Showing papers on "Foreign exchange market published in 2003"

The Mirage of Exchange Rate Regimes for Emerging Market Countries

Abstract: This paper argues that much of the debate on choosing an exchange rate regime misses the boat. It begins by discussing the standard theory of choice between exchange rate regimes, and then explores the weaknesses in this theory, especially when it is applied to emerging market economies. It then discusses a range of institutional traits that might predispose a country to favor either fixed or floating rates, and then turns to the converse question of whether the choice of exchange rate regime may favor the development of certain desirable institutional traits. The conclusion from the analysis is that the choice of exchange rate regime is likely to be of second order importance to the development of good fiscal, financial, and monetary institutions in producing macroeconomic success in emerging market countries. This suggests that less attention should be focused on the general question whether a floating or a fixed exchange rate is preferable, and more on these deeper institutional arrangements. A focus on institutional reforms rather than on the exchange rate regime may encourage emerging market countries to be healthier and less prone to the crises that we have seen in recent years.

Asset Prices and Exchange Rates

Abstract: This paper develops a simple two-country, two-good model, in which the real exchange rate, stock and bond prices are jointly determined. The model predicts that stock market prices are correlated internationally even though their dividend processes are independent, providing a theoretical argument in favor of financial contagion. The foreign exchange market serves as a propagation channel from one stock market to the other. The model identifies interconnections among stock, bond and foreign exchange markets and characterizes their joint dynamics as a three-factor model. Contemporaneous responses of each market to changes in the factors are shown to have unambiguous signs. These implications enjoy strong empirical support. Estimation of various versions of the model reveals that most of the signs predicted by the model indeed obtain in the data, and the point estimates are in line with the implications of our theory. Moreover, the factors we extract from daily data on stock indexes and exchange rates explain a sizable fraction of the variation in a number of macroeconomic variables, and the estimated signs on the factors are consistent with our model's implications. We also derive agents' portfolio holdings and identify economic environments under which they exhibit a home bias, and demonstrate that an international CAPM obtaining in our model has two additional factors.

Living with flexible exchange rates: issues and recent experience in inflation targeting emerging market economies

Abstract: This overview paper examines two main issues. The first is why the exchange rate matters, potentially for all economies, but especially for emerging market economies. The second is under what circumstances and how have emerging market economies that target inflation dealt with the various challenges presented by exchange rate fluctuations in recent years. We find that emerging market economies, being more exposed to the effects of exchange rate movements, are likely to have exchange rate considerations figure more prominently in policy decisions. However, this is not to suggest that attending to the exchange rate is relevant only to emerging market economies. Recent experience serves as a clear reminder that having to keep an eye on the exchange rate is also a fact of life in industrial economies, inflation targeting or not.

Is sterilised foreign exchange intervention effective after all? an event study approach

Abstract: This study provides evidence supporting the effectiveness of sterilised foreign exchange market intervention by central banks using an event study approach. An event study framework is better suited to the study of sporadic and intense periods of official intervention, juxtaposed with continuously changing exchange rates, than standard time-series studies. Focusing on daily Bundesbank and US official intervention operations, we identify separate intervention ‘episodes’ and analyse the subsequent effect on the exchange rate. Using the non-parametric sign test and matched-sample test, we find strong evidence that sterilised 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.

Effectiveness of Official Daily Foreign Exchange Market Intervention Operations in Japan

Abstract: Japanese official intervention in the foreign exchange market is of by far the largest magnitude in the world, despite little or no evidence that it is effective in moving exchange rates. Up until recently, however, official data on intervention has not been available for Japan. This paper investigates the effectiveness of intervention using recently published official daily data and an event study methodology. The event study better fits the stochastic properties of intervention and exchange rate data, i.e. intense and sporadic bursts of intervention activity juxtaposed against a yen/dollar rate continuously changing, than standard time-series approaches. Focusing on daily Japanese and US official intervention operations, we identify separate intervention "episodes" and analyze the subsequent effect on the exchange rate. Using the non-parametric sign test and matched-sample test, we find strong evidence that sterilized intervention systemically affects the exchange rate in the short-run (less than one month). This result holds even when intervention is not associated with (simultaneous) interest rate changes, whether or not intervention is "secret" (in the sense of no official reports or rumors of intervention reported over the newswires), and against other robustness checks. Large-scale (amounts over $1 billion) intervention, coordinated with the Bank of Japan and the Federal Reserve working in unison, give the highest success rate. During the period that the Bank of Japan has reduced interbank rates to 0.5 percent and below (from September 1995), however, only one intervention operation has been coordinated with the Fed and the success rate has been correspondingly low.

The Global Transmission of Volatility in the Foreign Exchange Market

Abstract: Volatility spillovers of the DM/$ and ¥/$ exchange rate across regional markets are examined using the integrated volatility of high-frequency data. An analysis of quoting patterns reveals five distinct regions: Asia, Asia-Europe overlap, Europe, Europe-America overlap, and America. After reviewing theoretical foundations for persistence of volatility in dealership markets, regional volatility models are constructed where volatility in one region is a function of yesterday's volatility in that region (“heat-wave effect”) and volatility in other regions (“meteor-shower effect”). Evidence of statistically significant effects is found for both own-region and interregional spillovers, but the economic significance of own-region spillovers indicates that heat waves are more important than meteor showers.

Foreign Exchange Intervention in Developing and Transition Economies: Results of a Survey

Abstract: Based on evidence obtained from the IMF`s 2001 Survey on Foreign Exchange Market Organization, the author argues that, for several reasons, some central banks in developing and transition economies may be able to conduct foreign exchange intervention more effectively than the central banks of developed countries issuing the major international currencies. First, these central banks do not always fully sterilize their foreign exchange interventions. In addition, they issue regulations and conduct their foreign exchange operations in a way that increases the central bank`s information advantage and the size of their foreign exchange intervention relative to foreign exchange market turnover. Some of the central banks also use moral suasion to support their foreign exchange interventions.

Volume and Volatility in the FX-Market: Does it matter who you are?

Abstract: The relationship between volume and volatility has received much attention in the the literature of financial markets. However, due to the lack of data, few results have been presented for the foreign exchange market. Further, most studies contain only aggregate series, and can not distinguish between the impact of different instruments or participants.We study the impact of volume on volatility in the the FX-market using a unique data set of daily trading in the Swedish krona (SEK) market. The data set covers 95 per cent of worldwide SEK-trading, and is disaggregated on a number of reporting banks’ buying and selling in five different instruments on a daily basis over a period of nine years. We find that volume in general depict a positive correlation with volatility. However, the strength of the relationship depends on the instrument used and the identity of the reporting bank. In particular we find that it is the large Swedish banks that dominate the relationship. These banks are probably also the best informed banks. We interpret this is as evidence that heterogeneous expectations are important to understand the volume-volatility relationship.

From Pipes to Scopes: The Flow Architecture of Financial Markets

Abstract: This article introduces a distinction between two types of markets and market coordination: those based on social networks and those based on a flow architecture. Flow architectures involve potentially global “scopic” reflex systems (GRSs) that project market reality while at the same time carrying it forward and allowing it to flow. The argument is that some financial markets have undergone a transition from a pre-reflexive network market to a reflexively coordinated flow market manifest in the different organization of trading floors, changes in trading patterns and the emergence of a moving market that gets transferred from time-zone to time-zone with the sun. To understand these markets, temporal concepts are needed in addition to the social structural (relational) concepts with which we commonly work. Networks emerge from this analysis as historically specific, relationship-based forms of market coordination which in some markets are in the process of being replaced by more reflexive temporal forms o...

Dollarization of Liabilities: Beyond the Usual Suspects

Abstract: Dollarization of liabilities (DL) has emerged as a key factor in explaining the vulnerability of emerging markets to financial and currency crises. The "usual suspects" of causing DL include fatalistic determinants such as a long history of unsound macroeconomic policies, financial development and institutional factors, aided by moral hazard opportunities arising from the existence of government guarantees. This paper assesses empirically the relevance of these factors, as well as that of alternative explanations for DL. Based on a sample of Latin American countries, we find that ongoing central bank intervention in the foreign exchange market, relative market power of borrowers, and financial penetration are at least as important as the usual suspects in explaining DL.

Government intervention in the foreign exchange market

Abstract: This article offers a survey of the literature on foreign exchange intervention, including sections on the theoretical channels through which intervention might affect exchange rates and a summary of the empirical findings. The survey emphasizes that intervention is intended to provide monetary authorities with an means of influencing their exchange rates independent from monetary policy, and tends to evaluate theoretical channels and empirical results from this perspective.

Market Making in the Interbank Foreign Exchange Market

Abstract: This paper studies the market making behavior of FX dealers in the interbank market which is characterized by high trade volume and decentralized market structure. The dataset for my empirical estimation is based on the complete trade records of a FX dealer at a major commercial bank over 25 trading days. The dealer is among the five largest DM/$ dealers in the world, and the composition of his trades (customer trades, inter-dealer trades, etc.) is representative of the industry. I find evidence that incoming trades have information effects. However, I do not find evidence of price-shading as a tool for inventory control in inter-dealer trades. This is consistent with the view that quote shading signals a dealer’s position, and further reveals information from his proprietary order flows. A representative FX dealer instead lays off most undesired inventories through outgoing trades against other dealers’ quotes. Price impacts of such outgoing trades are minimized because the depth and low transparency of this market, together with the electronic dealing systems, allow a dealer to search effectively for the best prices. A dynamic analysis indicates that large trades have significant lagged price impacts, and that FX dealer often strategically delays quote revision to take advantage of low market transparency while working off inventory shocks. My study also suggests that dealers with diverse market positions might prefer different trading strategies. For example, an uninformed dealer with little customer business is likely to shade quotes for inventory control.

New Electronic Trading Systems in Foreign Exchange Markets

Abstract: The foreign exchange market can be divided in two segments: the interbank market and the customer market. Two recent advances in trading technology, electronic brokers in the interbank market and internet trading for customers, have significantly changed the structure of the foreign exchange market. In this paper we explain the functioning of electronic brokers and internet trading and discuss the economic consequences.

Incomplete Consumption Risk Sharing and Currency Risk Premiums

Abstract: This article studies the impact of imperfect consumption risk sharing across countries on the formation of time-varying risk premiums in the foreign exchange market and on their cross-sectional differences. These issues are addressed within the framework of the Constantinides and Duffie (1996) model applied to a multi-country world. The paper shows that the cross-country variance of consumption growth rates is counter-cyclical and that this feature of consumption data is mildly helpful for currency pricing. While the new model does not fully account for the forward premium anomaly, it is able to generate currency risk premiums at relatively low values of risk aversion and provide certain explanatory power for cross-sectional differences in currency returns.

Anchoring and Psychological Barriers in Foreign Exchange Markets

Abstract: This paper develops a simple behavioral exchange rate model in which investor perception of the fundamental value is anchored to the nearest round number. Traders adjust their anchors in two ways. Some believe that exchange rates move toward (perceived) fundamentals, while others bet on a continuation of the current exchange rate trend. The behavior of the traders causes complex dynamics. Since the exchange rate tends to circle around its perceived fundamental value, the foreign exchange market is persistently misaligned. Central authorities have the opportunity to reduce such distortions by pushing the exchange rate to less biased anchors, but to achieve this, they have to break psychological barriers between anchors.

Incomplete Consumption Risk Sharing and Currency Risk Premiums

Abstract: This article studies the impact of imperfect consumption risk sharing across countries on the formation of time-varying risk premiums in the foreign exchange market and on their cross-sectional differences. These issues are addressed within the framework of the Constantinides and Duffie (1996) model applied to a multicountry world. The article shows that the cross-country variance of consumption growth rates is counter-cyclical and that this feature of consumption data is mildly helpful for currency pricing. In particular, unlike the standard CCAPM, the new model is able to generate currency risk premiums at lower values of risk aversion and provide certain explanatory power for cross-sectional differences in currency returns. Copyright 2003, Oxford University Press.

Exchange Rate Volatility and Democratization in Emerging Market Countries

Abstract: We examine some of the consequences of financial globalization for democratization in emerging market economies by focusing on the currency markets of four Asian countries at different stages of democratic development. Using political data of various kinds—including a new events data series—and the Markov regime switching model from empirical macroeconomics, we show that in young and incipient democracies politics continuously causes changes in the probability of experiencing two different currency market equilibria: a high volatility “contagion” regime and a low volatility “fundamentals” regime. The kind of political events that affect currency market equilibration varies cross-nationally depending on the degree to which the polity of a country is democratic and its policymaking transparent. The results help us better gauge how and the extent to which democratization is compatible with financial globalization.

The impact of the Asian financial crisis on foreign exchange market efficiency: The case of East Asian countries

Abstract: This paper investigates whether the Asian financial crisis in the second half of 1997 affected the foreign exchange market efficiency in four Asian countries hit hard by the crisis: Thailand, Indonesia, Malaysia and Korea. We find that empirical evidence based on the bivariate and multivariate cointegration estimations using the high-frequency data from January 1996 to February 2001 is mostly consistent with the across-country efficient market hypothesis in the Asian foreign exchange markets during the whole sample period except the short period immediately after the July 1997 crisis. Within-country market efficiency also appears to have become weaker immediately after the crisis than before the crisis, but market efficiency was recovered quickly, evidenced by the regained cointegrating relationship for the pairs of the spot-forward exchange rates in the Asian countries. The findings of the threshold effects in the forward market equation and asymmetrical responses of the spot rate to the forward spread imply that there has been a strong force of recovering new equilibrium exchange rate levels in the Asian foreign exchange markets once the rates have been disturbed, especially when their currencies are significantly undervalued compared to the rationally expected level of exchange rates.

Dollarization of Liabilities; Beyond the Usual Suspects

Abstract: Dollarization of liabilities (DL) has emerged as a key factor in explaining the vulnerability of emerging markets to financial and currency crises. "Usual suspects" of causing DL comprise "fatalistic" determinants such as a long history of unsound macroeconomic policies and development and institutional factors, aided by moral hazard opportunities related to government guarantees. This paper assesses empirically the relevance of these factors relative to alternative explanations. Based on a sample of Latin American countries, we find that ongoing central bank intervention in the foreign exchange market, relative market power of borrowers, and financial penetration are at least as important in explaining DL.

Liquidity Black Holes: Understanding, Quantifying and Managing Financial Liquidity Risk

Abstract: CONTENTS Foreword William W. Martin, Invesco Asset Management Liquidity Black Holes: An Introduction Avinash Persaud, Global Asset Management and Gresham College Section 1: The Background to Market Liquidity: Introduction 1. Liquidity in the Foreign Exchange Market: An Investment Manager's Perspective Harriett M. Richmond and Jack Crawford, JPMorgan Fleming Asset Management 2. Liquidity in the Equity Market: A Portfolio Trader's Perspective Sri Moorthy, Credit Suisse First Boston 3. Liquidity in the Fixed-Income Market and the Impact of EMU Hannah Scobie, European Economics and Financial Centre 4. Liquidity from a Central Banker's Perspective Roger Clews and David Rule, Bank of England Section 2: Liquidity Black Holes 5. Liquidity Black Holes Avinash Persaud, Global Asset Management and Gresham College 6. LTCM and the Asian Financial Crisis: Liquidity Black Holes Stephen Spratt, University of Sussex 7. Measuring Liquidity Black Holes Benjamin H. Cohen of International Monetary Fund and Hyun Song Shin of London School of Economics 8. Liquidity Black Holes: Testing Theory's Predictions Chris McCoy, State Street Fellow and Surrey University Section 3: Liquidity Black Holes and Institutional Behaviour 9. Liquidity and News Hyun Song Shin, London School of Economics 10. Volatility in the Foreign Exchange Market and Disclosure of Central Bank Reserves Michael Metcalfe, State Street Bank 11. Market Liquidity and Risk Management Avinash Persaud, Global Asset Management and Gresham College 12. Financial System Liquidity and Credit Risk Transfers Avinash Persaud, Global Asset Management and Gresham College Section 4: Liquidity and Architecture of the Financial System 13. Market Distress and Vanishing Liquidity: Anatomy and Policy Options Claudio Borrio, Bank for International Settlements 14. Beauty Contests, Liquidity and the New International Financial Architecture John Eatwell, University of Cambridge

Genetic learning as an explanation of stylized facts of foreign exchange markets

Abstract: This paper revisits the Kareken-Wallace model of exchange rate formation. Following the seminal paper by Arifovic (1996) we investigate a dynamic version of the model in which agents' decision rules are updated using genetic algorithms. Time series analysis of simulated data indicates that for particular parameterizations, the characteristics of the exchange rate dynamics are very similar to those of empirical data. The similarity appears to be quite insensitive with respect to the ingredients of the GA algorithm. However, appearance or not of realistic time series characteristics depends crucially on the mutation probability (which should be low) and the number of agents (not more than about 1000).