Showing papers on "Foreign exchange market published in 1979"

Money in International Exchange: The Convertible Currency System

Abstract: Focusing on monetization of international trade per se, this text analyses common financial practices of merchants and manufacturers, commercial banks, and central banks.

Commodity Futures and Spot Price Determination and Hedging in Capital Market Equilibrium

Abstract: Hedgers are an integral element of most models of futures markets. They are typically viewed as involved in the storage or production process and attempting by futures market transactions to avoid price risk associated with holdings of the underlying commodity. Speculators accept the risk and receive compensation whose size is in considerable dispute. (Keynes [16], Telser [24], Cootner [6], Dusak [8]). This “insurance” view of hedging is sometimes expanded to allow for “discretionary” or “selective” hedging which tends to arise when expectations differ across individuals. Narrow models of hedging in the commodities market (Johnson [14], Heifner [11], Peck [19]), in the foreign exchange market (Ethier [9]), and in the bank loan market (Pyle [20]) as well as more general models of the determination of spot and futures prices that incorporate hedging (Stein [22]) have preceded or ignored the theory of equilibrium asset prices (Sharpe [21], Lintner [17]). On the other hand, recent models of the valuation of futures contrasts in capital market equilibrium have not considered the role of hedgers (Grauer and Litzenberger [10]).

Exchange Market Pressure in Postwar Brazil: An Application of the Girton-Roper Monetary Model

Abstract: This study applies Lance Girton and Don Roper's (hereafter G-R) monetary model of exchange market pressure to the postwar Brazilian monetary experience. The model was designed specifically for the Canadian managed float during the period 1952-62. The object of their model is to explain what they term "exchange market pressure"; that is, the pressure on foreign exchange reserves and the exchange rate when there exists an excess of domestic money supply over money demand in a managed floating exchange rate regime. The basic theoretical proposition is that any such excess supply of money can be relieved by an exchange depreciation, a loss in foreign reserves, or, in the context of a managed float, by some combination of the two. In this sense, the G-R managed float model used here is firmly rooted in the modern monetary approach to exchange rates and the balance of payments.' Brazil provides a particularly good example for testing this approach, not only because it is in many senses a unique example of a postwar managed float system, but also because it can be treated as a "small, open" economy in the sense that world prices and monetary conditions faced by Brazil are taken as given. This particularly suits the purpose of most modern monetary models which make this assumption and obviates the problems of monetary dependence and neutralization dealt with in the pioneering G-R paper. Specifically, the small-country assumption permits us to devise a simple one-country equation of managed floating which depends upon four essential ingredients: 1) money demand, 2) money supply, 3) purchasing power parity, and 4) monetary equilibrium.2 Furthermore, in Brazil a much greater proportion of exchange market pressure was absorbed by exchange rate depreciation than in the Canadian case where changes in reserves were large relative to exchange rate movements. In short, postwar Brazil provides a singularly good opportunity to test the monetary model of exchange market pressure. Section I briefly states the essential elements of the monetary model, and derives the equation to be tested for the Brazilian experience from 1955 to 1975. Section II reports empirical results for the exchange market pressure model, and Section III examines the applicability of the relative version of purchasing power parity for the time period considered. Section IV summarizes the results and discusses the merits of the monetary approach in light of the Brazilian experience.

Foreign Exchange Rate Forecasting Techniques: Implications for Business and Policy

Abstract: FOREIGN EXCHANGE RATE FORECASTING is a growth industry. At least 23 commercial services throughout the world, employing a variety of techniques, now provide foreign exchange rate forecasts. The purpose of this paper is to review and evaluate these techniques and services and to consider the implications of the findings for business and policy. The paper first considers whether foreign exchange rate forecasting is futile in light of the evidence that the foreign exchange market is an efficient market. Ten major forecasting services that rely in whole, or in large part, on formal models or decision rules are then evaluated on the basis of their predictive accuracy. Finally, the implications of the findings are considered for corporations trying to manage their foreign exchange exposure and for policy makers concerned about exchange rate stability.

Why Markets in Foreign Exchange Are Different From Other Markets

Abstract: This paper, originally published in the fall 1979 Quarterly Review, explains why unfettered markets cannot determine a price at which the currency of one country exchanges for that of another. In effect, any price will work--something which is not true in other markets. The paper then argues that the only feasible regimes for these special markets are floating exchange rates with capital controls or fixed exchange rates with monetary and budget policy coordination. ; Originally published in Quarterly Review, Fall 1979.

An Example of Exchange Rate Overshooting

Abstract: Advocates of flexible exchange rates have long held that allowing exchange rates to adjust at market determined speeds provides a degree of order to international financial markets that is missing from the system of pegged but adjustable rates. Advocates of pegged but adjustable rates have claimed just the opposite; in their view, a flexible rate system is likely to be dominated by speculators whose actions will result in excessive exchange rate variability. These two views of the foreign exchange market were put to the test in the early 1970's when the major industrial countries moved to a system of flexible rates. As the data has accumulated, advocates of the flexible rate system have been perplexed by the large and abrupt movements shown by some key exchange rates (e.g., the U.S. dollar-Deutschmark rate). These data are clearly consistent with the foreign exchange market's being dominated by "badly behaved" speculators. The important question then is whether or not these data are necessarily inconsistent with the view that flexible exchange rates do not exhibit excessive fluctuations but rather exhibit fluctuations consistent

Growth policies and the exchange rate in Turkey

Abstract: This paper reviews Turkey's growth performance, which has had a pronounced cyclical pattern, and makes recommendations for policies for more stable economic growth. Turkey's growth performance is examined in relation to other major semi-industrialized countries. The economic effects of policy reform in Brazil are examined after a comparison is made between Turkey's economic situation and that of Brazil prior to the policy reforms. The recommended export-oriented strategy includes: (i) transfer of transactions to the parallel foreign exchange market; (ii) reduction of discriminatory measures against primary and manufactured exports and rationalization of tariffs and subsidies; (iii) modifying the allocation of investment funds, increasing their volume, and improving the efficiency of financial markets; (iv) providing incentives for foreign investment; (v) raising of real interest rates and development of bond and stock markets; and (vi) administrative and institutional reforms.

Efficient market implications for foreign exchange exposure management

Abstract: Under the hypothesis of efficient foreign exchange markets, the validity of the Purchasing Power Parity theorem may take care of the company’s uncertainty with respect to the mean value of its foreign currency portfolio. The remaining uncertainty, i.e. the variance of the value of the foreign currency portfolio around its mean, can be reduced by hedging. Assuming efficient markets, the expected cost of hedging is equal to the transaction costs incurred. Taking into account the low cost of hedging, one can substantially reduce the foreign exchange risk at a relatively low cost. Hedging should be used more extensively than is common practice.

Cross Country Effects of Sterilization, Reserve Currencies and Foreign Exchange Information

Abstract: This study examines the international repercussions of national sterilization policies under fixed exchange rates and managed flexibility. The effects of sterilization on the country pursuing the policy are well-known, but the adverse effects on other countries have not been adequately explored. In this study, a stochastic framework is used to analyze the impact of balance of payments disturbances on key financial variables in the domestic and foreign countries. The effects of sterilization are explored under fixed rates, and the combined effects of foreign exchange intervention and sterilization are similarly investigated in a regime of managed flexibility. In either regime, sterilization by the foreign country imposes costs on the domestic country by magnifying the impact of balance of payments disturbances on the domestic financial market. The analysis has important implications for the use of reserve currencies: Countries issuing reserve currencies benefit from the automatic sterilization of their balance of payments surpluses or deficits, while countries using reserve currencies encounter the same cross country effects as with discretionary sterilization.

Testing for the Role of Speculation in the Forward Exchange Market: Some Problems if There are Fisherian Expectations

Abstract: Tests of the so-called modern theory of the foreign exchange market (MT) have differed over the relative importance of interest arbitrage and speculation in forward exchange rate determination. For the Canadian-U.S. foreign exchange market, whereas Kesselman (1971) and Haas (1974) found the speculative demand schedule to have approximately the same slope as the arbitrage schedule, in a recent article in this REVIEW, McCallum's (1977) results using a rational expectations approach supported Stoll (1968). He stated that "the supply of arbitrage funds is highly elastic, relative to the supply of speculative funds" (McCallum, 1977, p. 150).1 In this note we point out that to the extent domestic financial markets and thus foreign exchange markets reflect Fisherian expectations about price changes and exchange rate changes, attempts to test the so-called modern theory of the foreign exchange market have been misinterpreted and also may have been misspecified. In fact, with purely Fisherian expectations, the MT is empirically unidentifiable and thus impossible to test. The MT expresses the forward premium as a weighted average of the interest-parity forward premium and the expected change in the spot rate. Problems in estimating the MT have primarily centered around what to use as a representation of the expected spot rate (often referred to as "unobservable"2): Stoll (1968) used an adaptive expectations, weighted average of past spot rates while Kesselman (1971) and Haas (1974) used "dual mechanistic" weighted averages of past spot rates, incorporating both extrapolative and regressive elements (Kesselman also incorporated some real world variables). McCallum (1977) alternatively uses "rational" expectations in the sense of Muth (1961). He uses the actual spot rate in existence at the maturity of the forward contract as a proxy for expectations that are formed rationally, treating the subsequent spot rate as an endogenous variable by utilizing a two-stage estimation technique with the exogenous variables of the system and lagged spot rates used as instruments in the first stage. The possibility of the existence of Fisherian exchange rate expectations has been derived from a Fisherian model of the relationships between real and nominal interest rates in domestic financial markets and has been outlined in Aliber (1975), Giddy (1976), Kohlhagen (1978), Pippenger (1972), Porter (1971), Willett (1970, 1972), and Willett, Katz, and Branson (1970). In such a model (adopting McCallum's (1977) notation and three-period maturity framework), the nominal interest rates in the United States (iut) and Canada (ict) are equal to the real rates (rut and rct, respectively) plus the expected rate of change of prices (1TeUt and 7TeCt, respectively):

Foreign Exchange Market Efficiency Under Flexible Exchange Rates: Comment

Abstract: IN A RECENT ARTICLE appearing in this Journal, Burt, Kaen and Booth (henceforth known as BKB) examine the efficiency of the spot exchange markets of Canadian dollars, German marks and British pounds. They claim that "the efficient market hypothesis may be accepted for the German mark and the British pound but should be rejected for the Canadian dollar". The rejection of the efficiency hypothesis for the Canadian dollar is based on BKB results that "daily price changes tended to underrespond to new information". BKB then attributed the underresponse to "the efficacy of central bank intervention and the institutional character of the Canadian dollar exchange market". However, we do not believe that central bank intervention or possible institutional differences can explain the lack of price response found by BKB for Canada. The central banks of each of these three countries were actively intervening to "stabilize" exchange rates over the period. Also, the thinness of the Canadian dollar market, or the fact that the Canadian dollar was not an "international vehicle currency", cannot explain the results, given the high levels of non-domestic Canadian dollar financing done by Canadians for example in London. An alternative and more general explanation of the BKB results can be obtained by more closely examining what is actually being tested. BKB are not testing the single hypothesis of whether the Canadian foreign exchange market is efficient. Instead they are testing the joint hypothesis that their model of how market equilibrium is attained is relevant, and that given the model, market behavior is consistent with.efficiency. The authors reject their joint hypothesis for Canada. However, this negative result does not indicate which portion of the joint hypothesis is being rejected. It is quite possible that exchange rate market behavior is actually efficient. The test rejection then applies to the model of how market equilibrium is attained. In order to distinguish between each of the joint hypothesis, an alternative model must be considered.

Analysis of the choice between domestic and foreign loan facilities

Abstract: When a corporation borrows from a non-domestic source, such as the Eurobond market, it is obliged to make interest payments in a foreign currency at pre-determined periods throughout the life of the loan. By doing this the corporation incurs an exchange risk which may outweigh any advantages of borrowing foreign currencies such as lower interest rates. This note describes a criterion which assists the corporate treasurer in his choice of currency by showing the exchange rates at the end of the life of the loan implied by each choice.

Exchange rate policy and the dual role of exchange rate movements in international adjustment

Abstract: 1. The Problem of International Adjustment and Its Relevance Over the past few years, the foreign exchange value of the dollar has gradually emerged as a primary concern of United States monetary authorities. This growing concern is well illustrated by a sampling of Wall Street Journal headlines. For example, on January 10, 1978, a headline read “Federal Reserve Moves to Tighten Credit in Escalating Effort to Bolster U. S. Dollar.” By November 1 of that year, the dollar had depreciated 35 percent against the Swiss franc, with most of the depreciation occurring after midyear. Other major exchange rates also moved substantially against the dollar with the result that U. S. officials came under heavy pressure to intervene in the foreign exchange market to prevent a further decline in the value of the dollar. On November 1, U. S. authorities publicly announced their intention to support the dollar with appropriate monetary policies, including direct intervention in the foreign exchange market. This policy was reported on November 1 in the headline “Dollar Dilemma-Bold Currency Support Announced by the U. S. Raises Recession Risks.” Although there was no official commitment to a particular rate, the decision represented a significant change of policy. Never since World War II had the U. S. publicly committed itself to intervene directly in the foreign exchange market on such a large scale to stabilize the exchange rate. While exchange rates fluctuated considerably in the months following November 1, on the whole, the policy action succeeded in arresting the dollar depreciation. In July, however, the renewed depreciation of the dollar began to concern U. S. officials. This time the Federal Reserve responded directly to events on the foreign exchange market by raising the Federal funds rate. This action was reported in a July 7 headline reading “Tighter Credit Policy of Fed Facing Test on the Foreign Exchange Market.” What is the reason for this “dollar dilemma” as it was called in the November 1 headline? Why should a sudden large exchange rate movement concern policymakers? And even if there are valid reasons for concern, what prevents the monetary authority from pegging the exchange rate if it so desires? These are the questions the article seeks to address. The sources of this policy dilemma stem from the operation of the international adjustment mechanism. This mechanism refers to the manner in which interaction among world goods markets and the foreign exchange market produces terms of trade, trade balance, and exchange rate responses to economic disturbances. It must be emphasized that the word response here refers not only to the immediate effects of disturbances but also to any persistence of the effects that may be produced by the adjustment mechanism itself. An important issue related to persistence concerns how long it takes for adjustment to occur, and whether that adjustment is, in fact, stable. If noninterference in the foreign exchange market is to be an acceptable policy alternative, then the exchange rate must automatically converge to a stable equilibrium following a disturbance. Otherwise, the exchange rate may in fact require official management. This article is partly concerned with examining potential adverse effects of allowing exchange rate movements to play a role in adjustment. Consequently, the body of this article is devoted to investigating the function of exchange rate movements in the adjustment process. It turns out that the source of the dilemma involved in holding the exchange rate fixed is easily recognized once the role of exchange rate movements in equilibrating the foreign exchange market is made clear. Exchange rate movements are shown to function in two ways in the adjustment mechanism: first, by changing the relative price of domestic and foreign produced goods in international trade, and second, by revaluing stocks of domestic relative to foreign assets in portfolios. Analysis of the terms of trade effect of