nep-ifn New Economics Papers
on International Finance
Issue of 2015‒05‒16
four papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. On the savings wedge in international capital fl ows By Jacek Rothert
  2. Carry and Trend Following Returns in the Foreign Exchange Market By Andrew Clare; James Seaton; Peter N. Smith; Stephen Thomas
  3. International Reserves for Emerging Economies: A Liquidity Approach. By Jung, Kuk Mo; Pyun, Ju Hyun
  4. Uncovered Interest Parity and Monetary Policy Near and Far from the Zero Lower Bound By Menzie D. Chinn; Yi Zhang

  1. By: Jacek Rothert (United States Naval Academy)
    Abstract: I explore the determinants of the savings wedge in international capital flows computed for a sample of 68 developing countries in Gourinchas and Jeanne (2013). I show that size (rather than direction (allocation)) of net capital fl ows we observe in the data is the major driver of the negative correlation between the calibrated savings wedge and productivity growth.
    Date: 2015–04
  2. By: Andrew Clare; James Seaton; Peter N. Smith; Stephen Thomas
    Abstract: Recent research has confirmed the behaviour of traders that significant excess returns can be achieved from following the predictions of the carry trade which involves buying currencies with relatively high short-term interest rates, or equivalently a high forward premium, and selling those with relatively low interest rates. This paper shows that similar-sized excess returns can be achieved by following a trend-following strategy which buys long positions in currencies that have achieved positive returns and otherwise holds cash. We demonstrate that market risk is an important determinant of carry returns but that the standard unconditional CAPM is inadequate in explaining the cross-section of forward premium ordered portfolio returns. We also show that the downside risk CAPM fails to explain this cross-section, in contrast to recent literature. A conditional CAPM which makes the impact of the market return as a risk factor depend on a measure of market liquidity performs very well in explaining more than 90% of the variation in portfolio returns and more than 90% of the average returns to the carry trade. Trend following is found to provide a significant hedge against these risks. The performance of the trend following factor is more surprising given that it does not have the negative skewness or maximum drawdown characteristic which is shown by the carry trade factor.
    Keywords: Forward exchange rate returns, trend following, carry trade, market liquidity and exchange risk
    JEL: F31 G12 G11 G15
    Date: 2015–05
  3. By: Jung, Kuk Mo; Pyun, Ju Hyun
    Abstract: The massive stocks of foreign exchange reserves, mostly held in the form of U.S. T-Bonds by emerging economies, are still an important puzzle. Why do emerging economies continue to willingly loan to the United States despite the low rates of return? We propose that a dynamic general equilibrium model incorporating international capital markets, characterized by a non-centralized trading mechanism and U.S. T-Bonds as facilitators of trade, can provide an answer to this question. Declining financial frictions in these over-the-counter (OTC) markets would generate rising liquidity premiums on U.S. T-Bonds. Meanwhile, the higher liquidity properties of the U.S. T-Bonds would induce recipients of foreign investments, namely emerging economies, to hold more liquidity, that is U.S. T-Bonds, in equilibrium. The prediction of our model is confirmed by an empirical simultaneous equations approach considering an endogenous relationship between OTC capital inflows and reserves holdings.
    Keywords: international reserves, over-the-counter markets, liquidity, simultaneous equations
    JEL: E44 E58 F21 F31 F36 F41
    Date: 2015–05
  4. By: Menzie D. Chinn; Yi Zhang
    Abstract: Relying upon a standard New Keynesian DSGE, we propose an explanation for two empirical findings in the international finance literature. First, the unbiasedness hypothesis – the proposition that expost exchange rate depreciation matches interest differentials – is rejected much more strongly at short horizons than at long. Second, even at long horizons, the unbiasedness hypothesis tends to be rejected when one of the currencies has experienced a long period of low interest rates, such as in Japan and Switzerland. Using a calibrated New Keynesian dynamic stochastic general equilibrium model, we show how a monetary policy rule can induce the negative (positive) correlation between depreciation and interest differentials at short (long) horizons. The tendency to reject unbiasedness for Japan and Switzerland even at long horizons we attribute to the interaction of the monetary reaction function and the zero lower bound.
    JEL: E12 F21 F31 F41 F47
    Date: 2015–05

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