nep-ifn New Economics Papers
on International Finance
Issue of 2011‒02‒26
sixteen papers chosen by
Ajay Shah
National Institute of Public Finance and Policy

  1. Interpreting Currency Movements During the Crisis: What's the Role of Interest Rate Differentials? By Nicoletta Batini; Thomas Dowling
  2. India's financial globalisation By Ila Patnaik; Ajay Shah
  3. Capital Flows, Exchange Rate Flexibility, and the Real Exchange Rate By Jean-Louis Combes; Patrick Plane; Tidiane Kinda
  4. Sudden stops : are global and local investors alike ? By Calderon, Cesar; Kubota, Megumi
  5. Identifying the Weights in Exchange Market Pressure By Franc Klaassen
  6. What is Driving Financial De-dollarization in Latin America? By Mercedes Garcia-Escribano; Sebastian Sosa
  7. Asian Financial Integration: Trends and Interruptions By Eduardo Borensztein; Prakash Loungani
  8. Measuring Financial Market Integration over the Long Run: Is there a U-Shape? By Vadym Volosovych
  9. Exorbitant Privilege and Exorbitant Duty By Pierre-Olivier Gourinchas; Helene Rey; Nicolas Govillot
  10. An Empirical The Restoration of the Gold Standard after the US Civil War: A Volatility Analysis By Max Meulemann; Martin Uebele; Bernd Wilfling
  11. Robust Global Stock Market Interdependencies By Brian M Lucey; Cal Muckley
  12. Capital Controls: Myth and Reality - A Portfolio Balance Approach By Nicolas E. Magud; Carmen M. Reinhart; Kenneth S. Rogoff
  13. European Financial Linkages: A New Look at Imbalances By Claire Waysand; John C De Guzman; Kevin Ross
  14. Capital Account Liberalization and the Role of the RMB By Nicholas Lardy; Patrick Douglass
  15. Monetary policy transmission in an emergingmarket setting By Ila Patnaik; Ajay Shah; Rudrani Bhattacharya
  16. International Risk Sharing in the Short Run and in the Long Run By Marianne Baxter

  1. By: Nicoletta Batini; Thomas Dowling
    Abstract: Using an adaptation of the Uncovered Interest Parity (UIP) condition, this paper analyzes the drivers behind the large, symmetric exchange rate swings observed during the financial crisis of 2008-2010. Employing a Nelson-Siegel model, we estimate yield curves and decompose the exchange rate movements into changes we attribute to monetary policy and a residual. We find that the depreciation phase of the currencies in our sample was largely dominated by safe-haven effects rather than carry trade activity or other return considerations. For some countries, however, the appreciation that began at the end of 2008 seems largely to reflect downward movement in the cumulative revisions to nominal forward differentials, suggesting carry trade.
    Keywords: Currencies , Developed countries , Economic models , Emerging markets , Exchange rate adjustments , Exchange rates , Financial crisis , Global Financial Crisis 2008-2009 , Interest rates , Monetary policy ,
    Date: 2011–01–20
  2. By: Ila Patnaik; Ajay Shah
    Abstract: India embarked on reintegration with the world economy in the early 1990s. At first, a certain limited opening took place emphasising equity flows by certain kinds of foreign investors. This opening has had myriad interesting implications in terms of both microeconomics and macroeconomics. A dynamic process of change in the economy and in economic policy then came about, with a co-evolution between the system of capital controls, macroeconomic policy, and the internationalisation of firms including the emergence of Indian multinationals.Through this process, de facto openness has risen sharply. De facto openness has implied a loss of monetary policy autonomy when exchange rate pegging was attempted. The exchange rate regime has evolved towards greater flexibility.
    Keywords: Capital controls , Capital flows , Economic integration , Exchange rate regimes , External borrowing , Financial sector , Foreign direct investment , Globalization , India , Monetary policy ,
    Date: 2011–01–07
  3. By: Jean-Louis Combes; Patrick Plane; Tidiane Kinda
    Abstract: This paper analyzes the impact of capital inflows and exchange rate flexibility on the real exchange rate in developing countries based on panel cointegration techniques. The results show that public and private flows are associated with a real exchange rate appreciation. Among private flows, portfolio investment has the highest appreciation effect-almost seven times that of foreign direct investment or bank loans-and private transfers have the lowest effect. Using a de facto measure of exchange rate flexibility, we find that a more flexible exchange rate helps to dampen appreciation of the real exchange rate stemming from capital inflows.
    Keywords: Capital flows , Capital inflows , Developing countries , Economic models , Exchange rate appreciation , Exchange rate regimes , External financing , Flexible exchange rates , Private capital flows , Real effective exchange rates ,
    Date: 2011–01–10
  4. By: Calderon, Cesar; Kubota, Megumi
    Abstract: The main goal of this paper is to characterize the determinants of sudden stops caused by domestic vis-a-vis foreign residents. Are the decisions of domestic investors to invest abroad or of foreign investors to cut off funds from the domestic economy governed by the same set of determinants? Given the distribution of different types of sudden stop episodes over time and its different macroeconomic consequences, the authors argue that the determinants may not be alike. Using an effective sample of 82 countries with annual information over the period 1970-2007, the analysis finds that global investors are less likely to stop bringing their capital when their economy is growing and the world interest rate is lower. Domestic agents are more willing to invest abroad if the macroeconomic performance of the domestic economy is poor (high inflation), the financial system is weak, and there are high external savings (current account surpluses). Increasing financial openness makes the domestic country more vulnerable to sudden stops caused by either local or global investors. Finally, countries with higher shares of foreign direct investment are less prone to inflow-driven sudden stops, whereas the opposite holds for outflow-driven sudden stops.
    Keywords: Debt Markets,Emerging Markets,Currencies and Exchange Rates,Economic Theory&Research,Access to Finance
    Date: 2011–02–01
  5. By: Franc Klaassen (University of Amsterdam)
    Abstract: Exchange market pressure (EMP) measures the pressure on a currency
    Keywords: currency crisis models; ERM crisis; exchange rate regime; instrumental variables; monetary policy; persistence
    JEL: E42 E58 F31 F33
    Date: 2011–02–11
  6. By: Mercedes Garcia-Escribano; Sebastian Sosa
    Abstract: In the last decade, a group of Latin American countries (Bolivia, Paraguay, Peru, and Uruguay) experienced a gradual, yet sustained decline in financial dollarization. This paper documents the stylized facts and uses a standard VAR approach to examine the drivers of both deposit and credit de-dollarization. It finds that the exchange rate appreciation has been a key factor explaining deposit de-dollarization. The introduction of prudential measures to create incentives to internalize the risks of dollarization (including an active management of reserve requirement differentials), the development of a capital market in local currency, and de-dollarization of deposits have all contributed to a decline in credit dollarization. Continuing efforts on these fronts, while maintaining macroeconomic stability and strong fundamentals, would help deepening de-dollarization.
    Keywords: Banking sector , Bolivia , Capital markets , Cross country analysis , Dollarization , Exchange rate appreciation , Foreign currency deposit accounts , Latin America , Paraguay , Peru , Uruguay ,
    Date: 2011–01–10
  7. By: Eduardo Borensztein; Prakash Loungani
    Abstract: The paper compares trends in financial integration within Asia with those in industrialized countries and other regional groups. Declines in cross-country dispersion in equity returns and interest rates suggest increased Asian integration, with the process interrupted by crises and global volatility. Cross-border equity and bond holdings have also increased, but Asian countries remain considerably more financially integrated with major countries outside the region than with those within the region. The paper also discusses whether potential benefits of regional financial integration, such as increased risk-sharing and stability of the investor base, have materialized.
    Keywords: Asia , Bond markets , Cross country analysis , Economic integration , Financial crisis , Global Financial Crisis 2008-2009 , Investment ,
    Date: 2011–01–05
  8. By: Vadym Volosovych (Erasmus University Rotterdam)
    Abstract: Using long time series for sovereign bond markets of fifteen industrialized economies from 1875 to 2009, I find that financial market integration by the end of the 20th century was higher than in earlier periods and exhibited a J-shaped trend with a trough in the 1920s. The main reason for the higher financial integration seen today is the recent extensive globalization. Around the turn of the 20th century, countries frequently drifted apart. Conversely, in recent years, the bond markets of most countries have moved together. Both policy variables and the global market environment play a role in explaining the time variation in integration, while 'unexplained' changes in the overall level of country risk are also empirically important. My methodology, based on principal components analysis, is immune to outliers and accounts for global and country-specific shocks and, hence, can capture trends in financial integration more accurately than standard techniques such as simple correlations.
    Keywords: financial markets integration; principal components; sovereign bonds
    JEL: F02 F36 G15 N20
    Date: 2011–01–31
  9. By: Pierre-Olivier Gourinchas (Associate Professor, Univeresity of California, Berkeley (; Helene Rey (Professor, London Business School); Nicolas Govillot (Ecole des Mines)
    Abstract: We update and improve the Gourinchas and Rey (2007a) dataset of the historical evolution of US external assets and liabilities at market value since 1952 to include the recent crisis period. We find strong evidence of a sizeable excess return of gross assets over gross liabilities. The center country of the International Monetary System enjoys an gexorbitant privilegeh that significantly weakens its external constraint. In exchange for this gexorbitant privilegeh we document that the US provides insurance to the rest of the world, especially in times of global stress. This gexorbitant dutyh is the other side of the coin. During the 2007-2009 global financial crisis, payments from the US to the rest of the world amounted to 19 percent of US GDP. We present a stylized model that accounts for these facts.
    Date: 2010–08
  10. By: Max Meulemann; Martin Uebele; Bernd Wilfling
    Abstract: Using a Markov-switching GARCH model this paper analyzes the volatility evolution of the greenback's price in gold from after the Civil War until the return to gold convertibility in 1879. The econometric inference associated with our methodology indicates a switch to a regime of low volatility roughly seven months before the actual resumption. Since this empirical finding is most likely to be reconciled with a change in market expectations, we conclude that expectations affected the exchange rate more than fundamentals. Our analysis also demonstrates that regime switches in the volatility of exchange rates may refl ect historical events that remain undiscovered otherwise.
    Keywords: Monetary history, 19th century, USA, greenback, Markov-switching GARCH models
    JEL: A
    Date: 2011–02
  11. By: Brian M Lucey (Institute for International Integration Studies, Trinity College Dublin); Cal Muckley (Smurfirt Business School, University College Dublin, Dublin 4, Ireland)
    Abstract: In this paper, we examine the scope for international stock portfolio diversification, from the viewpoint of a United States representative investor, in regard to both the Asian and theEuropean stock markets. Our findings indicate that despite correlation style evidence to thecontrary, the European stock markets provide a superior long-term diversification opportunity relative to that provided by the Asian stock markets. Hence, a short-term measurement of interdependence appears to be uninformative with respect to the diversification opportunities of investors with longer term investment horizons. In terms of methodology, we adopt common stochastic trend tests, including a common stochastic trend test which accounts for generalised autoregressive conditional heteroskedasticity effects in conjunction with the recursive estimation of these tests to estimate the development of longterm stock market interdependence linkages. Recursively estimated robust correlations between the international stock markets are utilised to reveal the nature of short-term stock market interdependence linkages.
    Keywords: Stock Market Linkages, Portfolio Diversification, Correlation, Cointegration
    JEL: F3 G1
    Date: 2011–02
  12. By: Nicolas E. Magud; Carmen M. Reinhart; Kenneth S. Rogoff
    Abstract: The literature on capital controls has (at least) four very serious apples-to-oranges problems: (i) There is no unified theoretical framework to analyze the macroeconomic consequences of controls; (ii) there is significant heterogeneity across countries and time in the control measures implemented; (iii) there are multiple definitions of what constitutes a “success” and (iv) the empirical studies lack a common methodology-furthermore these are significantly “overweighted” by a couple of country cases (Chile and Malaysia). In this paper, we attempt to address some of these shortcomings by: being very explicit about what measures are construed as capital controls. Also, given that success is measured so differently across studies, we sought to “standardize” the results of over 30 empirical studies we summarize in this paper. The standardization was done by constructing two indices of capital controls: Capital Controls Effectiveness Index (CCE Index), and Weighted Capital Control Effectiveness Index (WCCE Index). The difference between them lies in that the WCCE controls for the differentiated degree of methodological rigor applied to draw conclusions in each of the considered papers. Inasmuch as possible, we bring to bear the experiences of less well known episodes than those of Chile and Malaysia. Then, using a portfolio balance approach we model the effects of imposing capital controls on short-term flows. We find that there should exist country-specific characteristics for capital controls to be effective. From this simple perspective, this rationalizes why some capital controls were effective and some were not. We also show that the equivalence in effects of price- vs. quantity-capital control are conditional on the level of short–term capital flows.
    JEL: E44 E5 F3 F30 F32 F34 F41
    Date: 2011–02
  13. By: Claire Waysand; John C De Guzman; Kevin Ross
    Abstract: We document external investment positions among European Union countries at the start of the financial crisis through the creation of a new database comprising bilateral external financial asset and liabilities, excluding reserve assets and derivatives. While there are some gaps in the data, the overall coverage of reported bilateral net international investment positions (IIPs) appears satisfactory. The dataset provides a richer picture of financial linkages, enabling us to map the financing of Euro area imbalances. Creditor and debtor positions vis-à-vis the rest of the EU have tended to increase between 2000 and 2008, with capital flowing largely from wealthier to catching-up economies. This has in particular resulted in an increased interdependency among Euro Area economies.
    Keywords: Balance of payments , Cross country analysis , Current account balances , Data collection , Databases , Economic integration , Euro Area , Europe ,
    Date: 2010–12–21
  14. By: Nicholas Lardy (Peterson Institute for International Economics); Patrick Douglass (Peterson Institute for International Economics)
    Abstract: Despite an erosion of consensus on its benefits, capital account convertibility remains a long-term goal of China. This paper identifies three major preconditions for convertibility in China: a strong domestic banking system, relatively developed domestic financial markets, and an equilibrium exchange rate. The authors examine each of these in turn and find that, in significant respects, China does not yet meet any of the conditions necessary for convertibility. They then evaluate China’s progress to date on capital account liberalization, including recent efforts to promote RMB internationalization and greater use of the RMB in trade settlement. The paper concludes with an overview of remaining obstacles to convertibility and policy recommendations.
    JEL: G15 G21 O16 F31
    Date: 2011–02
  15. By: Ila Patnaik; Ajay Shah; Rudrani Bhattacharya
    Abstract: Some emerging economies have a relatively ineffective monetary policy transmission owing to weaknesses in the domestic financial system and the presence of a large and segmented informal sector. At the same time, small open economies can have a substantial monetary policy transmission through the exchange rate channel. In order to understand this setting, we explore a unified treatment of monetary policy transmission and exchangerate pass-through. The results for an emerging market, India, suggest that the most effective mechanism through which monetary policy impacts inflation runs through the exchange rate.
    Keywords: Economic models , Emerging markets , Exchange rates , Monetary policy , Monetary transmission mechanism ,
    Date: 2011–01–06
  16. By: Marianne Baxter
    Abstract: International risk-sharing has far-reaching implications both for economic policy and for basic research in economics. When countries do not share risk, individuals in those countries experience fluctuations in their consumption levels that are undesirable and possibly unnecessary. This paper extends and refines the study of international risk-sharing in two dimensions. First, this paper investigates risk-sharing at short vs. long horizons. Countries might, for example, pool risks associated with high-frequency shocks (e.g., seasonal fluctuations in crop yields) but might not share risks associated with low frequency shocks (e.g., different long-run national growth rates). Second, this paper studies bilateral risk-sharing, which is different from the approach taken in most previous studies. We find that there is evidence of substantial international risk-sharing at medium and low frequencies. There is evidence of high and increasing risk-sharing within Europe that is not apparent for other regions of the world.
    JEL: E2 E21 E32 F11 F15 F2 F4 F41
    Date: 2011–02

This nep-ifn issue is ©2011 by Ajay Shah. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.