Showing papers on "Foreign exchange market published in 2007"

The obstinate passion of foreign exchange professionals: Technical analysis

Abstract: Technical analysis involves the prediction of future exchange rate (or other asset-price) movements from an inductive analysis of past movements. A reading of the large literature on this topic allows us to establish a set of stylised facts, including the facts that technical analysis is an important and widely used method of analysis in the foreign exchange market and that applying certain technical trading rules over a sustained period may lead to significant positive excess returns. We then analyze four arguments that have been put forward to explain the continuing widespread use of technical analysis and its apparent profitability: that the foreign exchange market may be characterised by not-fully-rational behaviour; that technical analysis may exploit the influence of central bank interventions; that technical analysis may be an efficient form of information processing; and finally that it may provide information on non-fundamental influences on foreign exchange movements. Although all of these positions may be relevant to some degree, neither non-rationality nor official interventions seem to be widespread and persistent enough to explain the obstinate passion of foreign exchange professionals for technical analysis.

Cointegration in the Foreign Exchange Market and Market Efficiency since the Introduction of the Euro: Evidence based on bivariate Cointegration Analyses

Abstract: The aim of this paper is to investigate the market efficiency on the foreign exchange market since the introduction of the Euro by applying the cointegration analysis to exchange rates. The introduction of the Euro has changed the structure of the global foreign exchange market to the extent that the second most important currency in the world with the highest credibility in the foreign exchange market, namely the Deutsche Mark, has been assimilated into the Euro. In order to evaluate if the introduction of a new currency has resulted in inefficient markets, a bivariate cointegration analysis should be applied to the seven most important exchange rates. The empirical analysis predominantly draws on the Johansen (1988, 1991) approach and the Gregory-Hansen (1996) approach whereas the latter takes endogenous structural breaks into account. We show that the foreign exchange market is broadly consistent with the market efficiency hypothesis. A very important result is that we can find a longrun relationship between the exchange rate pairs EUR/USD and GBP/USD whereas the no-arbitrage condition is satisfied. Since the EUR/USD exchange rate is weakly exogenous the GBP/USD exchange rate takes the burden of adjustment to the long-run equilibrium.

Market efficiency in foreign exchange markets

Abstract: We investigate the relative market efficiency in financial market data, using the approximate entropy(ApEn) method for a quantification of randomness in time series. We used the global foreign exchange market indices for 17 countries during two periods from 1984 to 1998 and from 1999 to 2004 in order to study the efficiency of various foreign exchange markets around the market crisis. We found that on average, the ApEn values for European and North American foreign exchange markets are larger than those for African and Asian ones except Japan. We also found that the ApEn for Asian markets increased significantly after the Asian currency crisis. Our results suggest that the markets with a larger liquidity such as European and North American foreign exchange markets have a higher market efficiency than those with a smaller liquidity such as the African and Asian markets except Japan.

An objective function for simulation based inference on exchange rate data

Abstract: The assessment of models of financial market behaviour requires evaluation tools When complexity hinders a direct estimation approach, eg, for agent based microsimulation models, simulation based estimators might provide an alternative In order to apply such techniques, an objective function is required, which should be based on robust statistics of the time series under consideration Based on the identification of robust statistics of foreign exchange rate time series in previous research, an objective function is derived This function takes into account stylized facts about the unconditional distribution of exchange rate returns and properties of the conditional distribution, in particular, autoregressive conditional heteroscedasticity and long memory A bootstrap procedure is used to obtain an estimate of the variance-covariance matrix of the different moments included in the objective function, which is used as a base for the weighting matrix Finally, the properties of the objective function are analyzed for two different agent based models of the foreign exchange market, a simple GARCH-model and a stochastic volatility model using the DM/US-$ exchange rate as a benchmark It is also discussed how the results might be used for inference purposes

Strong comovements of exchange rates: Theoretical and empirical cases when currencies become the same asset

Abstract: The aim of this paper is to detect periods in which two currencies can be classified as being the'same' asset. Two currencies can be treated as the same asset if their exchange rates vis-a-vis the same base currency are cointegrated with a cointegration vector that is consistent with the triangular arbitrage condition. In a first step, it is theoretically derived under which conditions,with respect to the process of the fundamentals, the exchange rates are cointegrated. The empirical results yield that periods of strong comovements of the US dollar and Pound sterling based upon the Euro prevail during the 1990s and periods of comovements of Euro and Pound sterling denominated in US dollar prevail since the introduction of the Euro. Furthermore, no long-run relationships canbe discovered. This paper gives four major innovations to the literature. It first shows under which conditions exchange rates can be bivariately cointegrated. Secondly, it uses the cross-rate identity to test forcointegration, i.e. deducing recursively. Thirdly, it applies the cointegration methodology within atriangular framework by detecting cointegration between exchange rates that are not only denominated in U.S. dollars. And lastly, it shows that comovements between two exchange rates exist ina narrower sense but only in short periods, whereas the economic variables which have caused therelationship are explored.

Central Bank Authorities' Beliefs About Foreign Exchange Intervention

Abstract: This paper presents the results of a survey of monetary authorities with respect to foreign exchange intervention. The survey offers evidence on new issues that would otherwise be difficult to investigate, such as response times, non-foreign exchange factors in intervention and profitability. The survey also reveals new evidence on previously studied issues, such as channels of effectiveness. Respondents disagreed with predominant views on intervention and volatility and common arguments against intervention. Exchange rate regimes explain central bank beliefs about important aspects of intervention, including factors that lead to detection of secret interventions and the potential profitability of intervention.

Cointegration and Causality between Stock Index and Macroeconomic Variables in an Emerging Market

Abstract: This study examined the relationship between stock market index and selected macroeconomic variables during the post-financial liberalization (pre-financial crisis) and post-financial crisis in Thailand. In the empirical analysis, unit root, cointegration and Granger causality tests were performed. The post-financial liberalization results showed that the stock market index, the industrial production index, money supply, exchange rate, and world oil prices contained a unit root and were integrated of order one. Johansen cointegration test was then employed. The results showed at least one cointegrating or long-run relation between the stock market index and a set of macroeconomic variables. Money supply had a positive impact on the stock market index while the industrial production index, the exchange rate and oil prices had a negative impact. During the post-financial crisis, all variables were integrated at different orders. Cointegration existed between the stock market index and macroeconomic variables. In addition, the Granger causality test indicated money supply was the only variable positively affecting the stock market returns. INTRODUCTION The Stock Exchange of Thailand has been considered an emerging stock market since its inauguration in April 1975. The market capitalization of Thailand Stock Exchange is small while bond trading and other financial innovations have emerged in just the last few years. Like other emerging stock markets in Asia, liberalization in the Thai financial markets, both money and capital markets, reduced the regulation for foreign investors who were interested in investing in Thailand. The financial liberalization in 1992 included lifting capital control measures and allowing banks to lend and borrow more freely in both in- and off-shore transactions. In addition, the Thai government urged capital inflows in both portfolio and foreign direct investment. As a result, the volume of stock trading increased substantially in recent years. Equity instruments are a crucial source of funds for business firms. A continuous increase in private investment via issuing new stocks can be a conduit of GDP expansion and, thus, a high employment rate. Under the fixed exchange rate regime prior to the financial crisis in 1997, Thailand saw large capital inflows, especially in terms of portfolio investment. This nearly offset the huge current account deficits. Additionally, large capital inflows caused domestic financial institutions to lend a large number of loans to both firms and individual borrowers. The ratio between loans and deposits in the banking system was as high as 1.35 in mid-1990 compared to 0.75 in early 1990. Many analysts believed this was due to the overheating of the Thai economy. In late 1996, private investment accounted for more than 40 percent of the national income. Such phenomena showed that domestic borrowers relied more on foreign capital inflows than domestic savings. During this period, the domestic interest rate rose and caused a wide gap between domestic and foreign interest rates. This interest rate differential induced large capital inflows mostly in portfolio investment. The financial crisis in 1997 had a devastating impact on the Thai economy. A significant effect related to exchange rate risk under the floating exchange rate regime began in July 1 997. Other than real economic activity (e.g., real GDP or the industrial production index) that could affect an investment decision in common stocks, the risk generated from exchange rate fluctuations may also distort the portfolio investment decision. The main objective of this study was to investigate the effects of macroeconomic variables on stock market index/returns in Thailand during the post-financial liberalization prior to the financial crisis (January 1992- June 1997) and after the financial crisis (July 1997-December 2003). The stock market return represents the change in stock market index. …

Do China's capital controls still bind? Implications for monetary autonomy and capital liberalisation

Abstract: The paper argues that China's capital controls remain substantially binding. This has allowed the Chinese authorities to retain some degree of short-term monetary autonomy, despite the fixed exchange rate up to July 2005. Although the Chinese capital controls have not been watertight, we find sustained and significant gaps between onshore and offshore renminbi interest rates and persistent dollar/renminbi interest rate differentials during the period of a de facto dollar peg. While some cross-border flows do respond to market expectations and relative yields, they have not been large enough to equalise onshore and offshore renminbi yields.

Theory, Reality, and Performativity in Markets

Abstract: The purpose of this article is to analyze the relation between scientific knowledge in the form of theories and the world that such theories are about. The focus is on market theories. I argue that everyday knowledge, conceptualized using the notion of "life- world," is the bedrock of scientific knowledge. I also make two distinctions, one between types of markets and one between principles of order in markets. There are two different types of markets, fixed-role markets and switch-role markets, and no existing theory can be used to explain both of them. In fixed-role markets, such as a producer market of garments, actors are identified as either sellers or buyers. In switch-role markets, such as the stock exchange market or currency market, actors are not identified with one role. The other distinction is between standard and status markets. In a status market, order is maintained because the identities of actors on both sides of the market are ranked according to status, which is a more entrenched social construction than the commodity traded in the market. In a market characterized by standards, the situation is reversed: the commodity is a more entrenched social construction than the social status of actors in the market. These distinctions are the backdrop of my analysis of the idea that markets are performed. It is concluded that *The author studied sociology at Stockholm, Harvard, and Columbia Universities, and is research fellow at the Max-Planck Institute for the Study of Societies in Cologne and Associate Professor at Stockholm University. Aspers is the author of Markets in Fashion, A Phenomenological Approach (Routledge 2005), and he has been chair of the eco- nomic sociology research network of ESA. His research interests are economic sociol- ogy, especially markets, theory, fashion and phenomenology. The author gratefully acknowledges the financial support by Axel and Margaret Ax:son Johnson Foundation. He thanks Caroline Dahlberg, Richard Swedberg, and Olav Velthuis for their sugges- tions. He is especially grateful for the comments by the reviewers and Laurence Moss.

Modeling Optimism and Pessimism in the Foreign Exchange Market

Abstract: In this paper we model how the existence of different beliefs about the underlying fundamental value of a currency affects the dynamics of the exchange rate. We find that a divergence of beliefs creates the potential for waves of optimism and pessimism that alternate in an unpredictable way. These waves are disconnected from the underlying (objective) fundamental value. We also find that in such a world there is "sensitivity to initial conditions", i.e. small changes in beliefs can fundamentally alter the time path of the exchange rate.

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. D 2003 Elsevier B.V. All rights reserved.

The Effectiveness of Foreign Exchange Intervention in Emerging Market Countries: Evidence from the Czech Koruna

Abstract: We survey the literature on the efficacy of foreign exchange market intervention in emerging market countries, emphasising the differences with the literature on industrial countries. We then use official statistics on central bank intervention by the Czech National Bank in conjunction with options market data, to study the impact of intervention during 2001-02. We find that central bank intervention had some (weakly) statistically significant impact on the spot rate and the risk reversal but that this impact was small. We do not find evidence that intervention had an influence on short-term exchange rate volatility. We also find that, in our sample period, Czech authorities appeared to intervene mainly in response to an acceleration of the speed of koruna appreciation.

Volatility spillover between tock and foreign exchange markets: indian evidence

Abstract: The study of volatility spillovers provides useful insights into how information is transmitted from stock market to foreign exchange market and vice versa. This paper explores volatility spillovers between the Indian stock and foreign exchange markets. The results indicate that there exists a bidirectional volatility spillover between the Indian stock market and the foreign exchange market with the exception of SP Foreign exchange market; Volatility spillovers; Information transmission; ARCH; GARCH; EGARCH I. INTRODUCTION The objective of this paper is to examine the relationship and volatility spillovers between Indian stock and foreign exchange markets. Internationalization of stock markets, liberalized capital flows, huge foreign investment in Indian equity markets have led stock and foreign exchange markets to be increasingly interdependent. An understanding of the intermarket volatility is important for the pricing of securities within and across the markets for trading and hedging strategies as well as for formulation of regulatory policies in an emerging market like India that is rapidly getting integrated into the global economy. Several financial as well as currency crises across emerging markets around the globe and the advent of floating exchange rate led the academicians as well as practitioners to have a re-look into the nature of volatility spillovers between stock and foreign exchange markets that have seen large correlated movements resulting in market contagion. It has been observed that exchange rate has been used to explain the behavior of stock prices on the assumption that corporate earnings tend to respond to fluctuations in exchange rate [Kim (2003)]. This issue attracted a plethora of regulatory implications as well, whereby institutional restrictions were set up to mitigate the volatility spillover [Roll (1989)]. Besides, international diversification and cross-market return correlations have led these markets to be increasingly interdependent. To understand the risk-return tradeoff of international diversification and, therefore, management of multi currency equity portfolios, it is important to analyze the interaction between the exchange rate risk and stock price. With significant rise in cross border equity investments and, in particular, investments in emerging markets like India, this has become a critical issue for fund managers, especially in the domain of pricing of securities in the global market, international portfolio diversification, and hedging strategies. Moreover, continuous economic globalization and integration of Indian financial Markets with world financial markets, especially fueled by the development of information technology, increases the international transmission of returns and volatilities among financial markets. A competent knowledge of the volatility spillover effect between the stock and foreign exchange markets, and consequently the degree of their integration, will potentially expand the information set available to international as well as domestic investors, multinational corporations, and policy makers for decision making. The existing research generally supports the existence of interdependence in return and volatility of stock and foreign exchange markets. …

Volatility and the Carry Trade

Abstract: The currency “carry trade”, in which an investor buys assets in a higher yielding currency by borrowing in a lower yielding currency, has been consistently exploited as a source of profits by investors In this article, we discuss the effectiveness of the carry trade as prospective risk (measured by implied volatilities) in exchange rates varies Based on simple equilibrium arguments we propose the hypothesis that the carry trade is effectively a form of short volatility trade We also explore a simple strategy that combines carry with options and present a heuristic statistic for the measurement of the economics of the carry trade We test the stratgy on actual historical carry and option price data and find that the hypothetical strategy allows for the presence of arbitrage opportunities between the forex option and carry markets

Volatility and the Carry Trade

Abstract: The currency 'carry trade', in which an investor buys assets in a higher yielding currency by borrowing in a lower yielding currency, has been consistently exploited as a source of profits by investors. In this paper, we discuss the effectiveness of the carry trade as prospective risk (measured by implied volatilities) in exchange rates varies. Based on simple equilibrium arguments we propose the hypothesis that the carry trade is effectively a form of short volatility trade. We also explore a simple strategy that combines carry with options and present a heuristic statistic for the measurement of the economics of the carry trade. We test the stratgy on actual historical carry and option price data and find that the hypothetical strategy allows for the presence of arbitrage opportunities between the forex option and carry markets.

Conflicts between Home & Host Country Prudential Supervisors

Abstract: Potential conflicts between home and host supervisors are legion and may impose heavy compliance costs on internationally active banks, create competitive distortions and jeopardize financial stability. Nonetheless, in comparison to efforts to achieve international cooperation in other economic spheres such as trade, exchange rates and macroeconomic policy, efforts to achieve international cooperation among bank supervisors are relatively recent. They sprang from the unanticipated consequences of applying traditional domestic closure practices to a bank that had substantial cross-border activities. When the West German authorities closed Bankhaus Herstatt at 4:00 pm CET on June 26, 1974, they followed normal domestic procedures and waited until the end of the business day. But this was mid morning in New York, where the dollar leg of $625 million of Herstatt’s foreign exchange contracts remained to be settled. The closure of Herstatt thus resulted in abrogation of these foreign exchange contracts in New York and caused a prolonged disruption in foreign exchange trading and dislocations in the broader Eurodollar market as well. In reaction to the Herstatt crisis, the central bank governors of the Group of Ten formed what later became known as the Basel Committee on Baking Supervision (“Basel Committee”)

Macroeconomic Sources of Foreign Exchange Risk in New EU Members

Abstract: We address the issue of foreign exchange risk and its macroeconomic determinants in several new EU members. The joint distribution of excess returns in the foreign exchange market and the observable macroeconomic factors is modeled using the stochastic discount factor (SDF) approach and a multivariate GARCH-in-mean model. We find that in post-transition economies real factors play a small role in determining foreign exchange risk, while nominal and monetary factors have a significant impact. Therefore, to contribute to the further stability of their domestic currencies, the central banks in the new EU member countries should continue stabilization policies aimed at achieving nominal convergence with the core EU members, as nominal factors play a crucial role in explaining the variability of the risk premium.

Exchange Rate Pass-Through to Export Prices : Assessing Some Cross-Country Evidence

Abstract: A growing body of empirical work has found evidence of a decline in exchange rate pass-through to import prices in a number of industrial countries. Our paper complements this work by examining pass-through from the other side of the transaction; that is, we assess the exchange rate sensitivity of export prices (denominated in the exporter's currency). We first sketch out a streamlined analytical model that highlights some key factors that determine pass-through. Using this model as reference, we find that the prices charged on exports to the United States are more responsive to the exchange rate than is the case for export prices to other destinations, which is consistent with results in the literature suggesting that import price pass-through in the U.S. market is relatively low. We also find that moves in the exchange rate sensitivity of export prices over time have been significantly affected by country and region-specific factors, including the Asian financial crisis (for emerging Asia), deepening integration with the United States (for Canada), and the effects of the 1992 ERM crisis (for the United Kingdom).

Day-of-the-week effect in the Taiwan foreign exchange market

Abstract: This study uses stochastic dominance with and without risk-free assets to examine whether trading days can affect patterns of the day-of-the-week effect in the Taiwan foreign exchange market. Our results generally indicate that higher returns appear on the first three days of the week across different trading-day regimes in the Taiwan foreign exchange market, confirming day-of-the-week effect. Allocating part of investors’ assets in risk-free assets is useful in distinguishing returns among weekdays for all currencies.

Exchange Rate Exposure of Sectoral Returns and Volatilities: Evidence from Japanese Industrial Sectors

Abstract: Most studies of exchange rate exposure of stock returns do not address three relevant aspects simultaneously. They are, namely: sensitivity of stock returns to exchange rate changes; sensitivity of volatility of stock returns to volatility of changes in foreign exchange market; and the correlation between volatilities of stock returns and exchange rate changes. In this paper, we employ a bivariate GJR-GARCH model to examine all such aspects of exchange rate exposure of sectoral indexes in Japanese industries. Based on a sample data of fourteen sectors, we find significant evidence of exposed returns and its asymmetric conditional volatility of exchange rate exposure. In addition, returns in many sectors are correlated with those of exchange rate changes. We also find support for the “averaged-out exposure and asymmetries” argument. Our findings have direct implications for practitioners in formulating investment decisions and currency hedging strategies.