nep-ifn New Economics Papers
on International Finance
Issue of 2010‒05‒15
thirteen papers chosen by
Ajay Shah
National Institute of Public Finance and Policy

  1. The Impact of Central Bank's intervention in the foreign exchange market on the Exchange Rate: The case of Zambia (1995-2008) By Mwansa, Katwamba
  2. Exchange Rate Flexibility Across Financial Crises By Virginie Coudert; Cecile Couharde; Valerie Mignon
  3. Off-the-Record Target Zones: Theory with an Application to Hong Kong’s Currency Board By Yu-Fu Chen; Michael Funke; Nicole Glanemann
  4. Dynamic Correlation Analysis of Financial Spillover to Asian and Latin American Markets in Global Financial Turmoil By Matthew S. Yiu; Wai-Yip Alex Ho; Lu Jin
  5. Should Central Banks of Small Open Economies Respond to Exchange Rate Fluctuations? The Case of South Africa By Sami Alpanda; Kevin Kotze; Geoffrey Woglom
  6. Substitution between domestic and foreign currency loans in Central Europe. Do central banks matter? By Michał Brzoza-Brzezina; Tomasz Chmielewski; Joanna Niedźwiedzińska
  7. Offshore Markets for the Domestic Currency: Monetary and Financial Stability Issues By Dong He; Robert N. McCauley
  8. Zimbabwe’s Currency Crisis: Which Currency To Adopt In The Aftermath Of The Multi-Currency Regime? By Makochekanwa, Albert
  9. Determinants of intra-euro area government bond spreads during the financial crisis By Salvador Barrios; Per Iversen; Magdalena Lewandowska; Ralph Setzer
  10. Private Capital Flows to Low Income Countries: Country-Specific Effects and the Lucas Paradox By Sweder van Wijnbergen; Corine Franken
  11. Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach By Olivier Jeanne; Anton Korinek
  12. Information Flows around the Globe: Predicting Opening Gaps from Overnight Foreign Stock Price Patterns By Jan G. de Gooijer; Cees G.H. Diks; Lukasz T. Gatarek
  13. Gravity in International Finance By Yohei Okawa; Eric van Wincoop

  1. By: Mwansa, Katwamba
    Abstract: The central bank of Zambia called Bank of Zambia (BOZ) has, like many other central banks in both developing and developed economies, been from time to time intervening in the foreign exchange market by either purchasing or selling foreign exchange (mainly United States of America Dollars) to the market. Central banks have given a myriad of reasons for this particular behaviour. Chief among these and which is the focus of this paper is to smooth volatility or reverse a trend of the domestic currency in this case the kwacha. Despite central banks’ intervention activities in the foreign exchange markets, literature on the efficacy of these interventions in terms of impacting domestic currencies has remained controversial. While some strands of literature seem to suggest that such intervention has an impact on the currencies some literature disagrees. Early studies done in the 1980s suggest that intervention operations do not affect the exchange rate and if they do this effect is very small and only in the short run. More recent studies however, have found evidence of the effect on both the level and volatility of exchange rates. Further, recent studies focused on emerging market and developing countries have found strong evidence of the effect of central banks’ intervention operations in the foreign exchange market on exchange rates. This paper therefore examines the effect of the BOZ’s foreign currency market interventions on the level and volatility of the kwacha/ USD exchange rate between 1995 and 2008. In order to study the impact of interventions on the kwacha, the paper uses monthly data (both sales and purchases) on foreign exchange intervention and employs the GARCH (1, 1) and Exponential GARCH frameworks to model volatility. The results from GARCH model suggest that sales of foreign exchange in this case the $ causes the exchange rate to appreciate while purchases of the $ cause the exchange rate to depreciate. As for the impact on volatility, the GARCH (1, 1) model reveals that BOZ interventions increase volatility. Empirical results from the EGARCH model on the other hand suggest that both sales and purchases of $ cause the exchange rate to appreciate. The results on the impact of intervention on volatility are mixed though generally intervention appears to be increasing volatility.
    Keywords: foreign exchange intervention; Bank of Zambia; EGARCH
    JEL: F31 A10
    Date: 2009–05
  2. By: Virginie Coudert; Cecile Couharde; Valerie Mignon
    Abstract: This paper studies the impact of global financial turmoil on the exchange rate policies in emerging countries. Many emerging countries have loosened the link of their currencies to the US dollar since the bursting of the subprime crisis in July 2007. Spillovers from advanced financial markets to currencies in emerging countries stem from the same causes documented in the literature on contagion, such as the drying–up of investors’ liquidity, the rise in risk aversion, and the updating of their risk assessments. Consequently, interdependencies across currencies are likely to be exacerbated during crisis periods. To test this hypothesis, we assess the exchange rate policies by their degree of flexibility, itself proxied by the exchange rate volatility, and investigate their relationship to a global financial stress indicator, measured by the volatility on global markets. We introduce the possibility of non-linearities by running smooth transition regressions (STR) over a sample of 21 emerging countries from January 1994 to September 2009. The results confirm that exchange rate flexibility does increase more than proportionally with the global financial stress, for most countries in the sample. We also evidence regional contagion effects spreading from one emerging currency to other currencies in the neighboring area.
    Keywords: Financial crises; dollar pegs; contagion effects; nonlinearity
    JEL: F31 G15 C22
    Date: 2010–04
  3. By: Yu-Fu Chen; Michael Funke; Nicole Glanemann
    Abstract: This paper provides a modelling framework for evaluating the exchange rate dynamics of a target zone regime with undisclosed bands. We generalize the literature to allow for asymmet- ric one-sided regimes. Market participants' beliefs concerning an undisclosed band change as they learn more about central bank intervention policy. We apply the model to Hong Kong's one-sided currency board mechanism. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities nally revamped the regime as a symmetric two-sided system with a narrow exchange rate band.
    Keywords: Currency Board Arrangement, Target Zone Model, Hong Kong
    JEL: C61 E42 F31 F32
    Date: 2010–05
  4. By: Matthew S. Yiu (Research Department, Hong Kong Monetary Authority); Wai-Yip Alex Ho (Research Department, Hong Kong Monetary Authority); Lu Jin (Research Department, Hong Kong Monetary Authority)
    Abstract: This paper investigates the spillover of financial crises by studying the dynamics of correlation between eleven Asian and six Latin American stock markets vis-¨¤-vis the US stock market. A regional factor that drives common movements of stock markets in each region is identified for the period from 1993 to early 2009. We then estimate the time-varying volatility correlation between the regional factor and the US stock market by an asymmetric dynamic conditional correlation model. We find that there is a significant rise in the estimated time-varying correlation in the period from August 2007 to March 2009, suggesting evidence of contagion from the US stock market to markets in the two regions during the global financial turmoil. The magnitude of the contagion effect to both regions in the global financial crisis is very similar, albeit their different economic, political and institutional characteristics. On the other hand, we find no evidence of having contagion from the US to the Asian region during the Asian financial crisis in 1997 and 1998 as expected, since the crisis was originated locally.
    Keywords: Principal Component, Financial Contagion, Financial Crisis, Dynamic Conditional Correlation, Asia Pacific Economies, Latin American Economies
    JEL: F30 G15 G12
    Date: 2010–04
  5. By: Sami Alpanda; Kevin Kotze; Geoffrey Woglom
    Abstract: We estimate a New Keynesian small open economy DSGE model for South Africa, using Bayesian techniques. The model features imperfect competition, incomplete asset markets, partial exchange rate pass-through, and other commonly used nominal and real rigidities, such as sticky prices, price indexation and habit formation. We study the effects of various shocks on macroeconomic variables, and calculate the optimal Taylor rule coefficients using a loss function for the central bank. We find that the optimal Taylor rule places a heavier weight on inflation and output than the estimated Taylor rule, but almost no weight on the depreciation of currency.
    Keywords: optimal monetary policy, small open economy, Bayesian estimation
    JEL: F41 E52
    Date: 2010
  6. By: Michał Brzoza-Brzezina (National Bank of Poland, ul. Świętokrzyska 11/21, 00-919 Warszawa, Poland.); Tomasz Chmielewski (Warsaw School of Economics, al. Niepodległości 162, 02-554 Warszawa, Poland.); Joanna Niedźwiedzińska (National Bank of Poland, ul. Świętokrzyska 11/21, 00-919 Warszawa, Poland.)
    Abstract: In this paper we analyse the impact of monetary policy on total bank lending in the presence of a developed market for foreign currency denominated loans and potential substitutability between domestic and foreign currency loans. Our results, based on a panel of four biggest Central European countries (the Czech Republic, Hungary, Poland and Slovakia) confirm significant and probably strong substitution between these loans. Restrictive monetary policy leads to a decrease in domestic currency lending but simultaneously accelerates foreign currency denominated loans. This makes the central bank’s job harder. JEL Classification: E44, E52, E58.
    Keywords: Domestic and foreign currency loans, substitution, monetary policy, Central Europe.
    Date: 2010–05
  7. By: Dong He (Research Department, Hong Kong Monetary Authority); Robert N. McCauley (Bank for International Settlements)
    Abstract: We show in this paper that offshore markets intermediate a large chunk of financial transactions in major reserve currencies such as the US dollar. We argue that, for emerging market economies that are interested to see some international use of their currencies, offshore markets can help to increase the recognition and acceptance of the currency, while still allowing the authorities to retain a measure of control on the pace of capital account liberalisation. The development of offshore markets could pose risks to monetary and financial stability in the home economy, which need to be prudently managed. Experience in dealing with the Euromarkets by the Federal Reserve and other authorities of the major reserve currency economies show that policy options are available for managing such risks.
    Keywords: offshore markets; currency internationalisation; monetary stability; financial stability
    JEL: E51 E58 F33
    Date: 2010–03
  8. By: Makochekanwa, Albert
    Abstract: The study presented main features of possible currency options which can be potentially adopted by Zimbabwe in the aftermath of multi-currency regime. The currency options analyzed are dollarization, joining the CMA and re-introduction of the Zimbabwe dollar (Z$). The proposed management systems to underpin the reintroduction of the Zimbabwean dollar are currency board, free banking and Reserve Bank of Zimbabwe (RBZ). For each of the options analyzed, the practicality of Zimbabwe in adopting and/or implementing such currency was also explained. Although any of the three options could be adopted and implemented, the study considered the options in the following descending order of priority: (i) dollarization, (ii) retaining the Z$ but under the management system of a currency board, (iii) Joining the CMA, (iv) retaining the Z$ under the management of RBZ, with the institution having new management, and lastly (v) free banking.
    Keywords: Multi-currency; hyperinflation; dollarization; currency board; free banking
    JEL: F32 F31
    Date: 2009–12–28
  9. By: Salvador Barrios; Per Iversen; Magdalena Lewandowska; Ralph Setzer
    Abstract: This paper provides an empirical analysis of the determinants of government bond yield spreads in the euro area with a focus on developments during the global financial crisis that started in 2007. In line with the previous literature, we find that international factors, in particular general risk perception, play a major role in explaining governments bond yields differentials. While domestic factors such as liquidity and sovereign risk appear to be smaller but non-negligible drivers of yield spreads our results point to significant interaction of general risk aversion and macroeconomic fundamentals. Moreover, the impact of domestic factors on bond yield spreads increase significantly during the crisis, when international investors started to discriminate more between countries. In particular, the combination of high risk aversion and large current account deficits tend to magnify the incidence of deteriorated public finances on government bond yield spreads. Overall, our results suggest that an improvement in global risk perception will lead to a narrowing of intra-euro area bond yield differentials. However, the differing impact of the crisis on Member States' public finances and the expected higher risk awareness of investors after the crisis could keep government bond yield spreads at a higher level then in the pre-crisis period.
    Keywords: sovereign bond, intra-euro area government bond spreads, spread determinants, financial crisis Barrios, Iversen, Lewandowska, Setzer
    JEL: E44 F36 G12 G15
    Date: 2009–11
  10. By: Sweder van Wijnbergen (University of Amsterdam); Corine Franken (Nomura)
    Abstract: This paper analyses Net Private Capital Flows to LICs incorporating the recent surge in FDI between 2000 and 2006. We show that including country-specific effects in a paneldata setup resolves the Lucas Paradox, at least for LICs. Our results suggest that openness is among the most important factors explaining country-specific performance in attracting Net Private Capital Flows.
    Keywords: Private capital inflows; Low Income Countries; Lucas Paradox
    JEL: F21 G15
    Date: 2010–01–13
  11. By: Olivier Jeanne (Peterson Institute for International Economics); Anton Korinek
    Abstract: This paper analyzes prudential controls on capital flows to emerging markets from the perspective of a Pigouvian tax that addresses externalities associated with the deleveraging cycle. It presents a model in which restricting capital inflows during boom times reduces the potential outflows during busts. This mitigates the feedback effects of deleveraging episodes, when tightening financial constraints on borrowers and collapsing prices for collateral assets have mutually reinforcing effects. In our model, capital controls reduce macroeconomic volatility and increase standard measures of consumer welfare.
    Keywords: capital flows, deleveraging episodes, emerging market economies, Pigouvian tax
    JEL: F3 F32 F34 G15 G18 H21
    Date: 2010–05
  12. By: Jan G. de Gooijer (University of Amsterdam); Cees G.H. Diks (University of Amsterdam); Lukasz T. Gatarek (Erasmus University Rotterdam)
    Abstract: This paper describes a forecasting exercise of close-to-open returns on major global stock indices, based on price patterns from foreign markets that have become available overnight. As the close-to-open gap is a scalar response variable to a functional variable, it is natural to focus on functional data analysis. Both parametric and non-parametric modeling strategies are considered, and compared with a simple linear benchmark model. The overall best performing model is nonparametric, suggesting the presence of nonlinear relations between the overnight price patterns and the opening gaps. This effect is mainly due to the European and Asian markets. The North-American and Australian markets appear to be informationally more efficient in that linear models using only the last available information perform well.
    Keywords: Close-to-open gap forecasting; Functional data analysis; International stock markets; Nonparametric modeling
    JEL: C14 C53 F37
    Date: 2009–11–19
  13. By: Yohei Okawa (University of Virginia); Eric van Wincoop (University of Virginia, National Bureau of Economic Research and Hong Kong Institute for Monetary Research)
    Abstract: The past decade has witnessed an explosion of papers estimating gravity equations for cross-border financial holdings. The aim of the paper is to develop a theoretical foundation for the empirical gravity literature applied to finance. The gravity specification is closely analogous to that developed for goods trade, even though it is based on a very different type of theory. We show how the theory can be used to estimate international financial frictions and conduct comparative statics analysis with respect to changes in these frictions. We use a dataset for cross-border equity holdings among 24 industrialized countries to illustrate these results.
    Date: 2010–04

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