nep-ifn New Economics Papers
on International Finance
Issue of 2010‒05‒02
sixteen papers chosen by
Ajay Shah
National Institute of Public Finance and Policy

  1. Foreign direct investment and exchange rate regimes By Matthias Busse; Carsten Hefeker; Signe Nelgen
  2. Evaluating Exchange Rate Management An Application to Korea By David Parsley; Helen Popper
  3. A Concise History of Exchange Rate Regimes in Latin America By Roberto Frankel; Martín Rapetti
  4. Firm-level exchange exposure in the Eurozone By Elaine Hutson; Anthony O'Driscoll
  5. Gold and the U.S. Dollar: Tales from the Turmoil By Massimiliano Marzo; Paolo Zagaglia
  6. The Financial Crisis and Sizable International Reserves Depletion: From 'Fear of Floating' to the 'Fear of Losing International Reserves'? By Joshua Aizenman; Yi Sun
  7. Equity Home Bias in the Czech Republic By Karel Báťa
  8. Foreign Participation in Emerging Markets’ Local Currency Bond Markets By Shanaka J. Peiris
  9. The Forward Premium Puzzle and Latent Factors Day by Day By Kerstin Bernoth; Juergen van Hagen; Casper de Vries
  10. Currency Internationalisation: Analytical and Policy Issues By Hans Genberg
  11. Financial integration and risk-adjusted growth opportunities: a global perspective By Gianni De Nicolò; Luciana Juvenal
  12. Leverage constraints and the international transmission of shocks By Michael B. Devereux
  13. Capital Controls and Monetary Policy in Developing Countries By Juan Antonio Montecino; Jose Antonio Cordero
  14. Capital Flight: China's Experience By Yin-Wong Cheung; XingWang Qian
  15. Onshore and offshore market for Indian Rupee: recent evidence on volatility and shock spillover By Behera, Harendra
  16. Financial Integration in Autocracies: Greasing the Wheel or More to Steal? By Ramin Dadasov; Philipp Harms; Oliver Lorz

  1. By: Matthias Busse; Carsten Hefeker; Signe Nelgen
    Abstract: The paper uses a comprehensive data set with bilateral direct investment flows and establishes the influence of the de-facto exchange rate regime for FDI flows. We find a strong and significant effect from fixed rates on bilateral FDI flows in developed economies, but no significant effect for developing countries. There is thus no general and uniform impact of stable exchange rates on FDI. We provide several possible explanations for this difference.
    Keywords: foreign direct investment, multinational enterprises, exchanges rate regimes
    JEL: F21 F23 O24
    Date: 2010
  2. By: David Parsley (Vanderbilt University, Hong Kong Institute for Monetary Research); Helen Popper (Santa Clara University, Hong Kong Institute for Monetary Research)
    Abstract: This paper uses data-rich estimation techniques to study monetary policy in an open economy. We apply the techniques to a small, forward-looking model and explore the importance of the exchange rate in the monetary policy rule. This approach allows us to discern whether a monetary authority targets the exchange rate per se, or instead simply responds to the exchange rate in order to achieve its other objectives. The approach also removes a downward bias on the estimate of the extent of inflation targeting. We find that this bias is important in the case of Korea, a de jure inflation targeter. In contrast to previous studies, our findings suggest that the Bank of Korea actively targets inflation, not the exchange rate. Apparently, the exchange rate has been only indirectly important in Korea's monetary policy.
    Keywords: Exchange Rates, Exchange Rate Management, Monetary Policy Rule, Inflation Targeting, Exchange Rate Regimes, Exchange Rate Classification, Factor Instrumental Variables
    JEL: F3 F4
    Date: 2009–09
  3. By: Roberto Frankel; Martín Rapetti
    Abstract: This paper analyzes the experience of the major Latin American countries including Argentina, Brazil, Mexico, Colombia, Chile, Peru and others in the post-World-War period, up to the crisis caused by the collapse of the U.S. housing bubble. The authors provide a detailed historical analysis that takes into account the most important economic events that helped determine exchange rate policy, and evaluates the strengths and weaknesses of the various exchange rate regimes, and their impact on outcomes including economic growth and inflation.
    Keywords: capital controls, capital flows
    JEL: O5 O55 F F3 F31 F33
    Date: 2010–04
  4. By: Elaine Hutson (School of Business, University College Dublin); Anthony O'Driscoll (School of Business, University College Dublin)
    Abstract: Using a sample of 1,154 European firms from 11 countries, we show that firm-level exchange exposure for Eurozone and non-Eurozone European firms has increased since the advent of the euro, but this rise was smaller for Eurozone than non-Eurozone firms. The increase in firmspecific risk is offset by a substantial reduction in market-level exchange exposure in most Eurozone countries, so the advent of the Eurozone appears to have been associated with a shift in exchange risk from systematic to firm-specific. We also find that Eurozone firms’ exchange exposure is greater than that of non-Eurozone European firms, and univariate testing confirms the significance of this difference. In a multivariate setting, however, after controlling for countryspecific and firm-specific characteristics that potentially influence the extent of exposure – economic openness, governance factors, firm size, industry and several financial ratios – this difference is no longer apparent.
    Keywords: foreign exchange exposure, euro, Eurozone, economic openness
    Date: 2010–04–13
  5. By: Massimiliano Marzo (Department of Economics, Università di Bologna and Rimini Centre for Economic Analysis); Paolo Zagaglia (Department of Economics, Università di Bologna and Rimini Centre for Economic Analysis)
    Abstract: We investigate how the relation between gold prices and the U.S. Dollar has been affected by the recent turmoil in financial markets. We use spot prices of gold and spot bilateral exchange rates against the Euro and the British Pound to study the pattern of volatility spillovers. We estimate the bivariate structural GARCH models proposed by Spargoli e Zagaglia (2008) to gauge the causal relations between volatility changes in the two assets. We also apply the tests for change of co-dependence of Cappiello, Gerard and Manganelli (2005). We document the ability of gold to generate stable comovements with the Dollar exchange rate that have survived the recent phases of market disruption. Our findings also show that exogenous increases in market uncertainty have tended to produce reactions of gold prices that are more stable than those of the U.S. Dollar.
    Keywords: gold, exchange rates; GARCH, quantile regressions
    JEL: C22 F31 F33
    Date: 2010–01
  6. By: Joshua Aizenman (University of California at Santa Cruz ,Hong Kong Institute for Monetary Research); Yi Sun (University of California at Santa Cruz)
    Abstract: In this paper we study the degree to which emerging markets (EMs) adjusted to the global liquidity crisis by drawing down their international reserves (IR). Overall, we find a mixed and complex picture. Intriguingly, only about half of the EMs depleted their IR as part of the adjustment mechanism. To gain further insight, we compare the pre-crisis demand for IR of countries that experienced sizable IR depletion, to that of countries that did not, and find different patterns between the two groups. Trade related factors (such as trade openness, primary goods export ratio, especially large oil export) seem to play a significant role in accounting for the pre-crisis IR/GDP level of countries that experienced a sizable IR depletion during the first phase of the crisis. Our findings suggest that countries that internalized their large exposure to trade shocks before the crisis, used their IR as a buffer stock in the first phase of the crisis. Their reserves losses followed an inverted logistical curve. After a rapid initial depletion of reserves, within seven months they reached a markedly declining rate of IR depletion, losing not more than one-third of their pre-crisis IR. On the contrary, in the case of countries that refrained from a sizable IR depletion during the first phase of the crisis, financial factors seem more important than trade factors in explaining the initial IR/GDP level. Our results indicate that the adjustment of EMs was constrained more by their fear of losing IR than by their fear of floating.
    Keywords: Trade Shocks, Deleveraging, International Reserves, Emerging Markets
    JEL: F15 F21 F32 F43
    Date: 2009–12
  7. By: Karel Báťa (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: Investors reveal a tendency to prefer domestic over foreign equities despite the financial losses. From institutional perspective the factors that cause home biasness are the barriers to entry the foreign markets, transaction costs, illiquidity, asymmetric information and information costs, corporate governance and inflation and exchange rate risks. Behavioral finance argues that irrationality of investors cause the home biasness. Investors tend to be under the influence of psychological biases: optimism, overconfidence, social identity, narrow framing and loss aversion. In this paper we introduce a model of optimal portfolio of Czech investors with three utility functions: Markowitz, exponential and CRRA. The prediction of the model without short selling suggests that Czech investors should have more than 60 % (between 72 - 83 % for feasible levels of risk aversion) in domestic equities. The OECD data claims that they hold around 87 % in domestic equities.
    Keywords: Equity home bias, optimal investment portfolio, behavioral finance
    JEL: G11
    Date: 2010–04
  8. By: Shanaka J. Peiris
    Abstract: This paper estimates the impact of foreign participation in determining long-term local currency government bond yields and volatility in a group of emerging markets from 2000-2009. The results of a panel data analysis of 10 emerging markets show that greater foreign participation in the domestic government bond market tends to significantly reduce long-term government yields. Moreover, greater foreign participation does not necessarily result in increased volatility in bond yields in emerging markets and, in fact, could even dampen volatility in some instances.
    Keywords: Bond markets , Capital inflows , Cross country analysis , Emerging markets , Foreign investment ,
    Date: 2010–04–05
  9. By: Kerstin Bernoth; Juergen van Hagen; Casper de Vries
    Abstract: We use futures instead of forward rates to study the complete maturity spectrum of the forward premium puzzle from two days to six months. At short maturities the slope coefficient is positive, but these turn negative as the maturity increases to the monthly level. Futures data allow us to control for the influence of an unobserved factor that can be decomposed into a contract-specific and a time-to-maturity effect. Once we do this, we find that the coefficients on the forward premium are much closer to one. The latent factor is shown to be related to conventional proxies of risk.
    Keywords: forward premium puzzle; futures rates; latent factor
    JEL: F31 F37 G13
    Date: 2010–04
  10. By: Hans Genberg (Bank for International Settlements)
    Abstract: Interest in currency internationalisation among policy makers as well as the general public has intensified in recent years. One reason is a view that the global impact of the recent financial crisis has been intensified because of the dominant role of the US dollar in the international financial system. According to this view the system would be less prone to instability if international trade in goods and assets were denominated in a greater variety of currencies and if international reserve holdings were more diversified. Another reason is the perception that having an international currency is associated with significant benefits for the issuing national authorities. This raises the question whether there is a case for policy intervention by national authorities to promote the international use of their currency. This paper addresses this issue. It argues that authorities should not focus their primary attention on climbing the currency internationalization charts. Instead they should consider the pros and cons of policies and institutional changes that may pave the way for the private adoption of the currency in international transactions. The reason is that full internationalization of a currency will not come about unless a certain number of pre-requisites are met. Arguably the most important is that there be no restrictions on cross-border transfers of funds and no restrictions on third party use of the currency in contracts and settlements of trade in goods or assets, and no restriction on including assets denominated in the currency in private or official portfolios. In short, full internationalization of a currency requires full capital account liberalisation. Although there are gains from currency internationalisation, it is an open question whether public policy should attempt to promote it beyond establishing preconditions such as full capital account liberalisation, a deep and dynamic domestic financial market, a well-respected legal framework for contract enforcement, and stable and predictable macro and micro economic policies.
    Date: 2009–10
  11. By: Gianni De Nicolò; Luciana Juvenal
    Abstract: This paper documents the dynamics of financial integration for major advanced and emerging markets economies during the 1994-2009 period, assesses whether advances in integration have had a significant direct positive impact on countries' growth opportunities, and identifies some of the channels through which financial integration may indirectly foster growth. Three main results are obtained. First, financial integration has progressed significantly worldwide and has been fastest in emerging markets. Second, a country's speed of integration predicts its future risk-adjusted growth opportunities, while improved riskadjusted growth opportunities may predict future advances in integration, but not in all cases, suggesting a causal relationship from financial integration to improved real prospects. Third, advances in financial integration foster increased financial openness, financial development, and the liquidity of equity markets, but the reverse does not necessarily hold. Policies aimed at fostering financial integration may be necessary, albeit not sufficient, to allow countries to reap its benefits.
    Keywords: International finance ; Financial risk management
    Date: 2010
  12. By: Michael B. Devereux
    Abstract: Recent macroeconomic experience has drawn attention to the importance of interdependence among countries through financial markets and institutions, independently of traditional trade linkages. This paper develops a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained financial institutions. In the absence of leverage constraints, international portfolio diversification has no implications for macroeconomic comovements. When leverage constraints bind, however, the presence of diversified portfolios in combination with these constraints introduces a powerful financial transmission channel, which results in a high correlation among macroeconomic aggregates during business cycle downturns, quite independent of the size of international trade linkages. Conversely, the paper shows that, conditional on leverage constraints binding, international financial integration through equity markets reverses the sign of the international comovement of shocks, leading comovement to switch from negative to positive.
    Keywords: International finance ; International economic integration ; Business cycles ; Financial leverage
    Date: 2010
  13. By: Juan Antonio Montecino; Jose Antonio Cordero
    Abstract: This paper looks at both the theoretical and empirical literature on capital controls and finds that capital controls can play an important role in developing countries by helping to insulate them from some of the harmful effects of volatile and short-term capital flows. The authors look at controls on capital inflows in Malaysia (1989-1995); Colombia (1993-1998); Chile (1989-1998); and Brazil (1992-1998), and also consider the case of Malaysia’s controls on outflows in 1998-2001. They conclude that there is sufficient backing in both economic theory and empirical evidence to consider more widespread adoption of capital controls in order to address some of the macroeconomic problems associated with short-term capital flows, to enable certain development strategies, and to allow policy makers more flexibility with regard to crucial monetary and exchange rate policies.
    Keywords: capital controls, capital flows
    JEL: O O1 O16 O2 O23 O24 O5 O55 F F2 F20 F21 F3 F32
    Date: 2010–04
  14. By: Yin-Wong Cheung (University of California, Santa Cruz ,Hong Kong Institute for Monetary Research); XingWang Qian (SUNY, Buffalo State College)
    Abstract: We study the empirical determinants of China's capital flight. In addition to the covered interest differential, our empirical exercise includes a rather exhaustive list of macroeconomic variables and a few institutional factors. Overall, our regression exercise shows that China's capital flight is quite well explained by its own history and covered interest differentials. The other possible determinants offer relatively small additional explanatory power. It is also found that China's capital flight responds differently to the components of covered interest differentials and to the positive and negative components of these variables. The response pattern, however, depends on the choice of data frequency. The general impression is that the monthly results are more intuitive than the quarterly ones.
    Keywords: Covered Interest Differential, Forward Premium, Expected Depreciation, Asymmetric Response, Macro Determinants
    JEL: F3 F32 G15
    Date: 2010–03
  15. By: Behera, Harendra
    Abstract: The paper empirically examines the onshore-offshore linkages of the Indian rupee using recently developed multivariate GARCH techniques. The empirical results show that offshore non deliverable forward (NDF) market does not have mean spillover impact on onshore spot, forward and futures market while shocks and volatilities in NDF market influence the onshore markets. The magnitude of volatility spillover from NDF to spot market, which was lower earlier, became higher after the introduction of currency futures in India. This is probably due to the fact that large arbitrage had taken place between futures and NDF market in recent past. Hence, the study suggests the close monitoring of both the onshore and offshore markets.
    Keywords: Non deliverable forward; volatility spillover; multivariate GARCH
    JEL: C22 F31 G13
    Date: 2010–01
  16. By: Ramin Dadasov; Philipp Harms (University of Mainz); Oliver Lorz (
    Abstract: This paper analyzes the influence of financial integration on institutional quality. We construct a dynamic political-economic model of an autocracy in which a ruling elite uses its political power to expropriate the general population. Although financial integration reduces capital costs for entrepreneurs and thereby raises gross incomes in the private sector, the elite may counteract this effect by increasing the level of expropriation. Since de facto political power is linked to economic resources, financial integration also has long-run consequences for the distribution of power and for the rise of an entrepreneurial class.
    Keywords: Institutions, Capital Mobility, Political Economy
    JEL: F21 O16 P48
    Date: 2010

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