Showing papers on "Foreign exchange market published in 2001"

Distinguished Lecture on Economics in Government Exchange Rate Regimes: Is the Bipolar View Correct?

Abstract: “…. the choice of appropriate exchange rate regime, which, for economies with access to international capital markets, increasingly means a move away from the middle ground of pegged but adjustable fixed exchange rates towards the two corner regimes of either flexible exchange rates or a fixed exchange rate supported, if necessary, by a commitment to give up altogether an independent monetary policy.” Lawrence H. Summers (2000), p. 8.

Official Intervention in the Foreign Exchange Market: Is It Effective and, If So, How Does It Work?

Abstract: In this Paper we assess the progress made by the profession in understanding whether and how exchange rate intervention works. To this end, we review the theory and evidence on official intervention, concentrating primarily on work published within the last decade or so. Our reading of the recent literature leads us to conclude that, in contrast with the profession's consensus view of the 1980s, official intervention can be effective, especially through its role as a signal of policy intentions, and especially when it is publicly announced and concerted. We also note, however, an apparent empirical puzzle concerning the secrecy of much intervention and suggest an additional way in which intervention may be effective but which has so far received little attention in the literature, namely through its role in remedying a coordination failure in the foreign exchange market.

Mathematical Methods for Foreign Exchange: A Financial Engineer's Approach

Abstract: Introduction: Foreign Exchange Markets Mathematical Preliminaries: Elements of Probability Theory Discrete-Time Stochastic Engines Continuous-Time Stochastic Engines Discrete-Time Models: Single-Period Markets Multi-Period Markets Continuous-Time Models: Stochastic Dynamics of Forex European Options: The Group-Theoretical Approach European Options, the Classical Approach Deviations from the Black-Scholes Paradigm I: Nonconstant Volatility American Options Path-Dependent Options I: Barrier Options: Path-Dependent Options II: Lookback, Asian and other Options Deviations from the Black-Scholes Paradigm II: Market Frictions Future Directions of Research and Conclusions.

International Trade and Currency Exchange

Abstract: On the international scene, away from national legal rules, the use of different currencies is largely due to the operation of the "Invisible Hand". The paper develops a three-country model of the world economy. This links real trade patterns with currency exchange structures in a general equilibrium framework which includes transaction costs on foreign exchange markets. In the presence of strategic complementarities, there are multiple equilibrium structures of currency exchange for a given underlying real trade pattern. The existence conditions of these different equilibria are characterized, using the trade links between countries as the key parameters. Finally, repercussions on world output of the choice of a currency exchange structure are analysed.

A Reexamination of Exchange-Rate Exposure

Abstract: Finance theory suggests that changes in exchange rates should have little influence on asset prices in a world with integrated capital markets. Indeed, the existing literature examining the relationship between international stock prices and exchange rates finds little evidence of systematic exchange rate exposure. We argue in this paper that the absence of evidence may be due to restrictions imposed on the sample of data and the empirical specifications used in previous studies. We study a broad sample of firms in eight countries over an eighteen-year period. We find that firm-level and industry-level share values are significantly influenced by exchange rates. Further, we do not find evidence that exchange rate exposure is falling (or becoming less statistically significant) over time. Our results suggest that significant firm, industry and country-specific differences remain even as financial markets become more and more "integrated".

Expectations Hypotheses Tests

Abstract: We investigate the expectations hypotheses of the term structure of interest rates and of the foreign exchange market using vector autoregressive methods for U.S. dollar, Deutsche mark, and British pound interest rates and exchange rates. We examine Wald, Lagrange multiplier, and distance metric tests by iterating on approximate solutions that require only matrix inversions. Bias-corrected, constrained VARs provide Monte Carlo simulations. Wald tests grossly overreject the null, Lagrange multiplier tests slightly underreject, and distance metric tests overreject. A common interpretation emerges from the small sample statistics. The evidence against the expectations hypotheses is much less strong than under asymptotic inference. ACCORDING TO THE EXPECTATIONS HYPOTHESIS, information in current interest rates provides the conditional expectation of future asset prices. The expectations hypothesis of the term structure of interest rates ~EH-TS! states that the current term spread between a long-term interest rate and a short-term interest rate is the expected value of a weighted average of the expected future changes in the short-term interest rate. This theory, popularized in the writings of Fisher ~1930!, Keynes ~1930!, and Hicks ~1953!, continues to be a way that many economists think about the determination of long-term interest rates. Fisher ~1930! and Keynes ~1930! also discuss the expectations hypothesis in the foreign exchange market ~EH-FX!, which states that the interest-rate differential between two currencies is the conditional expected value of the rate of depreciation of the high interest-rate currency relative to the low interest-rate currency. Because of covered interest arbitrage, the interest differential equals the forward premium, which is the percentage difference between the forward exchange rate and the spot rate. Hence, the EH-FX is equivalent to the unbiasedness hypothesis, which is the proposition that the logarithm of the forward exchange rate is an unbiased predic* Bekaert and Hodrick are from Columbia University and are Research Associates of the National Bureau of Economic Research. Our research benefitted from the comments of Federico

Capital Markets and the Exchange Rate with Special Reference to the Dollarization Debate in Latin America

Abstract: The paper reviews the main challenges faced by policymakers in emerging market economies, EM, in light of recent financial crises, and taking into account salient factors like the existence of partial dollarization, imperfect credibility, weak financial systems, and contagion. The standard theory of optimal currency areas is discussed and criticized for omitting the above factors. When these factors are taken into account, an extreme foreign exchange regime like dollarization is shown to become much more attractive. The paper discusses the pros and cons of dollarization and, among other things, shows that the lack of a lender of last resort is not necessarily a major drawback in EM. The paper also discusses inflation targeting, IT. In a formal model, it is shown that IT could be subject to credibility problems similar to those found in exchange rate-based stabilization programs.

Importance of technical and fundamental analysis in the European foreign exchange market

Abstract: This article presents findings of a questionnaire and an interview survey on the perceived importance of chartist/technical and fundamental analysis among foreign exchange traders and financial journalists in Frankfurt, London, Vienna, and Zurich. Results confirm that most traders use both forecasting approaches, and that the shorter the forecasting horizon, the more important chartist/technical analysis is. Financial journalists put more emphasis on fundamental analysis than do foreign exchange traders. Results indicate that the importance of chartism may have increased over the last decade. Regarding the use of chartist/technical and fundamental analysis on seven forecasting horizons, four distinct clusters of traders can be identified. Forecasting styles and the overall importance attached to fundamental versus chartist/technical analysis vary across different trading locations. Foreign exchange traders mention a series of psychological motives and consequences of the use of chartism. Copyright © 2001 John Wiley & Sons, Ltd.

Official Intervention in the Foreign Exchange Market: Is it Effective, and, If so, How Does it Work?

Abstract: In this Paper we assess the progress made by the profession in understanding whether and how exchange rate intervention works. To this end, we review the theory and evidence on official intervention, concentrating primarily on work published within the last decade or so. Our reading of the recent literature leads us to conclude that, in contrast with the profession's consensus view of the 1980s, official intervention can be effective, especially through its role as a signal of policy intentions, and especially when it is publicly announced and concerted. We also note, however, an apparent empirical puzzle concerning the secrecy of much intervention and suggest an additional way in which intervention may be effective but which has so far received little attention in the literature, namely through its role in remedying a coordination failure in the foreign exchange market.

A Transaction Level Study of the Effects of Central Bank Intervention on Exchange Rates

Abstract: We study the effects of sterilised intervention operations executed on behalf of the Swiss National Bank (SNB) using tick-by-tick transactions data between 1986 and 1995. We extend the preliminary results obtained by Fischer and Zurlinden (1991) by matching these data with intra-day indicative exchange rate quotes. Via an event study analysis we examine the effects of intervention on exchange rate returns and volatility. We find that intervention has important short-run effects on the level of exchanges rates. There are also significant intra-day effects of intervention on exchange rate volatility. All of these effects are in line with theoretical predictions and it is shown that the impact on the exchange rate level is stronger when intervention is with the market rather than when it is again the wind. Finally, we find that the market partially anticipates the ¶information¶ contained in interventions as the exchange rate reacts in the 15 minute interval immediately before an event.

The Microstructure of the Foreign-Exchange Market: A Selective Survey of the Literature

Abstract: though the Section sponsors the Studies, the authors are free to develop their topics as they wish. The Section welcomes the submission of manuscripts for publication in this and its other series. Please see the Notice to Contributors at the back of this Study. The microstructure of the foreign-exchange market: a selective survey of the literature All rights reserved. Except for brief quotations embodied in critical articles and reviews, no part of this publication may be reproduced in any form or by any means, including photocopy, without written permission from the publisher.

Long-Run Purchasing Power Parity with Asymmetric Adjustment

Abstract: 1. Introduction Despite its intuitive appeal, there is inconclusive evidence supporting purchasing power parity (PPP) between countries with low inflation rates during the post-Bretton Woods period. For example, Enders (1988), Taylor (1988), and MacDonald (1993) use various forms of cointegration tests-called stage-three tests-and find that real exchange rates exhibit large fluctuations with slow rates of decay toward a long-run mean. Froot and Rogoff's (1995) literature review presents a consensus estimate that deviations from long-run PPP have a half-life of about three years. This is somewhat disappointing since stage-three tests seem to be well suited to the task-they require no assumptions concerning exogeneity and they imply a sensible dynamic relationship among price levels and the exchange rate. The vast literature on PPP is indicative of the importance of the issue and the ambiguity of the findings. It is well recognized that standard cointegration tests have low power to reject the null hypothesis of no cointegration. This observation is especially relevant for PPP since any mean reversion in real rates is very gradual and the length of the post-Bretton Woods period sample period is relatively short. Efforts to increase the power of unit-root and stage-three tests have had mixed success. For example, Lothian and Taylor (1996) and Mark (1990) have tried to circumvent the low power of stage-three tests by using long spans of time-series data. Unfortunately, the use of long time spans raises the possibility of structural changes occurring during the period being examined. Panel unit-root tests are generally more supportive of PPP than are bilateral tests of real exchange rate behavior. For example, Oh (1996), Wei and Parsley (1995), and Wu (1996) have used panel data in order to enhance the power of standard unit-root tests. Although these particular articles are supportive of PPP, panel studies must deal with the thorny issues of cross-sectional correlation and the choice of the nations to include in the panel. Papell (1997) finds that allowing for serial correlation substantially weakens the evidence in favor of long-run PPP. O'Connell (1998) applies generalized least squares to panel data to eliminate any contemporaneous correlation in the error structure and finds no evidence supporting PPP The second problem with the standard unit-root and cointegration tests is that they implicitly assume symmetric adjustment. However, official intervention in the foreign exchange market means that nominal exchange rate adjustment may be asymmetric. Under a managed float, for example, one of the monetary authorities might be more willing to tolerate currency appreciation than depreciation. Similarly, a currency band mitigates exchange rate movements until the level of the band is altered. Furthermore, the slow adjustment of real exchange rates is often explained by the "stickiness" of national price levels. For example, in the well-known Dornbusch (1976) "overshooting" model, prices and the exchange rate move in the same proportion as the money supply in the very long run. However, in the short run, prices are sticky and monetary shocks cause PPP deviations since the exchange rate moves proportionately more than prices. Rhee and Rich (1995) and Madsen and Yang (1998) provide empirical evidence corroborating the implications of the asymmetric price adjustment models. The key point to note is that, if prices are primarily sticky in the downward direction, there is no reason to presuppose that real exchange rate adjustment is symmetric. In spite of the evidence supportive of asymmetric exchange rate and price adjustments, there are only a few nonlinear tests of PPP Although they do not explicitly test for PPP, Michael, Nobay, and Peel (1997) and Taylor and Sarno (1998) estimate real exchange rates as smooth-- transition threshold adjustment processes. Enders and Falk (1998) formally apply various nonlinear unit-root tests to real exchange rates and find little evidence of PPP. …

International Macroeconomics and Finance: Theory and Econometric Methods

Abstract: Preface. 1. Some Institutional Background:. International Financial Markets. National Accounting Relations. The Central Banka s Balance Sheet. 2. Some Useful Time--Series Methods:. Unrestricted Vector Autoregressions. The Generalized Method of Moments. The Simulated Method of Moments. Unit Roots. Panel Unit--Root Tests. Cointegration. Filtering. 3. The Monetary Model:. Purchasing--Power Parity. The Monetary Model of the Balance of Payments. The Monetary Model under Flexible Exchange Rates. Fundamentals and Exchange Rate Volatility. Testing Monetary Model Predictions. Problems. 4. The Lucas Model:. The Barter Economy. The One--Money Monetary Economy. The Two--Money Monetary Economy. An Introduction to the Calibration Method. Calibrating the Lucas Model. Appendix: Markov Chains. Problems. 5. International Real Business Cycles:. Calibrating the One--Sector Growth Model. Calibrating a Two--Country Model. 6. Foreign Exchange Market Efficiency:. Deviations from UIP. Rational Risk Premia. Testing Euler Equations. Apparent Violations of Rationality. The "Peso Problem". Noise Traders. Problems. 7. The Real Exchange Rate:. Some Preliminary Issues. Deviations from the "Law--of--One--Price". Long--Run Determinants of the Real Exchange Rate. Long--Run Analyses of Real Exchange Rates. Problem. 8. The Mundell--Fleming Model:. A Static Mundell--Fleming Model. Dornbuscha s Dynamic Mundell--Fleming Model. A Stochastic Mundell--Fleming Model. VAR Analysis of Mundell--Fleming. Appendix: Solving the Dornbusch Model. Problems. 9. The New International Macroeconomics:. The Redux Model. Pricing to market. Problems. 10. Target--Zone Models:. Fundamentals of Stochastic Calculus. The Continuous--Time Monetary Model. Infinitesimal Marginal Intervention. Discrete Intervention. Eventual Collapse. Imperfect Target--Zone Credibility. 11. Balance--of--Payments Crises:. A First--Generation Model. A Second--Generation Model. Bibliography. Author Index. Subject Index.

Limiting Currency Volatility to Stimulate Goods Market Integration: a Price-Based Approach

Abstract: This Paper empirically studies the effect of instrumental and institutional stabilization of the exchange rate on the integration of goods markets. An instrumental stabilization of the exchange rate is accomplished through intervention in the foreign exchange market, or by monetary policies. An institutional stabilization is an adoption of a currency board or a common currency. In contrast to the literature that employs data on the volume of trade, an important novelty of this Paper is the use of a 3-dimensional panel of prices of 95 very disaggregated goods (e.g., light bulbs) in 83 cities from around the world from 1990-2000. We find that goods market integration is increasing over time and is inversely related to distance, exchange rate variability, and tariff barriers. In addition, the impact of an institutional stabilization of the exchange rate provides a stimulus to goods market integration that goes far beyond an instrumental stabilization. Among the institutional arrangements, long-term currency unions demonstrate greater integration than more recent currency boards. All of them can improve their integration further relative to a US benchmark.

A note on the pass-through from exchange rate and foreign price changes to inflation in selected emerging market economies

Abstract: This note presents estimates of the pass-through of exchange rate changes and import price changes (measured in foreign currency) into domestic inflation in a group of 13 emerging market economies. The note focuses on the variation in the pass-through elasticities across and within countries, and on their evolution during the 1980s and 1990s. The model and estimation methods used are very simple and are intended to illustrate how the pass-through effects can be analysed with only a few data series in a “bare bones” framework that could be easily replicated by analysts and interpreted by policymakers in the emerging market economies. The main findings are as follows:

Limiting currency volatility to stimulate goods market integration: a price based approach

Abstract: This paper studies the effect of instrumental and institutional stabilization of exchange rate volatility on the integration of goods markets. Rather than using data on volume of trade, this paper employs a 3-dimensional panel of prices of 95 very disaggregated goods (e.g., light bulbs) in 83 cities around the world during 1990-2000. We find that the impact of an institutional stabilization – currency board or dollarization – promotes market integration far beyond an instrumental stabilization. Among them, long-term currency unions are more effective than more recent currency boards. All have room to improve relative to a U.S. benchmark. Key Words: hard pegs, currency union, dollarization, market integration. JEL Classification Codes: F33 __________________ We would like to thank Charles Engel, Andy Rose and seminar participants at the IMF and the Hong Kong Monetary Authority for very helpful comments. The views presented in this paper are those of the authors and do not necessarily reflect the views of the IMF or any other institution with which they are or have been affiliated.

Managed floating: Understanding the new international monetary order

Abstract: Although there seems to be a broad consensus among economists that purely floating or completely fixed exchange rates (the so-called corner solutions) are the only viable alternatives of exchange rate management, many countries do not behave according to this paradigm and adopt a strategy within the broad spectrum of exchange rate regimes that is limited by the two corner solutions. These intermediate regimes are characterized by significant foreign exchange market interventions of central banks and a certain degree of exchange rate flexibility. We develop a new empirical methodology that identifies three different forms of floating on the basis of a central bank’s intervention activity: pure floating (no interventions), independent floating (exchange rate smoothing), and managed floating (exchange rate targeting). Our cross-country study shows that exchange rate targeting is at least as important as exchange rate smoothing. Subsequently we present a monetary policy framework in which central banks use the exchange rate as an operating target of monetary policy. We explain the mechanics of interventions and sterilization and we explain why a central bank has an interest of controlling simultaneously the exchange rate and the short-term interest rate. We derive the monetary policy rules for our two operating targets from a simple open economy macro model in which the uncovered interest parity condition and the Monetary Conditions Index play a central role.

Is Sterilized Foreign Exchange Intervention Effective after All? An Event Study Approach

Abstract: Central banks actively engage in sterilized foreign exchange market intervention despite numerous empirical studies indicating that these operations do not systematically affect the exchange rate. Are these policies misguided and central bankers irrational? Or is evidence showing the effectiveness of sterilized intervention being overlooked? This paper argues the latter, providing evidence on the effectiveness of sterilized intervention using an event study approach linking intervention with systematic exchange rate changes. Studies using time-series techniques are limited by the nature of the data: intense and sporadic bursts of intervention activity juxtaposed against exchange rates that change almost continuously on a daily basis. The event study framework used in standard finance studies, by contrast, is better suited to this circumstance. Focusing on daily Bundesbank and US official intervention operations, we identify separate intervention "episodes" and analyze the subsequent effect on the exchange rate. Using the nonparametric sign test and matched-sample test, we find strong evidence that sterilized intervention systemically affects the exchange rate in the short-run. This result is robust to changes in event window definitions over the short-run and to controlling for central bank interest rate changes during events.

Post-Crisis Exchange Rate Policy in Five Asian Countries; Filling in the "Hollow Middle"?

Abstract: Following the 1997-98 financial turmoil, crisis countries in Asia moved toward either floating or fixed exchange rate systems, reinforcing the bipolar view of exchange rate regimes and the "hollow middle" hypothesis. But some academics have claimed that the crisis countries' policies have been similar in the post- and pre-crisis periods. This paper analyzes the evidence and concludes that, except for Malaysia, which adopted a hard peg and imposed capital controls, the other crisis countries are floating more than before, though less than "real" floaters do. Further, the crisis countries' policies during the post-crisis period can be justified on second-best arguments.

Phase transition in a foreign exchange market-analysis based on an artificial market approach

Abstract: In this study, we propose an artificial market approach, which is a new agent-based approach to foreign exchange market studies. Using this approach, emergent phenomena of markets such as the peaked and fat-tailed distribution of rate changes were explained. First, we collected the field data through interviews and questionnaires with dealers and found that the features of dealer interaction in learning were similar to the features of genetic operations in biology. Second, we constructed an artificial market model using a genetic algorithm. Our model was a multiagent system with agents having internal representations about market situations. Finally, we carried out computer simulations with our model using the actual data series of economic fundamentals and political news. We then identified three emergent phenomena of the market. As a result, we concluded that these emergent phenomena could be explained by the phase transition of forecast variety, which is due to the interaction of agent forecasts and the demand-supply balance. In addition, the results of simulation were compared with the field data. The field data supported the simulation results. This approach therefore integrates fieldwork and a multiagent model, and provides a quantitative explanation of micro-macro relations in markets.

Adoption of On-line Trading in the Hong Kong Financial Market.

Abstract: The purpose of this research is to study what issues may affect investor adoption of on-line trading in the Hong Kong financial market. The studied system is a system that provides straight-through trading for investors, rather than an order routing system that forwards orders from a broker firm to the appropriate market. One communication infrastructure for on-line trading is the Internet. However, other infrastructures, such as wireless communication channels, may also be used to support direct interaction between the investors and the stock exchange. Feasibility of changing to a new service or system can be viewed from different perspectives, technical, operational, financial, and social/organizational. This paper focuses on the social/organizational perspective by using a research model based on the Decomposed Version Theory of Planned Behavior (DTPB) to identify the factors that affect investors’ adoption of on-line trading. A correlation analysis has been performed to investigate whether the hypothesized attributes, variables, and belief structure are correlated with each other. After such analysis, the factors that influence the adoption of the proposed system have been identified, as well as the relationships between the factors. Such results can be helpful to the Stock Exchange of Hong Kong (SEHK) and the Hong Kong Securities and Futures Commission (SFC) for planning the launch of Internet trading.

Predictability of Currency Market Exchange

Abstract: We analyze tick data of yen-dollar exchange with a focus on its up and down movement. We show that there exists a rather particular conditional probability structure with such high frequency data. This result provides us with evidence to question one of the basic assumption of the traditional market theory, where such bias in high frequency price movements is regarded as not present. We also construct systematically a random walk model reflecting this probability structure.

Canadian chartered banks’ stock returns and exchange rate risk

Abstract: The sensitivity of Canadian chartered banks to exchange rate risk is analyzed over the period 1988‐1995 through estimating the three‐factor asset pricing model (market, interest rate, and exchange rate). Results indicate that banks’ stock returns are sensitive to exchange rate risk and, mainly, to the US dollar relative to the Canadian dollar exchange rate. The sensitivity is, however, unstable over time. Moreover, there is an asymmetric response to exchange rate risk. Investors react more to a re‐evaluation of their portfolio after losses than to an appreciation after successive gains.

Foreign‐Exchange Trading Volume and Federal Reserve Intervention

Abstract: We find a large positive correlation between daily trading volume in currency futures markets and foreign exchange intervention by the Federal Reserve over the period 1979-1996. Neither contemporaneous nor predicted volatility can fully account for the increases in trading activity. Whether or not the intervention operation is publicly reported appears to be an important determinant of trading volume.

Managed floating: Understanding the new international monetary order

Abstract: Although there seems to be a broad consensus among economists that purely floating or completely fixed exchange rates (the so-called corner solutions) are the only viable alternatives of exchange rate management, many countries do not behave according to this paradigm and adopt a strategy within the broad spectrum of exchange rate regimes that is limited by the two corner solutions. These intermediate regimes are characterized by significant foreign exchange market interventions of central banks and a certain degree of exchange rate flexibility. We develop a new empirical methodology that identifies three different forms of floating on the basis of a central bank's intervention activity: pure floating (no interventions), independent floating (exchange rate smoothing), and managed floating (exchange rate targeting). Our cross-country study shows that exchange rate targeting is at least as important as exchange rate smoothing. Subsequently we present a monetary policy framework in which central banks use the exchange rate as an operating target of monetary policy. We explain the mechanics of interventions and sterilization and we explain why a central bank has an interest in controlling simultaneously the exchange rate and the short-term interest rate. We derive the monetary policy rules for our two operating targets from a simple open economy macro model in which the uncovered interest parity condition and the Monetary Conditions Index play a central role.