Showing papers on "Foreign exchange market published in 1981"
TL;DR: In this article, the authors examined the forward and futures prices in foreign exchange in an attempt to distinguish between the competing explanations for the differences between the two markets, and concluded that the differences are due to a combination of the CIR effect and the transaction costs common to both markets.
Abstract: Empirical studies of the Treasury Bill markets have revealed substantial differences between the futures price and the implied forward price. These differences have been attributed to taxes, transaction costs, and the settling up procedure employed in the futures market. This paper examines the forward and futures prices in foreign exchange in an attempt to distinguish between the competing explanations. EMPIRICAL STUDIES OF THE Treasury bill market have revealed differences between the futures price (or rate) and the implicit forward price derived from the term structure of interest rates.1 These differences have generally been attributed to market "imperfections" such as taxes and transaction costs. (See, for example, Arak [1], Capozza and Cornell [2], and Rendelman and Carabini [6]). Recently, however, Cox, Ingersoll, and Ross [3], henceforth CIR, derived a model in which forward and futures prices need not be equal, even in perfect markets without taxes, as long as interest rates are stochastic. The significance of the CIR effect may be hard to investigate using only data from the bill market, because of the potentially complicating effects of taxes and transaction costs unique to this market. By using data from the foreign exchange market, we are able to eliminate the tax effect and reduce the impact of transaction costs. The question we address is whether the discrepancies observed in the Treasury Bill market are also observed in the foreign exchange market. If they are, then we have evidence that the differences are due to a combination of the CIR effect and the transaction costs common to both markets. If they are not, then either the magnitude of the CIR effect is much less in the foreign exchange market, or the Treasury Bill results are due to the unique tax treatment and transaction costs of that market. This paper is organized as follows. In Section I the trading mechanics of the forward and futures markets in foreign exchange are discussed. Section II reviews the explanations for the discrepancies between the forward and futures prices for Treasury Bills. The institutional differences between the foreign exchange and bill markets are also summarized to show which of these explanations cannot apply to the foreign exchange market. In Section III, the data are decribed and the empirical results are presented. The conclusions are summarized in the final section.
179 citations
TL;DR: This article developed a dynamic partial equilibrium model of the foreign exchange market extending the standard textbook model in two respects: first, capital account transactions are explicitly incorporated into the model, and secondly, 'rational' speculative behaviour is also introduced.
Abstract: This paper develops a dynamic partial equilibrium model of the foreign exchange market extending the standard textbook model in two respects. First, capital account transactions are explicitly incorporated into the model, and secondly, 'rational' speculative behaviour is also introduced. At a point in time, or in a given day, exchange rate fluctuations are dominated by 'new information' that leads to revision of speculative expectations, as well as by other disturbances on the capital account. In the long run, fundamental factors, such as divergences of inflation rates and real changes influencing the trade balance, become relevant in determining the 'trend' of the exchange rate. A variety of exercises, and numerical simulations, illustrate the usefulness of the dynamic supply-demand model in understanding the behaviour of floating exchange rates in a world of high capital mobility.
127 citations
TL;DR: In this paper, models predicting overshooting and magnification, respectively, will be checked for their consistency with two key empirical regularities: A The observed pattern of price level vs exchange-rate volatility B The observed patterns of spot exchange rate vs forward exchange rate volatility.
86 citations
TL;DR: In this article, a quantitative assessment of the role of different assumptions about the values of key trade elasticities is provided, supporting the structuralist view that it is not sufficient to look at problems of adjustment only at the macroeconomic level.
Abstract: An acute shortage of foreign exchange has been a recurring problem for many developing economies. This paper reexamines the foreign exchange gap issue and the debate between structuralists and neoclassicists by providing a quantitative assessment of the role of different assumptions about the values of key trade elasticities. It also seeks to complement the existing descriptive analysis of the consequences of alternative adjustment mechanisms with a quantitative analysis that indicates the relative importance of different behavioural assumptions and policy regimes. The empirical analysis is based on a computable general equilibrium model which is Walrasian in spirit and captures price mechanisms, market interactions, and structural interdependence in a non-linear multisector framework. The analysis lends support to the structuralist view that it is not sufficient to look at problems of adjustment only at the macroeconomic level.
82 citations
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TL;DR: This paper developed a dynamic partial equilibrium model of the foreign exchange market extending the standard textbook model in two respects: first, capital account transactions are explicitly incorporated into the model, and secondly, 'rational' speculative behaviour is also introduced.
Abstract: This paper develops a dynamic partial equilibrium model of the foreign exchange market extending the standard textbook model in two respects. First, capital account transactions are explicitly incorporated into the model, and secondly, 'rational' speculative behaviour is also introduced. At a point in time, or in a given day, exchange rate fluctuations are dominated by 'new information' that leads to revision of speculative expectations, as well as by other disturbances on the capital account. In the long run, fundamental factors, such as divergences of inflation rates and real changes influencing the trade balance, become relevant in determining the 'trend' of the exchange rate. A variety of exercises, and numerical simulations, illustrate the usefulness of the dynamic supply-demand model in understanding the behaviour of floating exchange rates in a world of high capital mobility.
75 citations
TL;DR: This article reviewed the literature on Foreign Exchange Risk Management (FERM) which has burgeoned during the last decade and identified gaps in the existing literature and suggests directions for future research.
Abstract: This paper reviews the literature on Foreign Exchange Risk Management (FERM) which has burgeoned during the last decade. Scholars' and practioners' emerging interest in Foreign Exchange Risk Management was spurred by the advent of fluctuating exchange rates in the early seventies as well as by the pronouncement of the infamous FASB Statement No. 8 in 1976 which laid down unambiguous guidelines for consolidating financial statements of multinational corporations. A normative (rather than a market) view of Foreign Exchange Risk Management is taken and accordingly the author reviews first the two key informational inputs necessary for any Foreign Exchange Risk Management program: forecasting exchange rates and measuring exposure to exchange risk. Available decision models for handling transaction and translation exposures are reviewed next. A concluding section identifies gaps in the existing literature and suggests directions for future research.
71 citations
TL;DR: In this paper, it was shown that the variance bounds on exchange rate movements implied by the monetary approach to exchange rate in an efficient foreign exchange market are violated by sample data and that the forecast errors implied by monetary model can be forecasted using historical data.
Abstract: The variance bounds on exchange rate movements implied by the monetary approach to exchange rate in an efficient foreign exchange market is shown to be violated by sample data. The paper also presents evidence showing that the forecast errors implied by the monetary model can be forecasted using historical data. The results are interpreted to suggest either the incompatibility of the monetary approach with sample data, or an inefficient foreign exchange market or both. MODELS OF EXCHANGE RATE determination based on the monetary approach to the balance of payments imply, when coupled with an interest rate parity relation and the assumption of an efficient foreign exchange market, that exchange rates are related to a long average of money stocks differentials.1'2 The long average is analogous to the difference across countries of the long average of expected future money stocks which was supposed to characterize the price level of a single country (see, e.g., Sargent and Wallace [20]). Since long averages are known to have certain smoothing properties, it appears that the observed volatility of exchange rates may be inconsistent with these models. Thus, alternative tests of the models may be produced which rely on those properties. The aim of this paper is to determine if the observed volatility is consistent with those properties. The paper is the first to use tests based on the volatility of the exchange rate in an efficient market model of the monetary approach. The first set of tests is based on the property of implied variance bounds for exchange rate movements, and the second set consists of the more familiar efficient market tests of forecastability. The empirical results violate these two sets of tests of the model, thus casting doubt on the model. Even though the claim that exchange rates are "too" volatile has been commonly made, few direct attempts have been made in the past to determine the validity of the claim. Some studies have presented estimates of variances of spot and forward rates but, lacking an objective criterion to determine what constitutes
66 citations
TL;DR: In this paper, an equilibrium theory of the term structure of the forward premium is proposed for the German and Canadian exchange rates; the results indicate that the data are consistent with this theory for Germany and inconsistent with the theory for Canada.
47 citations
TL;DR: In this paper, a dynamic model of a small, competitive firm which is engaged in domestic production, foreign trade (through exports of its products and/or imports of its inputs), and financial transactions in domestic and foreign currencies is presented.
Abstract: Most proponents and opponents of floating believe that greater variability of foreign exchange rates will increase uncertainty in international transactions and, hence, that the volume of international trade and financial flows will be curtailed without well-developed facilities for hedging against exchange uncertainty. The effects of exchange risk on merchant exporters and importers have been studied by some authors under the assumption of fixed production (Ethier, 1973; Clark, 1973; Hodder, 1977; etc.). Others have investigated the production behaviour of an export firm in a static context (see, for example, Baron, 1976a, b). However, the impact of the greater volatility of exchange rates upon domestic employment and capital accumulation on the one hand and upon international financial transactions on the other has received scant attention in the literature. This paper establishes a dynamic model of a small, competitive firm which is engaged in domestic production, foreign trade (through exports of its products and/or imports of its inputs), and financial transactions in domestic and foreign currencies. Since the firm faces uncertainty about future exchange rates and future prices of outputs and inputs, it attempts to hedge against the risk if it is risk-averse. A forward foreign exchange market is assumed to exist. The firm's decisions on production, investment, forward contracting and financing, which are closely related in the model, are based on exogenously given probability distributions of exchange rates and prices. The paper is planned as follows. Section I presents a model of the firm and formulates its objective function and constraints. Section II solves its maximization problem and interprets the first-order conditions for short-run equilibrium. In particular, three different roles of the firm in the forward exchange or financial market are emphasized: pure hedging, speculative hedging and pure speculation. Section III analyses the dynamic behaviour of a typical open-economy firm. Section IV conducts comparative dynamic exercises of the firm in a long-run steady state equilibrium, and discusses how exchange rate uncertainty affects the firm's optimal decisions. The implications of the purchasing power parity condition are also developed. Section V summarizes our conclusions.
23 citations
TL;DR: In this paper, a simple model of exchange rate determination is proposed and the authors examine the issue of informational efficiency in the context of the foreign exchange market by setting up an exchange rate model and using the equilibrium properties of the model to examine market efficiency.
Abstract: Tests of informational efficiency of a given market involve testing two hypotheses simultaneously: the first is the hypothesis about the structure determining equilibrium prices or returns, and the second is the hypothesis about the information used in formulating expectations and the ability of agents to set current prices to conform with their expected values. We examine this issue in the context of the foreign exchange market by setting up a simple model of exchange rate determination, and using equilibrium properties of the model to examine market efficiency. The model of exchange rate determination involves monetary equilibrium and rational expectations. By virtue of the latter, equilibrium prices, by definition, 'fully reflect' available information, yet we show that conventional tests of market efficiency would fail when confronted by data generated by such a model. We then proceed to define more restrictive and more appropriate concepts of informational efficiency. We also illustrate and clarify a fundamental misconception with current rational expectations models. We believe that the current models employing the rational expectations hypothesis overemphasize the distinction between monetary and real shocks and underemphasize the distinction between permanent and transitory distinctions. For expectations formation, the conventional efficiency tests, it is the latter distinction that is the essential one.(This abstract was borrowed from another version of this item.)
19 citations
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TL;DR: In this article, models predicting overshooting and magnification, respectively, were checked for their consistency with two key empirical regularities: A. The observed pattern of price level vs. exchange-rate volatility.
Abstract: The present paper is intended to accomplish two tasks. First, models predicting overshooting and magnification, respectively, will be checked for their consistency with two key empirical regularities: A. The observed pattern of price level vs. exchange-rate volatility. B. The observed pattern of spot exchange-rate vs. forward exchange-rate volatility. Second, a widely neglected reason for exchange-rate volatility, activist monetary policy, will be studied.
TL;DR: In this paper, the theory of informationally efficient markets (EMIT) is applied to the foreign exchange market and some of its operational implications are illustrated; the EMIT is joined with alternative models of the equilibrium return on the Foreign Exchange market: the Pure Expectations Hypothesis, the Modern Theory and tentative formulations of return as a function of risk.
Abstract: The theory of informationally efficient markets ( EMIT ) is applied to the foreign exchange market and some of its operational implications are illustrated. The EMIT is joined with alternative models of the equilibrium return on the foreign exchange market: the Pure Expectations Hypothesis, the Modern Theory and tentative formulations of return as a function of risk. The alternative joint Hypotheses are rejected by the data but this does not necessarily imply the rejection of EMIT . The rejection may be due to the inadequacies of the equilibrium return models used, notwithstanding the fact that the risk premium has been captured, to a certain extent, in the empirical tests and the evidence against the EMIT weakened.
01 Jan 1981
TL;DR: In the case of the Swiss National Bank, the size of the revaluation came as a surprise as mentioned in this paper, which raised the question whether money stock targeting under a system of flexible exchange rates is the appropriate way of conducting monetary policy in a small open economy.
Abstract: At the beginning of 1975, the Swiss National Bank decided to adopt a money stock target. The adjusted monetary base was chosen as an instrument for controlling the growth in the money stock. The aim of this policy was to maintain a stable price level. When the decision for targeting the money stock was taken, the Swiss National Bank realised that a revaluation of the Swiss franc would be inevitable. However, the size of the revaluation came as a surprise. The exchange rate difficulties emerging in the autumn of 1978, in particular, have raised the question whether money stock targeting under a system of flexible exchange rates is the appropriate way of conducting monetary policy in a small open economy.
TL;DR: In this article, the authors test for the stability of the parameters in the regression relationship and show that variations in the degree of capital market imperfection, in political risk or in transactions costs are sufficient to cause statistically significant breakdowns in the basic relationship given by equation (1).
Abstract: where F and S are, respectively, the forward and spot prices of foreign exchange and r(*), the domestic (foreign) interest rate. Empirically, however, condition (1) does not always appear to have been satisfied, thus raising questions regarding the existence of unexploited profit opportunities in the foreign exchange market. Previous studies have attempted to offer explanations for these apparent deviations from interest parity. For example, Prachowny (1970) emphasized the role of capital market imperfections, Aliber (1973) stressed measurement error and political risk, while Branson (1969) and later Frenkel and Levich (1975) argued that departures from interest parity were due to transactions costs. In Canada, three of these factors have, with perhaps varying degree, had some influence on developments in financial markets during the 1970s. First, as evidence of capital market imperfections, there was the Winnipeg Agreement between the Bank of Canada and the chartered banks which imposed ceilings on large Canadian-dollar short-term bank deposits. Second, there was the potential for an increase in the political riskiness of Canadian-dollar denominated assets following the election of the separatist government in Quebec in late 1976. Finally, there was the market turbulence accompanying the sharp depreciation of the Canadian dollar during 1977 and 1978 and its potential for increased transactions costs in the market for foreign exchange resulting from greater uncertainty regarding exchange rate movements. But how important have these factors been as far as the robustness of the interest parity theorem is concerned? Indeed, have variations in the degree of capital market imperfection, in political risk or in transactions costs been sufficient to cause statistically significant breakdowns in the basic relationship given by equation (1)? This note attempts to throw some light on this question by testing for the stability of the parameters in the regression relationship,
TL;DR: In this article, the authors extended previous tests of weak-form efficiency in foreign exchange markets by testing the efficiency of trades involving a combination of forward markets, and by using data with a daily frequency.
TL;DR: In this article, the authors provide a systematic theoretical analysis of the portfolio selection approach to the determination of interregional and international capital flows, and identify the implications of this analysis for the appropriate specification of short-run econometric models of the foreign exchange market.
Abstract: This study attempts to provide a systematic theoretical analysis of the portfolio selection approach to the determination of inter‐regional and international capital flows, and to identify the implications of this analysis for the appropriate specification of short‐run econometric models of the foreign exchange market
TL;DR: For example, the authors showed that interest rate movements appeared to be the major force affecting exchange rates during the period, however, rising rates of inflation and inflationary expectations, as well as mid-year recessions in most industrial countries, also influenced exchange rate movements.
Abstract: OREIGN exchange markets during 1980 were dominated by ac~iivityin domestic financial markets throughout the world. Dramatic changes in the direction of international capital flows during the year reflected the relatively volatile interest rate movements in the United States. While these interest rate movements appeared to be the major force affecting exchange rates during the period, however, rising rates of inflation and inflationary expectations, as well as midyear recessions in most industrial countries, also influenced exchange rate movements.
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TL;DR: This paper developed a dynamic partial equilibrium model of the foreign exchange market extending the standard textbook model in two respects: first, capital account transactions are explicitly incorporated into the model, and secondly, speculative behavior is also introduced.
Abstract: This paper develops a dynamic partial equilibrium model of the foreign exchange market extending the standard textbook model in two respects First, capital account transactions are explicitly incorporated into the model, and secondly, 'rational' speculative behaviour is also introduced At a point in time, or in a given day, exchange rate fluctuations are dominated by 'new information' that leads to revision of speculative expectations, as well as by other disturbances on the capital account In the long run, fundamental factors, such as divergences of inflation rates and real changes influencing the trade balance, become relevant in determining the 'trend' of the exchange rate A variety of exercises, and numerical simulations, illustrate the usefulness of the dynamic supply-demand model in understanding the behaviour of floating exchange rates in a world of high capital mobility
01 Jan 1981
TL;DR: In this paper, the convergence properties of a generalised crawling peg system for a small economy open to international trade in goods and financial assets were studied, in which the latter is indexed to the target reserve level and to the domestic expected inflation rate.
Abstract: This paper will return to a subject dealt with in a previous essay1 in which we studied the convergence properties of a generalised crawling peg system for a small economy open to international trade in goods and financial assets. By generalised crawling peg we understood gradual movements in several endogenous variables of the economy, namely, the wage rate, the interest rate, prices and the exchange rate, the latter being indexed to the target reserve level and to the domestic expected inflation rate. This was a possible context within which to analyse the crawling peg proposal which was advanced in the 1960s as a type of limited exchange rate flexibility, because of the failure of the system created at Bretton Woods in 1945.
01 Jan 1981
TL;DR: In this article, the authors review the Brazilian experience with the crawling peg and evaluate the experiment, emphasising successes and failures, and conclude that the experiment has been a success and a failure.
Abstract: The purpose of this paper is to review the Brazilian experience with the crawling peg. The first part deals with the relevant historical facts, discussing the introduction and the main features of the Brazilian exchange rate regime. In the second part I proceed critically to evaluate the experiment, emphasising successes and failures. The last section contains a discussion of the alternatives suggested and the main conclusions arising from the analysis in the paper.1
TL;DR: The authors examines the problems airlines and tour companies have faced since then in adjusting their tariffs for value fluctuations in floating currencies, where adoption of the new European Currency Unit might provide a solution.
01 Jan 1981
TL;DR: In this article, the authors examined the position of US labor and the dollar in the currency market and pointed out the volatility of financial markets; the inelasticity of energy demand in view of higher prices, and the protectionism of American unions and corporations.
Abstract: The author sees 1980 as a troubled economic time for the world. He examines the position of US labor and the dollar in the currency market. The trouble is pinpointed as the volatility of financial markets; the inelasticity of energy demand in view of higher prices, and the protectionism of American unions and corporations. (PSB)