Showing papers on "Foreign exchange market published in 2008"

High frequency financial econometrics : recent developments

Abstract: Editor's introduction: Recent developments in high frequency financial econometrics.- Exchange rate volatility and the mixture of distribution hypothesis.- A multivariate integer count hurdle model: Theory and application to exchange rate dynamics.- Asymmetries in bid and ask responses to innovation in the trading process.- Liquidity supply and adverse selection in a pure limit oder book market.- How large is liquidity risk in an automated auction market.- Order aggressiveness and order book dynamics.- Modelling financial transaction price movements: a dynamic integer count data model.- The performance analysis of chart patterns: Monte Carlo simulation and evidence from the euro/dollar foreign exchange market.- Semiparametric estimation for financial durations.- Intraday stock prices, volume, and duration: a nonparametric conditional density approach.- Macroeconomic surprises and short-term behaviour in bond futures.- Dynamic modelling of large dimensional covariance matrices.

Why the Euro Will Rival the Dollar

Abstract: In the aftermath of World War II, the dollar emerged as the uncontested leaderamong international currencies, a development of historic significance. In 1899,the share of the pound in known foreign exchange holdings of officialinstitutionshadbeenmorethantwicethetotalofthenextnearestcompetitors,the franc and the mark, and much greater than the dollar.

The Real Exchange Rate and Economic Growth

Abstract: The real exchange rate was not at the center of the first generation of neoclassical growth models, nor was it prominent among the policy prescriptions that flowed from those models. Recent analyses, in contrast, have paid it more attention. This paper analyzes the role of the real exchange rate in the growth process, the channels through which the real exchange rate influences other variables, and policies useful (and not useful) for governing the real rate. An appendix provides econometric evidence supportive of the emphases in the text.

Debating China's exchange rate policy

Abstract: China's exchange rate policy has a great impact on the economies of the United States and the rest of the world. This important new book, based on an October 2007 conference looks at this issue in great detail. The book has four sections. The first section assesses progress since China's July 2005 reform of its currency regime, with due attention to China's global current account position, movement of China's real effective exchange rate, the extent of the remaining misalignment of the renminbi (RMB), the roles of market forces and a currency basket in the determination of the RMB exchange rate, and developments in the structure of the foreign exchange market. The second section analyzes how Chinese exchange rate policy reform will affect, and will be affected by, reforms and constraints in other areas of economic policy.The third section delves into the issues raised by China's exchange rate policies for international surveillance of exchange rates and for the timely correction of external payments imbalances. These issues include the appropriate "rules of the game" for International Monetary Fund (IMF) surveillance over exchange rate policies, the effects of China's exchange rate policies on other Asian emerging economies, and the contribution that US and European policies should make to external adjustment as a counterpart to and inducement for greater exchange rate flexibility in Asia. Finally, the concluding section presents specific proposals for how China's exchange rate and capital account policies might be modified over the medium term.These proposals address how best to eliminate any misalignment of the RMB; how best to reduce pressures emanating from the sterilization of large reserve accumulation; how best to make capital flows the ally - not the enemy - of exchange rate policy; and what institutional arrangements and policy guidelines to put in place to reap the greatest benefits from management of China's large exchange reserves.

The euro may over the next 15 years surpass the dollar as leading international currency

Abstract: The euro has arisen as a credible eventual competitor to the dollar as leading international currency, much as the dollar rose to challenge the pound 70 years ago. This paper uses econometrically-estimated determinants of the shares of major currencies in the reserve holdings of the world's central banks. Significant factors include: size of the home country, rate of return, and liquidity in the relevant home financial center (as measured by the turnover in its foreign exchange market). There is a tipping phenomenon, but changes are felt only with a long lag (we estimate a weight on the preceding year's currency share around .9). The equation correctly predicts out-of-sample a (small) narrowing in the gap between the dollar and euro over the period 1999-2007. This paper updates calculations regarding possible scenarios for the future. We exclude the scenario where the United Kingdom joins euroland. But we do take into account of the fact that London has nonetheless become the de facto financial center of the euro, more so than Frankfurt. We also assume that the dollar continues in the future to depreciate at the trend rate that it has shown on average over the last 20 years. The conclusion is that the euro may surpass the dollar as leading international reserve currency as early as 2025.

Sovereign Rating Changes - Do They Provide New Information for Stock Markets?

Abstract: The purpose of this paper is to examine the impact of sovereign rating changes on international financial markets using a comprehensive database of 42 countries, covering the major regions in the world over the period 1995-2003 In general, we find that rating agencies provide stock and foreign exchange markets with new tradable information Specifically, rating upgrades (downgrades) significantly increased (decreased) USD denominated stock market returns and decreased (increased) volatility Whereas the mean response is contributed evenly by the local currency stock returns and exchange rate changes that make up the USD returns, only the foreign exchange volatility was behind the USD denominated return volatility In addition, we find significant asymmetric effects of rating announcements The market responses - both return and volatility - are more pronounced in the cases of downgrades, foreign currency debt, emerging market debt, and during crisis periods This study has important policy implications for international investors' asset allocation plans and for regulatory bodies such as the Basel Committee who increasingly rely upon Moody's, Standard and Poor's and Fitch's ratings for their regulatory regimes

Commercially Available Order Flow Data and Exchange Rate Movements: Caveat Emptor

Abstract: Research suggests that customer order flow should help predict exchange rates. We make two contributions. First, we provide a review of the recent literature on order flow and exchange rate movements. Second, we critically evaluate the practical value of customer order flow data that are commercially available to the wider market, as well as the forecasting properties of inter-dealer order flow. In line with microstructure theory, we find little evidence that the latter can forecast exchange rates, but our results also cast considerable doubt on the practical value to market practitioners of commercially available customer order flow data.

Volatility Spillover between Stock and ForeignExchange 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 S&P CNX NIFTY and S&P CNX 500. The findings of the study also suggest that both the markets move in tandem with each other and there is a long run relationship between these two markets. The results of significant bidirectional volatility spillover suggest that there is an information flow (transmission) between these two markets and both these markets are integrated with each other. Accordingly, financial managers can obtain more insights in the management of their international portfolio affected by these two variables. This should be particularly important to domestic as well as international investors for hedging and diversifying their portfolio.

Exchange Rate Regimes, Foreign Exchange Volatility, and Export Performance in Central and Eastern Europe: Just another Blur Project?

Abstract: The authors attempt to analyze the direct impact of exchange rate volatility on the export performance of ten Central and Eastern European transition economies, as well as its indirect impact via changes in exchange rate regimes. Not only aggregate but also bilateral and sectoral export flows are studied. To this end, the authors first analyze shifts in exchange rate volatility linked to changes in the exchange rate regimes and, second, they use these changes to construct the dummy variables that they include in their export function. The results suggest that the size and the direction of the impact of forex volatility and of regime changes on exports vary considerably across sectors and countries and that they may be related to specific periods.

Crude Oil Prices and the USD/EUR Exchange Rate

Abstract: This paper investigates the impact of changes in the U.S. dollar/euro exchange rate on crude oil prices. The negative correlation of these two variables is ascribed to five possible channels: on the supply side, the purchasing power of oil export revenues and on the demand side, local prices in non-U.S. dollar regions, investments in crude oil-related asset markets, the monetary policy regime in oil-exporting countries and the efficiency of the currency market. We give evidence that using information on the U.S. dollar/euro exchange rate (and its determinants) significantly improves oil price forecasts. We discuss the possible implications these results might suggest with regard to the stabilization of oil prices or the adjustment of global imbalances.

Global Roles of Currencies

Abstract: Policy discussions and academic contributions on the international role of currencies abound. They come in two strands. The first strand deals with the general importance of a given currency in the world economy, and its standing and significance in the international monetary system. These are the contributions that occasionally make media headlines, especially when they raise questions such as whether the dollar could lose its leading global status to the euro, why the yen has lost global importance, and if one day the Chinese renminbi could challenge one — or all three — of these currencies. The second strand of contributions focuses more narrowly on the cross-border use of currencies, analysing which currencies are used outside their home constituencies, by what type of economic agents and for what purposes.

Capital Inflows and Reserve Accumulation: The Recent Evidence

Abstract: NBER WORKING PAPER SERIESCAPITAL INFLOWS AND RESERVE ACCUMULATION:THE RECENT EVIDENCECarmen M. ReinhartVincent R. ReinhartWorking Paper 13842http://www.nber.org/papers/w13842NATIONAL BUREAU OF ECONOMIC RESEARCH1050 Massachusetts AvenueCambridge, MA 02138March 2008Presented at the Korea Institute for International Economic Policy conference, "Capital Flows, MacroeconomicManagement and Regional Cooperation in Asia," where we benefited from the comments of our discussant,Prakash Loungani, and other participants. An earlier version was presented at the Konstanz Seminaron Monetary Policy and Theory, and we appreciate the comments of our discussant, Patrick Minford,and other participants. April Gifford and Meagan Berry provided excellent research support. Theviews expressed herein are those of the author(s) and do not necessarily reflect the views of the NationalBureau of Economic Research.© 2008 by Carmen M. Reinhart and Vincent R. Reinhart. All rights reserved. Short sections of text,not to exceed two paragraphs, may be quoted without explicit permission provided that full credit,including © notice, is given to the source.

Exchange Rate Risk and Commodity Trade Between the U.S. and India

Abstract: Floating exchange rates are said to introduce volatility into the foreign exchange market that could deter trade flows Previous research employed aggregate import and export trade data and provided mixed results In this paper we disaggregate the trade data between the US and the emerging economy of India and use the bounds testing approach to cointegration and error-correction modeling to show that in 40 industries that trade between the two countries, exchange rate volatility has negative and positive effects in 40% of industries, in the short run These short-run effects, however, do not last into the long run in many cases

Soft computing techniques applied to finance

Abstract: Soft computing is progressively gaining presence in the financial world. The number of real and potential applications is very large and, accordingly, so is the presence of applied research papers in the literature. The aim of this paper is both to present relevant application areas, and to serve as an introduction to the subject. This paper provides arguments that justify the growing interest in these techniques among the financial community and introduces domains of application such as stock and currency market prediction, trading, portfolio management, credit scoring or financial distress prediction areas.

India's Bond Market: Developments and Challenges Ahead

Abstract: While India boasts a world-class equity market and increasingly important bank assets, its bond market has not kept up. The government bond market remains illiquid. The corporate bond market, in addition, remains restrictive to participants and largely arbitrage-driven. Securitization, which once had the jump on other Asian markets, has failed to take off. To meet the needs of its firms and investors, the bond market must therefore evolve. This will mean creating new market sectors such as exchange-traded interest rate and foreign exchange derivatives contracts. It will mean relaxing exchange restrictions, easing investment mandates on contractual savings institutions, reforming the stamp duty tax, and revamping disclosure requirements for corporate public offers. This paper reviews the development and outlook of the Indian bond market. It looks at the market participants - including life insurance, pension funds, mutual funds and foreign investors - and it discusses the importance to development of learning from the innovations and experiences of others.

Aid inflows and the real effective exchange rate in Tanzania

Abstract: Tanzania is well placed to receive a significant increase in aid inflows in coming years. Despite the potential for the additional aid inflows to raise income levels in the country, increasing them may bring about structural changes in the economy that may be unwelcome. One such change is an appreciation of the real exchange rate that leads to a contraction of traditional export sectors and a loss of export competitiveness. This paper employs a reduced-form equilibrium real exchange rate approach to explain movements in Tanzania's real effective exchange in recent decades. Particular attention is paid to the relationship between aid inflows and the real effective exchange rate. The authors find that the long-run behavior of the real effective exchange rate is influenced by terms of trade movements, the government's trade liberalization efforts, and aid inflows. Positive terms-of-trade movements are associated with an appreciation, periods of improving trade liberalization are associated with a depreciation, and increases in aid inflows are associated with a depreciation in the real effective exchange rate. Although the last result is non-standard, it is not empirically unique and does have theoretical underpinnings. A detailed analysis of this relationship over the last decade shows that the Bank of Tanzania's response to aid inflows is likely the main reason for the finding.

Understanding Asian Equity Flows, Market Returns and Exchange Rates

Abstract: This paper examines from various angles foreign investors' daily transactions in six emerging Asian equity markets and their relationship with local market returns and exchange rate changes over the period 1999-2006. Confirming much of the literature, we find that equity market returns matter for net equity purchases, and vice versa. In addition, we find that while currency returns tend to show little influence over foreign investors' demand for Asian equities, net equity purchases do have some explanatory power over near-term exchange rate changes. Moreover, we find that foreign investors do quite often move in or out of multiple Asian markets simultaneously - but more so on the way in than on the way out. Nonetheless, during specific events of heightened market volatility, we observe some interesting deviations from the full-sample average relationships.

Costs and benefits of running an international currency

Abstract: This report discusses the cost and benefits of running an international currency. It starts by discussing the effect of the euro's internationalization on financial markets, and presents data on the impact of the single currency on private credit. It considers recent work on the effect of the euro on financial integration and the implications of the euro's rising internationalization on the liquidity premium. Then it turns to the vehicle currency role of the euro and presents some results using new data from the latest BIS Triennial Survey on the foreign exchange market. Concerning the direct benefits of running an international currency, the report first offers estimates on the likely gains from international seigniorage and discuss work on the effects of the internationalization of the euro on the terms of trade and invoicing patterns in international trade. The implications of the international role of the euro for portfolio returns and the so-called “exorbitant privilege” are analysed in detail. The effects of the single currency on exchange rate volatility are also considered. It summarizes recent research on the impact of the euro on global bond and equity and analyzes the potential implications of the euro's international status for central banks' reserve holdings. Finally, it turns to the effects of the euro on the stability of domestic money demand and the problems posed for monetary policy, and the implications for international financial stability.

What determines transaction costs in foreign exchange markets

Abstract: Using detailed data on the currency transactions of institutional fund managers, this paper shows that funds that experience high returns on their currency holdings also incur lower transaction costs on their currency trades. This finding holds both in the cross section, i.e. funds that perform better on average incur lower average transaction costs, as well as in time series, i.e. funds that do better over the past two months incur lower transaction costs on subsequent transactions. The results are consistent with foreign exchange dealers bidding for information from successful traders. They are also consistent with foreign exchange dealers exploiting price inelastic demand for foreign currency trades, or funds acting as secondary liquidity providers in foreign exchange markets. The paper also investigates the role of fund size, transaction frequency and return volatility on transactions costs.

Relationship between Exchange Rate Volatility and Central Bank Intervention An Empirical Analysis for India

Abstract: In a world of high capital mobility, several risks are emerging in the financial markets and the Central Bank intervention has played an important role in managing these risks. In India, the Reserve Bank of India (RBI) intervenes in the foreign exchange market to maintain orderly market conditions. This article empirically explores the relationship between Central Bank intervention and exchange rate behaviour in the Indian foreign exchange market. Specifically, the article investigates the effects of RBI intervention on exchange rate level and volatility. Using monthly data for April 1995 through December 2006 and GARCH (1,1) model, it is found that the intervention of the RBI is effective in reducing volatility in the Indian foreign exchange market instead of reversing trend movement of exchange rate. It is also observed that FII investments increase exchange rate volatility in India.

Exchange Rates and Fundamentals: A Generalization

Abstract: Working Paper 2008-16 June 2008 Abstract: Exchange rates have raised the ire of economists for more than twenty years. The problem is that few, if any, exchange rate models are known to systematically beat a naive random walk in out-of-sample forecasts. Engel and West (2005) show that these failures can be explained by the standard present value model (PVM) because it predicts random walk exchange rate dynamics if the discount factor approaches one and fundamentals have a unit root. This paper generalizes the Engel and West hypothesis to the larger class of open economy dynamic stochastic general equilibrium (DSGE) models. The Engel and West hypothesis is shown to hold for a canonical open economy DSGE model. We show that all the predictions of the standard PVM carry over to the DSGE PVM. The DSGE PVM also yields unobserved components (UC) models that we estimate using Bayesian methods and a quarterly Canadian-U.S. sample. Bayesian model evaluation reveals that the data support a UC model that calibrates the discount factor to one, implying the Canadian dollar-U.S, dollar exchange rate is a random walk dominated by permanent cross-country monetary and productivity shocks. JEL classification: E31, E37, F41 Key words: exchange rates, present value model and fundamentals, random walk, DSGE model, unobserved components model, Bayesian model comparison 1. INTRODUCTION The search for satisfactory exchange rate models continues to be elusive. This paper studies a workhorse theory of currency market equilibrium determination, the present-value model (PVM) of exchange rates, in the spirit of Engel and West (2005). Starting with the PVM and using uncontroversial assumptions about fundamentals and the discount factor, Engel and West (EW) hypothesize that the PVM generates an approximate random walk in exchange rates if the PVM discount factor approaches one and fundamentals are I(1). An important implication of the EW hypothesis is that fundamentals have no power to forecast future exchange rates, even with the PVM dictating equilibrium in the currency market. EW support their hypothesis with a key theorem and empirical and simulation evidence. This paper complements Engel and West (2005) by generalizing their main hypothesis in two ways. First, the EW hypothesis is generalized using a canonical two-country monetary dynamic stochastic general equilibrium (DSGE) model. Its linearized uncovered interest parity (UIP) and money demand equations yield the DSGE-PVM that coincides with the standard PVM of the exchange rate. Second, we show the standard- and DSGE-PVMs make equivalent predictions for exchange rates. The predictions are summarized in five propositions: (1) the exchange rate and fundamental cointegrate [Campbell and Shiller (1987)], (2) the PVM yields an error correction model (ECM) for currency returns in which the lagged cointegrating relation is the only regressor, (3) the PVM predicts a limiting economy (Le., the PVM discount factor approaches one from below) in which the exchange rate is a martingale, (4) given fundamental growth depends only on the lagged cointegrating relation, the exchange rate and fundamental have a common trend-common cycle decomposition [Vahid and Engle (1993)], and (5) the EW hypothesis is also satisfied when the exchange rate and fundamental share a common feature and the PVM discount factor approaches one. A corollary to (5) is that the exchange rate is unpredictable when the PVM discount factor goes to one. We report evidence from vector autoregression (VARs) about the propositions using quarterly floating rate Canadian-, Japanese-, and U.K.-U.S. samples. The VAR evidence rejects cointegration and reveals substantial serial correlation for the exchange rate and the fundamental. There is also evidence that a common feature exists between the Canadian dollar-, Yen-, and Pound-U.S. dollar exchange rates and the relevant fundamentals. …

The Costs and Implications of PBC Sterilization

Abstract: Since China revalued its currency against the U.S. dollar by 2.1 percent in July 2005, from RMB 8.27 per US$ to RMB 8.11, the RMB has appreciated by a further 14 per cent percent to about RMB 6.97 per US$ (as of May 2008). On a trade-weighted basis, however, the currency has appreciated less than half this amount. Using J.E Morgan's trade-weighted index (broad basis) for the RMB, the currency appreciated just 6.1 percent in nominal terms between August 2005 and May 2008. Although the currency has been very gradually appreciating, the flexibility promised by China's leaders has been more illusory than real, and, more importantly, the underlying international payment imbalances have continued to widen both in absolute terms and as a fraction of GDP. In this article, I set out the magnitude of the problem of China's international payment imbalances, summarize the techniques used by the People's Bank of China to sterilize China's overall balance of payments surplus, and assess the costs and benefits of the PBC's sterilization strategy--both from a theoretical perspective and in the light of the experience of other East Asian currencies that have witnessed large-scale sterilization operations in the past. I also consider whether, for the purpose of ensuring satisfactory monetary arrangements in the 21st century, it is appropriate for a country of the size and stature of China to delay adjustment by means of large-scale sterilization. China's International Payments Imbalance In the period prior to 2002, there were few presumptions that China's currency would appreciate. There had been a long history of devaluations between 1960 and 1994. However, following the devaluation of 1994 and the subsequent monetary reforms the external value of the currency was held stable against the US$, notably throughout the Asian financial crisis of 1997-98. Nevertheless, the NDF (non-deliverable forward) value of China's currency traded at a persistent discount to the spot value of the currency (that is, weaker than the spot rate of around 8.27 per US$) until December 2002 when it moved to a premium for the first time (Figure 1). In the same year, the errors and omissions item in China's balance of payments shifted from negative to positive, suggesting a change from unreported outflows to unreported inflows. In 2003 and 2004 both the current account and the capital account showed marked increases in the size of their surpluses. [FIGURE 1 OMITTED] Since the revaluation of July 2005, and despite the gradual subsequent appreciation of the RMB against the U.S. dollar and other currencies, the low level of the Chinese currency is causing China to run increasingly large overall (current plus private sector capital account) surpluses in its balance of payments. The simplest measure of that overall (current and capital) surplus is the increase in China's foreign exchange reserves. (1) In 2006, the overall surplus was $246 billion or 9.1 percent of GDP, while the current account surplus was $249 billion or 9.2 percent of GDP (Table 1). In 2007, the current account surplus increased to $371.8 billion or 11.1 percent of GDR Similarly, the overall surplus in 2007 was $461.7 billion, or 13.8 percent of GDP. By any standard, these imbalances are of a very substantial magnitude, and will have large consequences for both China's trading partners as well as for China itself. PBC's Sterilization Techniques The overall surpluses in the balance of payments require the PBC, China's central bank, to intervene almost daily and buy any excess foreign currency on the Shanghai foreign exchange market in order to hold down the value of the RMB. Based on 250 trading days per year, the PBC's foreign exchange purchases exceeded $1.8 billion per day in 2007. In making these purchases, the PBC typically credits the reserve accounts of mainland banks with an equivalent amount of RMB, which in the normal course of events would cause China's money supply to accelerate (as in 2002-03), and this in turn would normally lead to inflation. …

The Evolution of Trading Activity in Asian Foreign Exchange Markets

Abstract: We exploit previously unpublished data on foreign exchange turnover to analyse the institutional setting in which the currencies of non-Japan Asia are traded. Volumes grew rapidly between 2004 and 2007 and the diversity of market participants increased. Nevertheless, liquidity is undermined by foreign exchange controls. For Asian currencies other than JPY, HKD and SGD, non-residents account for a relatively small share of activity and FX swap markets are still in their infancy. Offshore non-deliverable markets have developed in response to controls, causing segmentation in trading activity. Furthermore, Herstatt risk remains high in Asian foreign exchange markets.

Modeling foreign exchange risk premium in Armenia

Abstract: This paper applies stochastic discount factor methodology to modeling the foreign exchange risk premium in Armenia. We use weekly data on foreign and domestic currency deposits, which coexist in the Armenian banking system. This coexistence implies elimination of the cross-country risks and transaction costs, leaving the pure foreign exchange risk. It is shown that there exists a systematic time-varying risk premium that increases with maturity. Using two-currency affine term structure and generalized autoregressive conditional heteroskedasticity (GARCH)-in-mean models, we find that the central bank's foreign exchange market interventions and ratio-of-deposit volumes significantly affect public expectations about foreign exchange fluctuations. We also find that the foreign exchange risk premium accounts for the largest part of the interest differential. When accounting for economic and institutional differences, our results can be extended to other countries.

Mundell-Fleming Lecture: Exchange Rate Systems, Surveillance, and Advice

Abstract: This paper draws together some lessons and questions about exchange rate systems and attempts to state what is known and what is not known about them. It begins by revisiting the bipolar issue with regard to exchange rates, restating the hypothesis and updating it in light of events of this decade, arguing that the bipolar view is fundamentally correct for emerging market and industrialized countries with open capital accounts. It also examines the choice of exchange rate regime for countries with capital accounts that are not open, and managed floating regimes and exchange market intervention for countries with open capital accounts. Concluding remarks provide comments and advice for IMF surveillance.

Asymmetric information in the interbank foreign exchange market

Abstract: This paper provides evidence of private information in the interdealer foreign exchangemarket. In so doing it provides support for the hypothesis that information is an importantreason for the strong positive correlation between order flow and returns. It also providesevidence that information influences order-book structure. Our data comprise the completerecord of interdealer trades at a good-sized Scandinavian bank during four weeks in 1998 and1999, including bank identities. Our results indicate that larger banks have more informationthan smaller banks, that the relation between order flow and returns is stronger for largerbanks than smaller banks, and that larger banks exploit their information advantage in limit-order placement. JEL Classifications : G15; F31; F33 Keywords : Foreign exchange, microstructure, asymmetric information, liquidity premium We have benefited from the comments by Martin Evans, Michael King, Richard K. Lyons, and Michael Moore, inaddition to participants at presentations at the