the country provides a useful, cautionary tale of the bad things that can happen to good sovereign debt contracts.
    Keywords: International finance; sovereign debt; default; Latin America; Argentina; Ecuador
    JEL: F34 F5 F3 F51
    Date: 2010–02

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