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Asian Monetary Cooperation
China's acession to the World Trade Organization (WTO)
Conditionality (of international donation and loans)
Covered and Uncovered Interest Parities
Crises
Development Bank
Economic Research Forum
Exchange Rate Arrangements
Financial liberalization
Foreign Exchange Intervention
Globalisation
Official Development Assistance
Parallel trade
Purchasing Power Parity (PPP)
Regional Trading Agreements
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  Covered and Uncovered Interest Parities
   

What is CIP?
Covered Interest Parity (CIP) is also called covered interest rate parity. Under the assumption of free capital flow, it states that the forward premium of a foreign currency should be equal to the interest rate differential between a domestic asset and a substitutable foreign asset.

CIP implies the equality of returns on comparable financial assets denominated in different currencies. The underlying mechanism for CIP is covered interest arbitrage.

What is Covered Interest Arbitrage?
Covered interest arbitrage is the transfer of liquid funds from one monetary center to another to take advantage of higher rates of return or interest, while covering the transaction with a forward currency hedge.

Suppose the 3-month T-bill rate in the U. S. is 12%, higher than the 3-month T-bill rate of 8% in Canada. Attracted by the higher interest rate, investors would tend to change their Canadian dollar into U.S. dollar and invest their funds in the U.S. Simultaneously, they buy contracts to sell dollars in 3 months in the forward market. If the spot exchange rate is 1.00CAD/USD at present, and the 3-month forward exchange rate is 0.99CAD/USD at present, then the investors' losses in exchange conversion will be 1%. From the interest rate differential, they will earn 1% in 3 months (since annually they earn (12%-8%)=4% by investing in U.S. rather than in Canada). This profit is just offset by the loss. However, if the interest rate in U.S. is higher, making the earning in interest rate differential much larger in absolute value than the loss in foreign exchange, this arbitrage process will continue. Then, large amount of funds flow from Canada into U.S., putting pressures for U.S. to lower its interest rate and for Canada to raise its interest rate. In addition, the increasing demand of U.S. dollar in the current market tends to raise the spot rate for U.S. dollar. The increasing demand of Canada dollar in the forward market tends to decrease the future rate for U.S. dollar. The process continues until returns from investing in the two countries reach the same level. Then the CIP conditions will be satisfied again.

How can we explain deviations from CIP?
Academically, the empirical deviations from CIP are always explained as violations to the assumption of free capital flow and the substitutability of assets from different countries. The possible explanations include:

  1. There may be transaction costs, which introduces a "transaction band" into the CIP equation. Recently, Cody (1990), Moosa (1996) and Balke and Wohar (1998) studied about the relation between CIP and the transaction costs.
  2. There may be possible capital controls, which actually adds costs to the investment in other countries and creates similar effects of the transaction costs to the CIP equation.
  3. There may be difference in tax rates on interest income and foreign exchange losses/gains in different countries. This difference contributes to the non-substitutability of investments in different countries and makes investment in a country more preferable than the other.

What is UIP?
UIP states that if funds flow freely across country boarders and investors are risk neutral, after the adjustment of expected depreciation, the expected rates of return to substitutable assets denominated in different currencies should be equal. In equation, it is expressed as the equality between the expected changes in spot exchange rate and the interest differentials of two countries.

Like that of CIP, the underlying mechanism of UIP is interest arbitrage activities. For example, if domestic interest rate is lower than the expected rate of return on an identical foreign asset, investors will borrow from the home country and invest in the foreign country. The borrowing and investing process will cause domestic interest rate to increase and foreign interest rate to decrease-until two kinds of return reach the same level.

What is the difference between CIP and UIP?
CIP is based on the assumption that the forward market is used to cover against exchange risk. Foreign exchange transactions are conducted simultaneously in the current market and forward markets. The variables in CIP equation are all realized values. Whereas in UIP, there is not any covers against exchange risk. Transactions are conducted only in the current market. The change in spot exchange rate is estimated on its expected value.

Why is it important to study UIP's potential validity/failure?
First, UIP links the exchange rates and interest rates of different countries. It is a basic assumption in many economic models. The validity of these models thus partially relies on UIP's validity.

Second, UIP states the equality of returns to investment in different countries. This equality means an exclusion of arbitrage opportunities. Therefore, the failure of UIP may indicate arbitrage benefits in international financial markets, which means much to international investors.

Third, according to Flood and Rose (2001), "deviations from UIP are the basis for interest rate defense of fixed exchange rate." Since interest rate defense of fixed exchange rates is similar to the use of interest rate policy to stabilize an exchange rate, failure of UIP also ensures the effectiveness of interest rate policy to stabilize an exchange rate.

What are the results of empirical UIP studies?
Empirically, under the assumption of rational expectation, UIP is always tested in a form of equality between realized change in spot exchange rate and interest rate differential. Its empirical failure is well known. Concerning UIP's empirical failure, studies of UIP can be classified into two categories:

The first is to explain UIP's empirical failure by considering violations to its basic assumptions. These violations include the irrational expectation indicated by Frankel and Froot (1990) and a time-varying risk premium studied by Fama (1984) and Malliaropulos (1997). In sum, these studies give mixed evidence for the validity of UIP.

Another branch of UIP studies is based on the intuition that UIP is actually a long-run relationship obscured by short-run exogenous shocks. Economists have used methods that can extract long-run information to study this feature. Their tools include cointegration analysis (e.g. Moosa and Bhatti, 1995), using long-run average data (e.g. Lothian, 1998). Most of these studies yield results favoring a long-run UIP relationship.

    Keywords: Exchange Rate, Covered interest parity, Uncovered interest parity
     
 

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International Financial Encyclopaedia
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  It's an interactive Financial Encyclopaedia which is the courtesy of Investor's Galleria. It presents very brief entries which help if no other source of information is available. This dictionary includes a number of Standard terms which are accepted by a major standards setting body such as the International Standards Organisation.
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Foreign Currency Notes Exchange Rates
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Economagic: Economic Time Series Page
  URL: http://www.EconoMagic.com/
  This website is made by Ted Bos of University of Alabama, at Birmingham. This page is meant to be a comprehensive site of free, easily available economic time series data useful for economic research, in particular economic forecasting. This site (set of web pages) was started in 1996 to help students in an Applied Forecasting class. The idea was to give students easy access to large amounts of data, and to be able to quickly get charts of that data. There are more than 100,000 time series for which data and custom charts can be retrieved. Though the greatest utility of this site is the vast number of economic time series, and the easily modified charts of that same data, an overlooked facility of great utility is the availability of Excel files for all series. The majority of the data is USA data. The core data sets involve US macroeconomic data (that is, for the whole US), but the bulk of the data is employment data by local area -- state, county, MSA, and many cities and towns. A subscription allows a user to use the on-site programs that provide mechanical forecasts for any time series. These time series can be those freely available on this site, any series that the user pastes to the download area, or any series that the user has negotiated with Economagic to provide or maintain. The price of an annual subscription is US$200, or US$120 for six months.
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Global Financial Data Home Page
  URL: http://www.globalfindata.com/
  This impressive collection of historical global financial data stretches from the years 1264 to 2000. While most of the actual data must be purchased, this Website does offer several free series, including Stock Markets since 1693, Interest Rates since 1700, and Inflation Rates since 1264. The site also contains a decent-sized collection of research papers written about the Eurodollar and a links page with financial Websites from around the world. Subscriptions to the database are charged.
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References
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References related to Exchange Rate (51 references are shown.)

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China's exchange rate policy

  Author: Xu, Yingfeng
Book: China Economic Review
  Year: 2000 Vol: Vol. 11
  Should or will the yuan depreciate? This is an important question widely speculated in world financial markets and intensively debated in China in the wake of the East Asian financial crisis in 1997. The present paper examines in detail the fundamentals that determine the exchange rate in China and concludes with two important findings. One is that the past two decades of economic reform has made domestic prices in China sufficiently market-determined and linked to world prices so that the exchange rate can serve as an effective nominal anchor. Exchange rate stability leads to domestic price stability. The other result is that because of the flexibility of domestic prices, a change in the exchange rate has only a modest and ephemeral effect on the terms of trade and trade flows. Therefore, exchange rate flexibility is not essential to keep the current account in balance. Such evidence suggests that China should continue the policy to maintain exchange rate stability, as it has done since 1994.
  Remarks:
   
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Fear of Floating

  Author: Guillermo A. Calvo University of Maryland and NBER Carmen M. Reinhart* University of Maryland and NBER
Book:
  Year: September 25, 2000 Vol: 63 pages
  In recent years, many countries have suffered severe financial crises, producing a staggering toll on their economies, particularly in emerging markets. One view blames fixed exchange rates-- "soft pegs"--for these meltdowns. Adherents to that view advise countries to allow their currency to float. They analyze the behavior of exchange rates, reserves, the monetary aggregates, interest rates, and commodity prices across 154 exchange rate arrangements to assess whether "official labels" provide an adequate representation of actual country practice. We find that, countries that say they allow their exchange rate to float mostly do not--there seems to be an epidemic case of "fear of floating". Since countries that are classified as having a free or a managed float mostly resemble noncredible pegs--the so-called "demise of fixed exchange rates" is a myth--the fear of floating is pervasive, even among some of the developed countries. They present an analytical framework that helps to understand why there is fear of floating.
  Remarks: Paper can be downloaded in http://www.bsos.umd.edu/econ/ciecrp11.pdf
   
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Fixed vs. Flexible Exchange Rates. Preliminaries of a Turn-of-Millennium Rematch

  Author: Guillermo A. Calvo - University of Maryland
Book:
  Year: May 16, 1999 Vol: 17 pages
  This note examines the pros and cons of flexible and fixed exchange rates in terms of a bear-bones model which, however, takes into account features that have played a prominent role in recent currency crises, namely, volatility of capital flows and the real exchange rate, currency substitution and financial fragility, and the Credit Channel.
  Remarks: The paper is downloadable at http://www.bsos.umd.edu/econ/ciecrp10.pdf
   
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Exchange Rate Regimes and Institutional Arrangements in the Shadow of Capital Flows

  Author: Dani Rodrik
Book:
  Year: Sep 2000 Vol: 20 Pages
  This paper has been prepared for a conference on Central Banking and Sustainable Development, held in Kuala Lumpur, Malaysia, August, 28-30, 2000, in honor of Tun Ismail Mohamed Ali. It talks about the Choice of exchange rate regimes. The conventional wisdom today is that countries need to choose between two corners: either floating exchange rates or irrevocably fixed rates. The reason is the potential of capital flows to wreak havoc with any intermediate regime (“soft pegs”). So much of the debate on exchange rate policy focuses on the pros and cons of currency boards/dollarization versus floats. The trouble with this debate is that the evidence shows clearly that neither corner works very well for developing countries for long periods of time. Countries that have done well in the postwar period in terms of economic performance have in almost all cases had intermediate exchange rate regimes. Then he discussed 1) Why floating is not a solution; 2) Why currency boards or dollarization are not a solution
  Remarks: This paper can be downloaded in http://ksghome.harvard.edu/~.drodrik.academic.ksg/Malaysia%20conference%20paper.PDF
   
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International Financial Crises and Flexible Exchange Rates: Some Policy Lessons from Canada

  Author: John Murray, Mark Zelmer and Zahir Antia
Book: Technical Report
  Year: April 2000 Vol: No. 88
  This paper examines the behaviour of the Canadian dollar from 1997 to 1999 to see if there is any evidence of excess volatility or significant overshooting. A small econometric model of the exchange rate, based on market fundamentals, is presented and used to make tentative judgments about the extent to which the currency might have been systematically over- or undervalued. Three major conclusions emerge from the analysis. First, movements in world commodity prices and Canada-U.S. interest rate differentials can account for most of the observed variation in the value of the Canadian dollar. Any deviations that were recorded between actual and predicted values of the exchange rate were generally small and short-lived, suggesting that destabilizing speculative behaviour did not play a very important role in recent market developments. Second, while it is possible to explain most of the past movements in the Canadian dollar using a simple exchange rate equation, its ability to predict future movements in the exchange rate is limited due to the inherent instability of the fundamental variables guiding its behaviour. Exchange rate predictions, in short, are only as accurate as the forecasts of future commodity prices and interest rates. Third, it appears that periods of market turbulence are often dominated by fundamentalists as opposed to noise traders and are triggered typically by large external shocks. Monetary authorities should therefore be wary of resisting any movements in the exchange rate, since they are often part of a necessary and unavoidable adjustment process. Aggressive foreign exchange market intervention and other monetary policy actions designed to stabilize the exchange rate could easily prove counterproductive and subvert market efficiency.
  Remarks: This paper is accessible at: http://www.bankofcanada.ca/en/res/tr88-e.htm
   
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The "Exchange Risk Premium," Uncovered Interest Parity, and the Treatment of Exchange Rates in Multicountry Macroeconomic Models

  Author: Ralph C. Bryant, Senior Fellow, Economic Studies
Book: Brookings Discussion Papers in International Economics
  Year: 1995
  The literature on exchange markets conventionally defines the gap between the forward exchange rate and the expected future spot exchange rate as an "exchange risk premium." Part I of this paper skeptically reviews existing interpretations of the exchange risk premium and then presents an alternative conceptual framework. Part II revisits the issue of how to model the determination of exchange rates in empirical macroeconomic models, focusing on the typical use of the uncovered interest parity condition combined with the assumption of model-consistent expectations. The paper discusses why this treatment of exchange rates is inadequate and makes some suggestions for future research. Part III of the paper replicates some "standard" regressions, widely reported in the empirical literature, thought to have a bearing on whether the forward exchange rate is an unbiased predictor of the future spot rate, whether survey expectations produce unbiased predictions of actual changes in exchange rates, and whether a bias in the forward rate can be attributed to a time-varying risk premium. If the perspective in this paper is accepted, the conventional statistical literature has devoted excessive resources to estimation of these standard but not particularly revealing regressions. All three parts of this paper make use of empirical data on exchange rate expectations collected since 1985 by the Japan Center for International Finance.
  Remarks: The full version of the paper in PDF format can be downloaded at: http://www.brook.edu/views/papers/bryant/111.htm
   
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Currency crises and fixed exchange rates in the 1990s: A review

  Author: Patrick Osakwe and Lawrence Schembri
Book: Bank of Canada Review article
  Year: Autumn 1998
  Currency crises in the 1990s, especially those in emerging markets, have sharply disrupted economic activity, affecting not only the country experiencing the crisis, but also those with trade, investment, and geographic links. The authors review the theoretical literature and empirical evidence regarding these crises. They conclude that their primary cause is a fixed nominal exchange rate combined with macroeconomic imbalances, such as current account or fiscal deficits, that the market perceives as unsustainable at the prevailing real exchange rate. They also conclude that currency crises can be prevented through the adoption of sound monetary and fiscal policies, effective regulation and supervision of the financial sector, and a more flexible nominal exchange rate.
  Remarks: The paper is downloadable at: http://www.bankofcanada.ca/en/res/r984b-ea.htm
   
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International price comparisons based on purchasing power parity

  Author: Michelle A. Vachris - Associate professor of economics at Christopher Newport University James Thomas - enior economist, Office of Prices and Living Conditions, Bureau of Labor Statistics
Book: Montly Labor Review Online
  Year: October 1999 Vol: October 1999, Vol. 122, No. 10
  Because exchange rate movements, in general, tend to be more volatile than changes in national price levels, the purchasing power parity approach provides the proper basis for comparing living standards and examining productivity levels over time.
  Remarks: The full document can be downloaded at: http://stats.bls.gov/opub/mlr/1999/10/art1abs.htm
   
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The Failure of Uncovered Interest Parity: Is It Near-Rationality in the Foreign Exchange Market?

  Author: David Gruen, Gordon Menzies
Book: Publication of Reserve Bank of Australia
  Year: May 1991
  A risk-averse US investor adjusts the shares of a portfolio of short-term nominal domestic and foreign assets to maximise expected utility. The optimal strategy is to respond immediately to all new information which arrives weekly. They calculate the expected utility foregone when the investor abandons the optimal strategy and instead optimises less frequently. They also consider the cases where the investor ignores the covariance between returns sourced in different countries, and where the investor makes unsystematic mistakes when forming expectations of exchange rate change. They demonstrate that the expected utility cost of sub-optimal behaviour is generally very small. Thus, for example, if investors adjust portfolio shares every three months, they incur an average expected utility loss equivalent to about 0.16 per cent p.a.. It is therefore plausible that slight opportunity costs of frequent optimisation may outweigh the benefits. This result may help explain the failure of uncovered interest parity.
  Remarks: An electronic version of this paper is not available. If you want to the printed copy of the paper, you can simply follow the instruction in this site: http://www.rba.gov.au/PublicationsAndResearch/RDP/RDP9103.html
   
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Long-Horizon Uncovered Interest Rate Parity

  Author: Guy Meredith, Menzie D. Chinn
Book: NBER Working Paper
  Year: November 1998 Vol: No. W6797
  Uncovered interest parity (UIP) has been almost universally rejected in studies of exchange rate movements, although there is little consensus on why it fails. In contrast to previous studies, which have used relatively short-horizon data, we test UIP using interest rates on longer-maturity bonds for the G-7 countries. These long-horizon regressions yield much more support for UIP -- all the coefficients on interest differentials are of the correct sign, and almost all are closer to the UIP value of unity than to the zero coefficient implied by the random walk hypothesis. We then use a small macroeconomic model to explain the differences between the short- and long-horizon results. Regressions run on data generated by stochastic simulations replicate the important regularities in the actual data, including the sharp differences between short- and long-horizon parameters. In the short run from risk premium shocks in the face of endogenous monetary policy. In the long run, in contrast, exchange rate movements are driven by the "fundamentals," leading to a relationship between interest rates and exchange rates that is more consistent with UIP.
  Remarks: The full version of the paper in PDF format can be downloaded at: http://papers.nber.org/papers/W6797
   
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Purchasing Power Parity and Interest Parity in the Laboratory

  Author: Eric O™N. Fisher, Department Of Economics, The Ohio State University
Book:
  Year: 10 April 2001
  This paper analyzes purchasing power parity and uncovered interest parity in the laboratory. It finds strong evidence that purchasing power parity, covered interest parity, and uncovered interest parity hold. Subjects are endowed with an intrinsically useless (green) currency that can be used to purchase another useless (red) currency. Green goods can be bought only with green currency, and red goods can be bought only with red currency. The foreign exchange markets are organized as call markets. In the treatment analyzing purchasing power parity, the price of the red good varies. In a second treatment, the interest rate on red currency varies. In a third treatment, the interest rate on red currency varies, and the price of the red good is random. The paper is 35-page long and can be downloaded at: http://econ.ohio-state.edu/efisher/pppuip.pdf
  Remarks:
   
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Haircuts or Hysteresis? Sources of Movements in Real Exchange Rates

  Author: Rogers,John H.; Jenkins, Michael
Book: Journal of International Economics
  Year: 1995 Vol: 38(3-4), pages 339-60.
  The authors empirically assess the importance of two sources of real exchange rate movements. In models where purchasing power parity holds only among traded goods, real exchange rate variation results from relative price movements within countries. An alternative explanation relies on hysteretic price-setting and nominal exchange rate changes. Using disaggregated price data from eleven OECD nations, the authors find some support for the nontraded goods models. For example, prices of haircuts in Canada and the United States are related in the long run. The authors find stronger evidence to support models that emphasize sticky prices, transportation costs, or other impediments to frictionless trade.
  Remarks:
   
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Risk, Policy Rules, and Noise: Rethinking Deviations from Uncovered Interest Parity

  Author: Nelson Mark, Ohio State University Yangru Wu, West Virginia University
Book:
  Year:
  This paper attempts to understand why the forward premium helps to predict the future change in the exchange rate, but with the wrong (negative) sign. A corollary to the negative forward premium bias is that the rational deviation from uncovered interest parity (DUIP) is negatively correlated with the rationally expected rate of depreciation. These facts have long posed a challenge to international economic theory. In this paper, they explore three approaches to explain these puzzles: (i)the standard representative-agent asset pricing model, (ii)a monetary-policy rule model with exchange-rate feedback, and (iii)a model of noise trading. They begin by presenting some stylized facts that characterize the problem. They obtain implied values of the rational DUIP and the rationally expected depreciation from a vector error correction model (VECM) for log spot and forward exchange rates and demonstrate the credibility of the estimates of these unobserved series by showing that they match a number key sample moments. With these credible estimates of the rational DUIP in hand, They then ask if they behave like risk premia implied by the standard representative agent asset pricing approach. The answer to this question is no. The risk premium is a conditional covariance between the intertemporal marginal rate of substitution of money and the payoff from forward currency speculation. Since the rational DUIP fluctuates between positive and negative values, according to the risk premium hypothesis, this conditional covariance must also. Our empirical analysis shows, however, that required conditional correlations required by the theory are largely absent from the data. Next, they re-examine a recent contribution by McCallum~(1994), who develops a non-risk interpretation of the rational DUIP. There, monetary policy involves the setting of the interest differential according to a rule that partially offsets the contemporaneous depreciation of the domestic currency. The feedback of the contemporaneous depreciation to the interest differential induces an error in the variables problem in the regression of the future depreciation on the forward premium and perfectly negatively correlated rational DUIPs and rationally expected depreciations. The error in the variables problem is the source of the forward premium bias in this model. Their investigation of McCallum's model uncovers suggests two reasons to apply his results with caution. First, they report econometric estimates of the policy rule parameters which have the wrong sign required to explain the forward premium bias. The second reason is that the results are not robust to a reasonable reformulation of the policy rule. In the original formulation, the interest rate differential depends on the contemporaneous rate of depreciation. A trading sequence that rationalizes this rule is that the foreign exchange market closes before the monetary policy authorities determine the current period interest differential. But an alternative and equally plausible sequence is to have the authorities determine the interest differential prior to the opening of the foreign exchange market. Under the alternative sequence, the interest rate rule depends on the lagged depreciation and the forward premium bias vanishes. The third approach that they explore is the Delong et. al. noise trader model. This model combines rational investors with noise traders who hold distorted beliefs concerning future currency returns. They model this distortion in beliefs in a particular way by building in Frankel and Froot's (1989) finding that foreign exchange traders place excessive weight on the forward premium in forming their expectations of the future depreciation. Their model of noise-trader beliefs also induces an error in the variables problem into the forward premium regression which forms the basis of the noise trader model's explanation of the forward premium bias. Trading volume is induced entirely by the presence of noise traders and the rational DUIP is not compensation for risk. In addition to the forward premium bias, the noise-trader model provides an explanation for the apparent short-term overreaction of exchange rate changes and the gradual adjustment towards its (economic) fundamental value in the long run that has been documented in recent empirical work.
  Remarks: The paper is not available in the Internet, JEL classification is available -- F31, F47
   
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Co-Movements in Long-Term Interest Rates and the Role of PPP-Based Exchange Rate Expectations

  Author: Jan Marc Berk and Klaas H.W. Knot
Book:
  Year: April 1999
  They investigate international co-movements in bond yields by testing for uncovered interest parity. They supplement existing work by focussing on long instead of short-term interest rates, and, related to that, by employing exchange rate expectations derived from purchasing power parity instead of actual outcomes. For the major floating currencies over the period 1975-97, they cannot support the notion of further increases in co-movement beyond that associated with the wave of financial market liberalization and deregulation in the early 1980s. Given the similarity between PPP-based UIP tests and those employing actual exchange rate outcomes, the value added of the former mainly lies with their ready availability.
  Remarks:
   
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Testing Uncovered Interest Parity at Short and Long Horizons

  Author: Menzie Chinn, University of California Guy Meredith, IMF and HKMA
Book:
  Year: July 11, 2000
  The unbiasedness hypothesis -- the joint hypothesis of uncovered interest parity (UIP) and rational expectations -- has been almost universally rejected in studies of exchange rate movements. In contrast to previous studies, which have used short-horizon data, we test this hypothesis using interest rates on longer-maturity bonds for the G-7 countries. The results of these long-horizon regressions are much more positive — the coefficients on interest differentials are of the correct sign, and almost all are closer to the predicted value of unity than to zero. These results are robust changes in data type and to base currency (i.e., Deutschemark versus US dollar). We appeal to an econometric interpretation of the results, which focuses on the presence of simultaneity in a cointegration framework.
  Remarks: The full version of the paper can be download at: http://econ.ucsc.edu/faculty/chinn/UIP_empr.pdf
   
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"Purchasing Power Parity and Interest Parity in the Laboratory"

  Author: Eric O™N. Fisher, Department Of Economics, The Ohio State University
Book:
  Year: 10 April 2001
  This paper analyzes purchasing power parity and uncovered interest parity in the laboratory. It finds strong evidence that purchasing power parity, covered interest parity, and uncovered interest parity hold. Subjects are endowed with an intrinsically useless (green) currency that can be used to purchase another useless (red) currency. Green goods can be bought only with green currency, and red goods can be bought only with red currency. The foreign exchange markets are organized as call markets. In the treatment analyzing purchasing power parity, the price of the red good varies. In a second treatment, the interest rate on red currency varies. In a third treatment, the interest rate on red currency varies, and the price of the red good is random.
  Remarks: The full version of the paper can be downloaded at: http://economics.sbs.ohio-state.edu/efisher/pppuip.pdf
   
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Nonlinear dynamics and covered interest rate parity

  Author: Nathan S. Balke
Book: Empirical Economics
  Year: 1998 Vol: Pages: 535-559 Volume: 23 Issue: 4
  This paper examines the dynamics of deviations from covered interest parity using daily data on the UK/US spot, forward exchange rates and interest rates over the period January 1974 to September 1993. Like other studies we find a substantial number of instances during the sample in which the covered interest parity condition exceeds the transaction costs band, implying arbitrage profit opportunities. While most of these implied profit opportunities are relatively small, there is also evidence of some very large deviations from covered interest parity in the sample. In order to examine the persistence of these deviations, we estimated a threshold autoregression in which the dynamics behavior of deviations from covered interest parity is different outside the transaction costs band than inside them. We find that while the impulse response functions when inside the transaction costs band are nearly symmetric, those for the outside the bands are asymmetric-suggesting less persistence outside of the transaction costs band than inside the band.
  Remarks: The full version of the paper in PDF format can be downloaded at: http://netec.mcc.ac.uk/WoPEc/data/Articles/sprempecov:23:y:1998:i:4:p:535-559.html
   
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A Century of Purchasing-Power Parity

  Author: Alan M. Taylor
Book: NBER Working Paper
  Year: November 2000 Vol: No. W8012
  This paper investigates purchasing-power parity (PPP) since the late nineteenth century. I collected data for a group of twenty countries over one hundred years, a larger historical panel of annual data than has ever been studied before. The evidence for long-run PPP is favorable using recent multivariate and univariate tests of higher power. Residual variance analysis shows that episodes of floating exchange rates have generally been associated with larger deviations from PPP, as expected; this result is not attributable to significantly greater persistence (longer halflives) of deviations in such regimes, but is due to the larger shocks to the real-exchange rate process in such episodes. In the course of the twentieth century there was relatively little change in the capacity of international market integration to smooth out real exchange rate shocks. Instead, changes in the size of shocks depended on the political economy of monetary and exchange-rate regime choice under the constraints imposed by the trilemma.
  Remarks: This paper is available in PDF (527 K) format and can be downloaded at http://papers.nber.org/papers/W8012
   
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An Empirical Test of Purchasing Power Parity in Selected African Countries - a Panel Data Approach

  Author: Beatrice Kalinda Mkenda
Book: Scandinavian Working papers in Economics
  Year: April 30, 2001 Vol: No 39
  The paper tests whether the theory of Purchasing Power Parity holds in a selected sample of twenty African countries. The paper employs a panel unit root test to test whether the real exchange rates in the panel are mean reverting or not. The test employed is the Im et al (1997) test. Results show that the null of a unit root is rejected for the three real exchange rate indices, namely, the import-based and trade-weighted multilateral indices, and the bilateral indices, while for the export-based indices, the null hypothesis is not rejected. That is, Purchasing Power Parity is confirmed for the import-based and trade-weighted multilateral indices, and the bilateral indices, while it is rejected for the export-based multilateral indices. After performing the demeaning adjustment to account for cross-sectional dependence, our results show that the null hypothesis of a unit root is rejected for the import-based multilateral indices and the bilateral indices, while the null is not rejected for the trade-weighted multilateral indices. Purchasing Power Parity is therefore only confirmed for the import-based multilateral indices and bilateral indices, while it is rejected for the trade-weighted multilateral indices.
  Remarks: The paper in PDF format can be downloaded at: http://swopec.hhs.se/gunwpe/abs/gunwpe0039.htm
   
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Purchasing Power Parity

  Author: Steven M. Suranovic
Book: International Finance Theory & Policy
  Year: Vol: Chapter 30
  This is an online book which collects materials about International Finance Theory and Policy. In chapter 30, it covers Purchasing Power Parity. There are 4 sections in chapter 30: 30-1 Introduction to Purchasing Power Parity (PPP) 30-2 The Consumer Price Index (CPI) and PPP 30-3 PPP as a Theory of Exchange Rate Determination 30-4 Problems and Extensions of PPP Problem set is available at the end of the chapter but the answer key in PDF format is subject to sale!!
  Remarks: The book is accessible at: http://internationalecon.com/v1.0/Finance/ch30/ch30.html
   
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Does Purchasing Power Parity Hold in African Less Developed Countries? Evidence from a Panel Data Unit Root Test.

  Author: Holmes, Mark J
Book: Oxford University Press in its journal Journal of African Economies
  Year: March 2000 Vol: Pages: 63-78 Volume: 9 Issue: 1
  This study tests for long-run relative purchasing power parity among a sample of 27 African less developed countries. For this purpose, a new test advocated by Im and co-workers is employed which allows one to test for unit roots in heterogeneous panel datasets. This is known as the t-bar test, by which purchasing power parity is confirmed or rejected on the basis of whether or not the average augmented Dickey-Fuller statistic based on demeaned data is significantly different from zero. Using quarterly data covering the period 1974-97, purchasing power parity is generally rejected using individual country unit root tests but support is found using the t-bar test. This suggests that low power problems in testing for purchasing power parity can be overcome using this panel data procedure. The findings also support the view that purchasing power parity is most likely to be found among high inflation less developed countries and that the half-life of a one-off random shock to parity is approximately six quarters. These results are generally confirmed for the 1960-73 period. Copyright 2000 by Oxford University Press.
  Remarks: The paper is not downloadable, but you can get the paper copy if available.
   
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A Cointegration Analysis of Purchasing Power Parity: 1973-96

  Author: MIGUEL D. RAMIREZ AND SHAHRYAR KHAN
Book: International Advances in Economic Research
  Year: August 1999 Vol: VOLUME 5 NUMBER 3 Pages 369-385
  This paper tests the purchasing power parity (PPP) hypothesis for five industrial countries using cointegration and error-correction modeling. The cointegration test indicated that for all countries the PPP hypothesis holds in the long run but not in the short run. Further, the error-correction models suggested that deviations of the actual exchange rate from its long-run PPP value were corrected in subsequent periods. Finally, the high frequency monthly data models did a better job of tracking the turning points of the actual data than the low-frequency quarterly and yearly models.
  Remarks: The whole paper is available at: http://www.iaes.org/journal/iaer/aug_99/ramirez/
   
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A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries

  Author: Jeffrey A. Frankel, Andrew K. Rose
Book: NBER Working Paper
  Year: February 1995 Vol: No. W5006
  Previous time-series studies have shown evidence of mean- reversion in real exchange rates. Deviations from purchasing power parity (PPP) appear to have half-lives of approximately four years. However, the long samples required for statistical significance are unavailable for most currencies, and may be inappropriate because of regime changes. In this study, we re-examine deviations from PPP using a panel of 150 countries and 45 annual observations. Our panel shows strong evidence of mean-reversion that is similar to that from long time-series. PPP deviations are eroded at a rate of approximately 15% annually, i.e., their half-life is around four years. Such findings can be masked in time-series data, but are relatively easy to find in cross-sections.
  Remarks: The paper is downloadable at: http://papers.nber.org/papers/W5006
   
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External Shocks, Purchasing Power Parity, and the Equilibrium Real Exchange Rate

  Author: Shantayanan Devarajan, Jeffrey D. Lewis, and Sherman Robinson
Book: The World Bank Economic Review
  Year: January 1993 Vol: Volume 7, Number 1
  Two approaches are commonly used to determine the equilibrium real exchange rate in a country after external shocks: purchasing power parity (PPP) calculations and the Salter-Swan, tradables-nontradables model. There are theoretical and empirical problems with both approaches, and tensions between them. In this article we resolve these theoretical and empirical difficulties by presenting a model which is a generalization of the Salter-Swan model and which incorporates imperfect substitutes for both imports and exports. Within the framework of this model, the definition of the real exchange rate is consistent both with that of the PPP approach and with that of the Salter-Swan model (suitably extended). Our model, however, is capable of capturing a richer set of phenomena, including terms of trade shocks and changes in foreign capital inflows. It also provides a practical way to estimate changes in the equilibrium real exchange rate, requiring little more information than is required to do PPP calculations. The results are consistent with those of multisector computable general equilibrium models, which generalize the trade specification of the small model.
  Remarks: The full text of this article is not available on-line. Many past issues of the WBER can be purchased for $13 per issue at: http://www.worldbank.org/research/journals/wber/revjan93/external.htm
   
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Purchasing Power Parity: Three Stakes through the Heart of the Unit Root Null

  Author: Matthew Higgins and Egon Zakrajk
Book: Staff report of Federal Reserve Bank of New York.
  Year: June 1999 Vol: Number 80
  A recent influential paper (O'Connell 1998) argues that panel data evidence in favor of purchasing power parity disappears once test procedures are altered to accommodate heterogenous cross-sectional dependence among real exchange rate innovations. We present evidence to the contrary. First, we modify two extant panel unit root panel unit root tests to eliminate the upward size distortion induced by contemporaneous cross-sectional dependence. Second, we exploit a recently-introduced test, based on SUR techniques, that also remains valid in the presence of cross-sectional dependence. Using the three new tests, we find overwhelming evidence in favor of real exchange rate stationarity during the post-Bretton Woods era among OECD economies, as well as among a larger group of pen? economies. We also find emphatic evidence of stationarity using O'Connell's GLS test. Bias-corrected parameter estimates indicate that deviations from PPP erode more quickly for real exchange rates defined using wholesale rather than consumer price indices. Monte Carlo experiments indicate that several of the tests discussed here have considerable power against the unit root null.
  Remarks: The entire paper in PDF format can be downloaded at: http://www.ny.frb.org/rmaghome/staff_rp/sr80.html
   
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Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price

  Author: Alan M. Taylor
Book: NBER Working Paper
  Year: March 2000 Vol: No. W7577
  The PPP puzzle is based on empirical evidence that international price differences for individual goods (LOOP) or baskets of goods (PPP) appear highly persistent or even non-stationary. The present consensus is these price differences have a half-life that is of the order of five years at best, and infinity at worst. This seems unreasonable in a world where transportation and transaction costs appear so low as to encourage arbitrage and the convergence of price gaps over much shorter horizons, typically days or weeks. However, current empirics rely on a particular choice of methodology, involving (i) relatively low-frequency monthly, quarterly, or annual data, and (ii) a linear model specification. In fact, these methodological choices are not innocent, and they can be shown to bias analysis to-wards findings of slow convergence and a random walk. Intuitively, if we suspect that the actual adjustment horizon is of the order of days then monthly and annual data cannot be expected to reveal it. If we suspect arbitrage costs are high enough to produce a substantial band of inaction' then a linear model will fail to support convergence if the process spends considerable time random-walking in that band. Thus, when testing for PPP or LOOP, model specification and data sampling should not proceed without consideration of the actual institutional context and logistical framework of markets.
  Remarks: The paper is downloadable at: http://papers.nber.org/papers/W7577
   
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Deviations from Purchasing Power Parity: The Australian Case

  Author: Adrian Blundell-Wignall, Marilyn Thomas
Book: Reserve Bank of Australia Discussion Paper
  Year: September 1987 Vol: RDP8711
  The hypothesis that deviations from PPP follow a random process is tested against two alternatives: that the real exchange rate reverts to a constant equilibrium level (long-run PPP); and that it reverts to an equilibrium level which is itself a function of shifts in commodity prices (long-run PPP doesn't hold, but for reasons that are predictable). The random walk hypothesis cannot be rejected if commodity prices are ignored or if the nominal exchange rate is fixed. It is consistently rejected when commodity prices are included and the exchange rate is floating.
  Remarks: An electronic version of this paper is not available. To order a printed copy you have to complete an RDP Order Form at: http://www.rba.gov.au/PublicationsAndResearch/RDP/RDP_Order/index.html
   
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International price comparisons based on purchasing power parity

  Author: Michelle A. Vachris and James Thomas
Book: Monthly Labor Online review
  Year: October 1999 Vol: Vol. 122, No. 10
  This paper is interesting and you may understand more about PPP via studying daily cases: magine you are planning a trip to France and would like to figure out how much currency you will need during your visit. You would need to know how much in French francs it would cost for incidentals such as meals, sightseeing, and souvenirs. What information would be helpful to you in making your estimate? You could check the price of, say, a lunch in your hometown and then convert that figure into francs using the exchange rate. This type of estimate would not be very accurate, however, because it is likely that a lunch in your hometown costs relatively more or less than a lunch in France. A better estimate would be based on the price of a lunch in France. Similarly, if you were opening a subsidiary company in Japan, how would you determine the salaries for your employees? Again, using the exchange rate to convert the salary you would pay in the United States into yen would not be accurate. To adequately compensate employees moving overseas, you would need information about the cost of living in Japan. Finally, if a government or international organization were comparing national expenditures across different countries, merely collecting the gross domestic products (GDPs) of the countries and using exchange rates to convert them into a single currency would not yield an accurate comparison. Again, the comparison based on exchange rates does not take into account differing prices among the countries.
  Remarks: The paper can be downloaded at: http://stats.bls.gov/opub/mlr/1999/10/art1exc.htm
   
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Official Exchange Rate Arrangements and Real Exchange Rate Behavior

  Author: David C. Parsley and Helen A. Popper
Book: Journal of Money, Credit and Banking
  Year: March 2000
  Here is the abstract of the paper: We study the behavior of real exchange rates under various official designations of exchange rate arrangements. Examining many currencies, we find important differences across the designations. Most notably, real exchange rate mean reversion is fastest when nominal exchange rates are officially pegged. We also find a large nonlinear effect: adjustment is fastest when the real exchange rate deviates greatly from its mean. This nonlinear effect is also most striking among officially pegged currencies. Finally, we find that nominal exchange rates, rather than prices, do most of the adjusting.
  Remarks: The paper can be downloaded at: http://mba.vanderbilt.edu/fmrc/papers/wp9730.htm
   
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Testing Deviations from Purchasing Power Parity (PPP)

  Author: Aizenman, Joshua
Book: NBER Working Paper
  Year: 1984 Vol: NBER Working Paper:1475
  The purpose of this paper is to study analytically how the presence of transportation costs in a model of deviations from PPP affects the testing procedure of the PPP hypothesis. The analysis shows that in the presence of transportation costs traditional regression analysis will tend to reject the PPP hypothesis even if goods markets are well arbitraged, because the values of the regression coefficients are affected systematically by considerations that are independent of the degree to which markets are arbitraged. Thus, the content of the PPP approach cannot be tested satisfactorily without considering the systematic affects of transportation costs and other costs of goods arbitrage.
  Remarks:
   
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Monopolistic Competition and Deviations from PPP

  Author: Aizenman, Joshua
Book: NBER Working Paper
  Year: 1985 Vol: NBER Working Paper:1552
  The purpose of this paper is to explain deviations from PPP in an economy characterized by a monopolistic competitive market structure in which pricing decisions incur costs that lead producers to pre-set the price path for several periods. The paper derives an optimal pricing rule, including the optimal pre-setting horizon. It does so for a rational expectation equilibrium, characterized by staggered, unsynchronized price setting, for which the degree of staggering is endogenously determined. The discussion focuses on the critical role of the degree of domestic-foreign goods substitutability in explaining observable deviations from PPP.
  Remarks:
   
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Idiosyncratic Tastes in a Two-Country Optimizing Model: Implications of a Standard Presumption

  Author: Warnock, Francis E.
Book: Board of Governors of the Federal Reserve System, International Finance Discussion Paper
  Year: 1998 Vol: 631, pages 21
  International spillovers and exchange rate dynamics are examined in a two-country dynamic optimizing model that allows for idiosyncratic tastes across countries. Specifically, there is a home-good bias in consumption patterns: at given relative prices the ratio of home goods consumed to foreign goods consumed is higher in the home country. The setup nests Obstfeld and Rogoff (1995), who assume identical tastes. Allowing for idiosyncratic tastes produces results that differ from Obstfeld and Rogoff's: expansionary monetary policy increases home utility by more, the positive spillovers of a fiscal expansion are reduced, and both short-run and long-run deviations from consumption-based purchasing power parity (PPP) are possible. The model's predictions are broadly consistent with those from the Frenkel, Razin and Yuen (1996) version of the two-country Mundell-Fleming model and with observed behavior of real and nominal exchange rates.
  Remarks:
   
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Beyond the Purchasing Power Parity: Testing for Cointegration and Causality between Exchange Rates, Prices, and Interest Rates

  Author: Cheng, Benjamin S.
Book: Journal of International Money and Finance
  Year: 1999 Vol: 18(6), pages 911-24.
  This paper reexamines the causality between the dollar and the yen in a multivariate framework with the aid of cointegration and error-correcting modeling for the 1951-94 period. The Phillips-Perron tests and Johansen's tests are performed. While causality from interest rates to exchange rates is found in the short run, no causality between prices and exchange rates is found in the short run. However, causality is found running from relative prices to exchange rates along with interest rates between the U.S. and Japan in the long run, which supports the long-run PPP hypothesis.
  Remarks:
   
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Does PPP Hold between Asian and Japanese Economies? Evidence Using Panel Unit Root and Panel Cointegration

  Author: Azali, M.; Habibullah, M. S.; Baharumshah, A. Z.
Book: Japan and the World Economy
  Year: 2001 Vol: 13(1), pages 35-50.
  This paper presents an empirical analysis of panel unit root and panel cointegration tests of long-run absolute purchasing power parity (PPP) for seven Asian developing economies (ADE). The evidence shows that the panel parametric and non-parametric tests either with a trend term or without a trend term support the hypothesis of cointegration between the bilateral exchange rates and relative prices against the selected foreign country--Japan.
  Remarks:
   
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An Empirical Investigation into the Causes of Deviations from Covered Interest Parity across the Tasman

  Author: Moosa, Imad A.
Book: New Zealand Economic Papers
  Year: 1996 Vol: 30(1), pages 39-54.
  This paper examines deviations from the equilibrium condition implied by covered interest parity as applied to the exchange rate between the Australian and New Zealand dollars over the period 1985 to 1994. Formal empirical evidence shows that spot and forward speculation do not play any role in determining the forward exchange rate. The significant deviations in 1985 are attributed to political risk. Further shrinkage of the deviations in the 1990s is attributed to a possible reduction in transaction costs resulting from financial deregulation.
  Remarks:
   
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Exchange Controls, Political Risk and the Eurocurrency Market: New Evidence from Tests of Covered Interest Rate Parity

  Author: Cody, Brian J.
Book: International Economic Journal
  Year: 1990 Vol: 4(2), pages 75-86.
  This study employs daily data to examine the effects on Eurocurrency and onshore returns of the May 21, 1981 imposition of exchange controls by French President Mitterand. Prior to this time, transaction costs explain the average onshore deviations from covered parity; however, these averages ignore short-lived political risk premia which emerged just before the imposition of controls. As expected, there is no evidence of political risk on Eurocurrency markets. Yet when exchange controls were in effect, premia in excess of transaction costs surfaced on nonfranc Eurocurrency deposits at the time of devaluations of the franc within the EMS.
  Remarks:
   
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Forward and Spot Exchange Rates

  Author: Fama, Eugene F.
Book: Journal of Monetary Economics
  Year: 1984 Vol: 14(3), pages 319-38.
  In this study Fama decomposes the forward premium into a risk premium and an expected depreciation premium based on the information set available. By constructing a statistical model on this relation, he finds the relative importance of the risk premium and the expected depreciation premium.
  Remarks:
   
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Exchange Rate Forecasting Techniques, Survey Data, and Implications for the Foreign Exchange Market

  Author: Frankel, Jeffrey A.; Froot, Kenneth
Book: International Monetary Fund Working
  Year: 1990 Vol: Paper: WP/90/43, pages 26.
  This paper examines the dynamics of the foreign exchange market. The first half addresses a number of key questions regarding the forecasts of future exchange rates made by market participants, by means of updated estimates using survey data. Here the authors follow most of the theoretical and empirical literature in acting as if all market participants share the same expectation. The second half then addresses the possibility of heterogeneous expectations, particularly the distinction between "chartists" and "fundamentalists," and the implications for trading in the foreign exchange market and for the formation of speculative bubbles.
  Remarks:
   
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A Multivariate GARCH Model of Risk Premia in Foreign Exchange Markets

  Author: Malliaropulos, Dimitrios
Book: Economic Modelling
  Year: 1997 Vol: 14(1), pages 61-79.
  This paper investigates the existence of time-varying risk premia in deviations from uncovered interest parity based on the market capital asset pricing model. The empirical analysis is conducted using a broad data set of seven major currencies against the US dollar, and a world equity index in order to approximate the benchmark portfolio. The conditional covariance matrix of excess returns is modelled as a multivariate GARCH process. The results indicate significant conditional systematic risk. Estimated conditional beta coefficients are very similar across currencies and behave uniformly over time. The explanatory power of the model is significantly higher compared to the constant beta CAPM specification. Furthermore, estimation results suggest that (1) expected excess returns are less volatile in foreign exchange markets compared to stock markets, and (2) including nominal dollar assets in international equity portfolios can reduce overall portfolio risk.
  Remarks:
   
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International Financial Relations under the Current Float: Evidence from Panel Data

  Author: Lothian, James R.; Simaan, Yusif
Book: Open-Economies-Review
  Year: 1998 Vol: 9(4), pages 293-313.
  This paper uses multi-country data for the period 1973-94 to investigate five key equilibrium conditions in international finance--purchasing power parity, the Fisher equation, uncovered interest parity, and the equity-return analogues of the latter two. The results are largely consistent with theoretical expectations. Over the long run, purchasing power parity, uncovered interest parity and the Fisher effect prove to be rather good first approximations. The equity-return relations, though somewhat less so are nevertheless much better behaved than past studies would lead one to expect. Average rates of equity returns keep pace with inflation within countries in almost all instances; across countries, they are positively correlated with average rates of inflation. This is particularly the case when the data period is extended to include earlier decades.
  Remarks:
   
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An Alternative Approach to Testing Uncovered Interest Parity

  Author: Bhatti, Razzaque H.; Moosa, Imad A.
Book: Applied-Economics-Letters
  Year: 1995 Vol: 2(12), pages 478-81.
  Supportive evidences of UIP hypothesis through a cointegration analysis. The authors compare the Treasury bill rates denominated in 11 currencies to the U.S. dollar, and find a long-run relationship in all cases.
  Remarks:
   
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Uncovered Interest Parity in Crisis: The Interest Rate Defense in the 1990s

  Author: Flood, Robert P; Rose, Andrew K.
Book:
  Year: 2001 Vol: This paper is available online at http://haas.berkeley.edu/~arose/UIPC.pdf
  This paper tests for uncovered interes parity (UIP) using daily data for twenty-three developing and developed countries through the crisis-strewn 1990s. The authors find that UIP works better on average in the 1990s than previous eras in the sense the slope coefficient from a regression of exchange rate changes on interest differentals yields a positive coefficient (which is sometimes insignificantly different from unity). UIP works systematically worse for fixed and flexible exchange countries than for crisis countries, but we find no significant differences between rich and poor countries. Finally, the authors find evidence that varies considerably across countries and time, but is usually weakly consistent with an effective "interest defense" of the exchange rate.
  Remarks:
   
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An Intraday Analysis of the Effectiveness of Foreign Exchange Intervention

  Author: Neil Beattie and Jean-François Fillion
Book:
  Year: February 1999
  This paper assesses the effectiveness of Canada's official foreign exchange intervention in moderating intraday volatility of the Can$/US$ exchange rate, using a 2-1/2-year sample of 10-minute exchange rate data. The use of high frequency data (higher than daily frequency) should help in assessing the impact of intervention since the foreign exchange market is efficient and reacts rapidly to new information. The estimated equations explain volatility in terms of four major factors: intraday seasonal pattern; daily volatility persistence; macroeconomic news announcements; and the impact of central bank intervention. Rule-based (or expected) intervention apparently had no direct impact on the reduction of foreign exchange volatility, although the existence of a non-intervention band seemed to provide a small stabilizing influence. This result is interpreted to mean that the stabilizing effect of expected intervention came into play as the Canadian dollar approached the upper or lower limits of the band. When the dollar exceeded the band, actual intervention did not have any direct impact because it was expected. Moreover, the results show that discretionary (or unexpected) intervention might have been effective in stabilizing the Canadian dollar, although the impact of an intervention sequence diminished as it increased beyond a few days.
  Remarks: The paper can be downloaded in PDF format at: http://www.bankofcanada.ca/publications/working.papers/1999/wp99-4.pdf
   
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Measuring the Profitability and Effectiveness of Foreign Exchange Market Intervention: Some Canadian Evidence

  Author: John Murray, Mark Zelmer, and Shane Williamson
Book: Technical Report No. 53
  Year: March 1990
  When the major industrial countries decided to move to a system of managed flexible exchange rates following the collapse of the Bretton Woods system, many observers thought that this would reduce, if not eliminate, the need for official foreign exchange market intervention. During the past fifteen years, however, intervention in most countries, including Canada, has risen steadily in both frequency and intensity. This paper presents new empirical evidence on the profitability and effectiveness of Canadian intervention from 1975 to 1988. The results suggest that the government's foreign exchange operations have been very profitable and have tended to be stabilizing, in the sense that authorities were typically pushing the exchange rate towards its long-run trend and helping to reduce short-run volatility in the market.
  Remarks: We can order printed copies of this paper at no charge from: Publications Distribution, Bank of Canada 234 Wellington Street, Ottawa, Canada K1A 0G9 E-mail: publications@bank-banque-canada.ca Telephone: 613-782-8248 Fax: 613-782-8874
   
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The Temporal Pattern of Trading Rule Returns and Central Bank Intervention: Intervention Does Not Generate Technical Trading Rule Profits

  Author: Christopher J. Neely
Book:
  Year: November 2000
  It is provided by the Federal Reserve Bank of St. Louis. This paper characterizes the temporal pattern of trading rule returns and official intervention for Australian, German, Swiss and U.S. data to investigate whether intervention generates technical trading rule profits. High frequency data show that abnormally high trading rule returns precede German, Swiss and U.S. intervention, disproving the hypothesis that intervention generates inefficiencies from which technical rules profit. Australian intervention precedes high trading rule returns, but trading/intervention patterns make it implausible that intervention actually generates those returns. Rather, intervention responds to exchange rate trends from which trading rules have recently profited.
  Remarks: This paper is downloadable at: http://www.stls.frb.org/docs/research/wp/2000-018C.pdf
   
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Intraday Technical Trading in the Foreign Exchange Market

  Author: hristopher J. Neely and Paul A. Weller
Book:
  Year: January 2001
  It is provided by the Federal Reserve Bank of St. Lois. This paper examines the out-of-sample performance of intraday technical trading strategies selected using two methodologies, a genetic program and an optimized linear forecasting model. When realistic transaction costs and trading hours are taken into account, we find no evidence of excess returns to the trading rules derived with either methodology. Thus, our results are consistent with market efficiency. We do, however, find that the trading rules discover some remarkably stable patterns in the data.
  Remarks: This paper is downloaded at: http://www.stls.frb.org/docs/research/wp/99-016B.pdf
   
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Technical Analysis and Central Bank Intervention

  Author: Christopher Neely and Paul Weller
Book:
  Year: Feburary 2000
  This paper extends the genetic programming techniques developed in Neely, Weller and Dittmar (1997) to provide some evidence that information about U.S. foreign exchange intervention can improve technical trading rules?profitability for two of four exchange rates over part of the out-of-sample period. Rules tend to take positions contrary to official intervention and are unusually profitable on days prior to intervention, indicating that intervention is intended to check or reverse predictable trends. Intervention seems to be more successful in checking predictable trends in the out-of-sample (1981-1998) period than in the in-sample (1975-1980) period. We conjecture that instability in the intervention process prevents more consistent improvement in the excess returns to rules. We find that the improvement in performance results from more precise estimation of the information in the past exchange rate series, rather than from information about contemporaneous intervention.
  Remarks: This paper is downloadable at: http://www.stls.frb.org/docs/research/wp/97-002c.pdf
   
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The exchange rate and the MPC: What can we do?

  Author: Sushil Wadhwani
Book: Bank of England. Quarterly Bulletin; London
  Year: Aug 2000 Vol: Vol. 40, Iss. 3; pg. 297-306, 10 pgs
  In Sushil Wadhwani's speech (member of the Bank of England's Monetary Policy Committee), he argued that looking only at a two-year ahead inflation forecast when setting interest rates is likely to be suboptimal, and that allowing asset price misalignments to have an additional impact on interest rates could enable a reduction in the volatility of inflation. Currently, sterling is probably overvalued against the euro, and so this might affect the appropriate level of interest rates. He also suggested that, under certain circumstances, sterilized intervention can be effective.
  Remarks: The full text is downloadable at: http://global.umi.com/pqdweb?Did=000000058049040&Fmt=6&Deli=1&Mtd=1&Idx=36&Sid=1&RQT=309&Q=1&IE=x.pdf
   
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The Use of Fundamental and Technical Analyses by Foreign Exchange Dealers: Honk Kong Evidence

  Author: Lui,Yu Hon; Mole, David
Book: Journal of International Money and Finance
  Year: 1998 Vol: 17(3), pages 535-45.
  This article reports the results of a questionnaire survey conducted in February 1995 on the use by foreign exchange dealers in Hong Kong of fundamental and technical analyses to form their forecasts of exchange rate movements. The authors' findings reveal that > 85 percent of respondents rely on both fundamental and technical analyses for predicting future rate movements at different time horizons. At shorter horizons, there exists a skew towards reliance on technical analysis as opposed to fundamental analysis, but the skew becomes steadily reversed as the length of horizon considered is extended. Technical analysis is considered slightly more useful in forecasting trends than fundamental analysis, but significantly more useful in predicting turning points. Interest rate-related news is found to be a relatively important fundamental factor in exchange rate forecasting, while moving average and/or other trend-following systems are the most useful technical technique.
  Remarks:
   
Untitled Document

Does Central Bank Intervention Stabilize Foreign Exchange Rates?

  Author: Catherine Bonser-Neal
Book: Federal Reserve Bank of Kansas City
  Year:
  This paper is written by Catherine Bonser-Neal. It's about the exchange rate volatility, its causes and its consequence, how it measures, how central bank intervention affects the volatility, etc.
  Remarks: The paper is downloadable at: http://www.kc.frb.org/publicat/econrev/pdf/1q96bons.pdf
   
Untitled Document

Smoke and Mirrors in the Foreign Exchange Market

  Author: Willem H. Buiter and Anne C. Sibert
Book:
  Year:
  The plight of manufacturing has focussed attention on the sterling’s persistent strength. The MPC recognises the problem, but argues there is little it can do. It is mandated to pursue the government’s inflation target. Only subject to this target being met, can other objectives be pursued. This leaves little scope for reining in the pound; the short-term interest rate the MPC uses as its instrument cannot be used to achieve both inflation and exchange rate goals. The authors claim that there are additional monetary and financial policy tools available.
  Remarks: The text is downloadable at: http://www.nber.org/~wbuiter/observer.pdf
   
Untitled Document

References related to Covered interest parity (12 references are shown.)

Untitled Document

An Examination of Uncovered Interest Rate Parity in Segmented International Commodity Markets

  Author: Burton Hollifield (University of British Columbia) Raman Uppal (University of British Columbia)
Book: The Journal of Finance
  Year: Dec, 1997 Vol: Volume: 52 Number: 5 Page Number: 2145 - 2170
  They examine the effect of segmented commodity markets on the relation between forward and future spot exchange rates in a dynamic economy. They calculate the slope coefficient in our theoretical economy from regressing exchange rate changes on forward premia. With reasonable parameter values, the slope coefficient is less than unity. However, even for extreme parameters the slope is not less than zero, as found in the data. A negative slope coefficient in a nominal version of the model requires the covariance between monetary shocks and relative output shocks to be significantly negative, in contrast to the covariance in the data.
  Remarks: Paper can't be downloaded on web!
   
Untitled Document

Purchasing Power Parity and Interest Parity in the Laboratory

  Author: Eric O™N. Fisher, Department Of Economics, The Ohio State University
Book:
  Year: 10 April 2001
  This paper analyzes purchasing power parity and uncovered interest parity in the laboratory. It finds strong evidence that purchasing power parity, covered interest parity, and uncovered interest parity hold. Subjects are endowed with an intrinsically useless (green) currency that can be used to purchase another useless (red) currency. Green goods can be bought only with green currency, and red goods can be bought only with red currency. The foreign exchange markets are organized as call markets. In the treatment analyzing purchasing power parity, the price of the red good varies. In a second treatment, the interest rate on red currency varies. In a third treatment, the interest rate on red currency varies, and the price of the red good is random. The paper is 35-page long and can be downloaded at: http://econ.ohio-state.edu/efisher/pppuip.pdf
  Remarks:
   
Untitled Document

"Purchasing Power Parity and Interest Parity in the Laboratory"

  Author: Eric O™N. Fisher, Department Of Economics, The Ohio State University
Book:
  Year: 10 April 2001
  This paper analyzes purchasing power parity and uncovered interest parity in the laboratory. It finds strong evidence that purchasing power parity, covered interest parity, and uncovered interest parity hold. Subjects are endowed with an intrinsically useless (green) currency that can be used to purchase another useless (red) currency. Green goods can be bought only with green currency, and red goods can be bought only with red currency. The foreign exchange markets are organized as call markets. In the treatment analyzing purchasing power parity, the price of the red good varies. In a second treatment, the interest rate on red currency varies. In a third treatment, the interest rate on red currency varies, and the price of the red good is random.
  Remarks: The full version of the paper can be downloaded at: http://economics.sbs.ohio-state.edu/efisher/pppuip.pdf
   
Untitled Document

Nonlinear dynamics and covered interest rate parity

  Author: Nathan S. Balke
Book: Empirical Economics
  Year: 1998 Vol: Pages: 535-559 Volume: 23 Issue: 4
  This paper examines the dynamics of deviations from covered interest parity using daily data on the UK/US spot, forward exchange rates and interest rates over the period January 1974 to September 1993. Like other studies we find a substantial number of instances during the sample in which the covered interest parity condition exceeds the transaction costs band, implying arbitrage profit opportunities. While most of these implied profit opportunities are relatively small, there is also evidence of some very large deviations from covered interest parity in the sample. In order to examine the persistence of these deviations, we estimated a threshold autoregression in which the dynamics behavior of deviations from covered interest parity is different outside the transaction costs band than inside them. We find that while the impulse response functions when inside the transaction costs band are nearly symmetric, those for the outside the bands are asymmetric-suggesting less persistence outside of the transaction costs band than inside the band.
  Remarks: The full version of the paper in PDF format can be downloaded at: http://netec.mcc.ac.uk/WoPEc/data/Articles/sprempecov:23:y:1998:i:4:p:535-559.html
   
Untitled Document

An Empirical Investigation into the Causes of Deviations from Covered Interest Parity across the Tasman

  Author: Moosa, Imad A.
Book: New Zealand Economic Papers
  Year: 1996 Vol: 30(1), pages 39-54.
  This paper examines deviations from the equilibrium condition implied by covered interest parity as applied to the exchange rate between the Australian and New Zealand dollars over the period 1985 to 1994. Formal empirical evidence shows that spot and forward speculation do not play any role in determining the forward exchange rate. The significant deviations in 1985 are attributed to political risk. Further shrinkage of the deviations in the 1990s is attributed to a possible reduction in transaction costs resulting from financial deregulation.
  Remarks:
   
Untitled Document

Exchange Controls, Political Risk and the Eurocurrency Market: New Evidence from Tests of Covered Interest Rate Parity

  Author: Cody, Brian J.
Book: International Economic Journal
  Year: 1990 Vol: 4(2), pages 75-86.
  This study employs daily data to examine the effects on Eurocurrency and onshore returns of the May 21, 1981 imposition of exchange controls by French President Mitterand. Prior to this time, transaction costs explain the average onshore deviations from covered parity; however, these averages ignore short-lived political risk premia which emerged just before the imposition of controls. As expected, there is no evidence of political risk on Eurocurrency markets. Yet when exchange controls were in effect, premia in excess of transaction costs surfaced on nonfranc Eurocurrency deposits at the time of devaluations of the franc within the EMS.
  Remarks:
   
Untitled Document

Forward and Spot Exchange Rates

  Author: Fama, Eugene F.
Book: Journal of Monetary Economics
  Year: 1984 Vol: 14(3), pages 319-38.
  In this study Fama decomposes the forward premium into a risk premium and an expected depreciation premium based on the information set available. By constructing a statistical model on this relation, he finds the relative importance of the risk premium and the expected depreciation premium.
  Remarks:
   
Untitled Document

Exchange Rate Forecasting Techniques, Survey Data, and Implications for the Foreign Exchange Market

  Author: Frankel, Jeffrey A.; Froot, Kenneth
Book: International Monetary Fund Working
  Year: 1990 Vol: Paper: WP/90/43, pages 26.
  This paper examines the dynamics of the foreign exchange market. The first half addresses a number of key questions regarding the forecasts of future exchange rates made by market participants, by means of updated estimates using survey data. Here the authors follow most of the theoretical and empirical literature in acting as if all market participants share the same expectation. The second half then addresses the possibility of heterogeneous expectations, particularly the distinction between "chartists" and "fundamentalists," and the implications for trading in the foreign exchange market and for the formation of speculative bubbles.
  Remarks:
   
Untitled Document

A Multivariate GARCH Model of Risk Premia in Foreign Exchange Markets

  Author: Malliaropulos, Dimitrios
Book: Economic Modelling
  Year: 1997 Vol: 14(1), pages 61-79.
  This paper investigates the existence of time-varying risk premia in deviations from uncovered interest parity based on the market capital asset pricing model. The empirical analysis is conducted using a broad data set of seven major currencies against the US dollar, and a world equity index in order to approximate the benchmark portfolio. The conditional covariance matrix of excess returns is modelled as a multivariate GARCH process. The results indicate significant conditional systematic risk. Estimated conditional beta coefficients are very similar across currencies and behave uniformly over time. The explanatory power of the model is significantly higher compared to the constant beta CAPM specification. Furthermore, estimation results suggest that (1) expected excess returns are less volatile in foreign exchange markets compared to stock markets, and (2) including nominal dollar assets in international equity portfolios can reduce overall portfolio risk.
  Remarks:
   
Untitled Document

International Financial Relations under the Current Float: Evidence from Panel Data

  Author: Lothian, James R.; Simaan, Yusif
Book: Open-Economies-Review
  Year: 1998 Vol: 9(4), pages 293-313.
  This paper uses multi-country data for the period 1973-94 to investigate five key equilibrium conditions in international finance--purchasing power parity, the Fisher equation, uncovered interest parity, and the equity-return analogues of the latter two. The results are largely consistent with theoretical expectations. Over the long run, purchasing power parity, uncovered interest parity and the Fisher effect prove to be rather good first approximations. The equity-return relations, though somewhat less so are nevertheless much better behaved than past studies would lead one to expect. Average rates of equity returns keep pace with inflation within countries in almost all instances; across countries, they are positively correlated with average rates of inflation. This is particularly the case when the data period is extended to include earlier decades.
  Remarks:
   
Untitled Document

An Alternative Approach to Testing Uncovered Interest Parity

  Author: Bhatti, Razzaque H.; Moosa, Imad A.
Book: Applied-Economics-Letters
  Year: 1995 Vol: 2(12), pages 478-81.
  Supportive evidences of UIP hypothesis through a cointegration analysis. The authors compare the Treasury bill rates denominated in 11 currencies to the U.S. dollar, and find a long-run relationship in all cases.
  Remarks:
   
Untitled Document

Uncovered Interest Parity in Crisis: The Interest Rate Defense in the 1990s

  Author: Flood, Robert P; Rose, Andrew K.
Book:
  Year: 2001 Vol: This paper is available online at http://haas.berkeley.edu/~arose/UIPC.pdf
  This paper tests for uncovered interes parity (UIP) using daily data for twenty-three developing and developed countries through the crisis-strewn 1990s. The authors find that UIP works better on average in the 1990s than previous eras in the sense the slope coefficient from a regression of exchange rate changes on interest differentals yields a positive coefficient (which is sometimes insignificantly different from unity). UIP works systematically worse for fixed and flexible exchange countries than for crisis countries, but we find no significant differences between rich and poor countries. Finally, the authors find evidence that varies considerably across countries and time, but is usually weakly consistent with an effective "interest defense" of the exchange rate.
  Remarks:
   
Untitled Document

References related to Uncovered interest parity (18 references are shown.)

Untitled Document

Uncovered Interest Parity: A Further Reconsideration

  Author: Floyd, John E.
Book:
  Year: 1995
  This paper reexamines the uncovered interest parity condition within the context of a structural view of real exchange rate determination that emphasizes the real exchange rate as the relative price of domestic in terms of foreign output. This structural interpretation complements rather than replaces the asset-market view of nominal exchange rate determination. Because structural shocks to the real exchange rate are unpredictable, forward discounts need not predict actual future nominal exchange rate movements with any reliability, except in cases where there are continuing long-term differences in countries' inflation rates. Once the integrated nature of the world capital market is taken into account, it turns out that governments can and probably do smooth price levels, nominal exchange rates and possibly also domestic/foreign interest rate differentials, but have no power to manipulate any of these variables independently of the others. As a result, they cannot bring about major movements in real exchange rates without destabilizing the economy.
  Remarks: The full version of the paper in PDF format can be downloaded at: http://netec.mcc.ac.uk/WoPEc/data/Papers/tortecipaFLOYD-95-01.html
   
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The "Exchange Risk Premium," Uncovered Interest Parity, and the Treatment of Exchange Rates in Multicountry Macroeconomic Models

  Author: Ralph C. Bryant, Senior Fellow, Economic Studies
Book: Brookings Discussion Papers in International Economics
  Year: 1995
  The literature on exchange markets conventionally defines the gap between the forward exchange rate and the expected future spot exchange rate as an "exchange risk premium." Part I of this paper skeptically reviews existing interpretations of the exchange risk premium and then presents an alternative conceptual framework. Part II revisits the issue of how to model the determination of exchange rates in empirical macroeconomic models, focusing on the typical use of the uncovered interest parity condition combined with the assumption of model-consistent expectations. The paper discusses why this treatment of exchange rates is inadequate and makes some suggestions for future research. Part III of the paper replicates some "standard" regressions, widely reported in the empirical literature, thought to have a bearing on whether the forward exchange rate is an unbiased predictor of the future spot rate, whether survey expectations produce unbiased predictions of actual changes in exchange rates, and whether a bias in the forward rate can be attributed to a time-varying risk premium. If the perspective in this paper is accepted, the conventional statistical literature has devoted excessive resources to estimation of these standard but not particularly revealing regressions. All three parts of this paper make use of empirical data on exchange rate expectations collected since 1985 by the Japan Center for International Finance.
  Remarks: The full version of the paper in PDF format can be downloaded at: http://www.brook.edu/views/papers/bryant/111.htm
   
Untitled Document

An Examination of Uncovered Interest Rate Parity in Segmented International Commodity Markets

  Author: Burton Hollifield (University of British Columbia) Raman Uppal (University of British Columbia)
Book: The Journal of Finance
  Year: Dec, 1997 Vol: Volume: 52 Number: 5 Page Number: 2145 - 2170
  They examine the effect of segmented commodity markets on the relation between forward and future spot exchange rates in a dynamic economy. They calculate the slope coefficient in our theoretical economy from regressing exchange rate changes on forward premia. With reasonable parameter values, the slope coefficient is less than unity. However, even for extreme parameters the slope is not less than zero, as found in the data. A negative slope coefficient in a nominal version of the model requires the covariance between monetary shocks and relative output shocks to be significantly negative, in contrast to the covariance in the data.
  Remarks: Paper can't be downloaded on web!
   
Untitled Document

The Failure of Uncovered Interest Parity: Is It Near-Rationality in the Foreign Exchange Market?

  Author: David Gruen, Gordon Menzies
Book: Publication of Reserve Bank of Australia
  Year: May 1991
  A risk-averse US investor adjusts the shares of a portfolio of short-term nominal domestic and foreign assets to maximise expected utility. The optimal strategy is to respond immediately to all new information which arrives weekly. They calculate the expected utility foregone when the investor abandons the optimal strategy and instead optimises less frequently. They also consider the cases where the investor ignores the covariance between returns sourced in different countries, and where the investor makes unsystematic mistakes when forming expectations of exchange rate change. They demonstrate that the expected utility cost of sub-optimal behaviour is generally very small. Thus, for example, if investors adjust portfolio shares every three months, they incur an average expected utility loss equivalent to about 0.16 per cent p.a.. It is therefore plausible that slight opportunity costs of frequent optimisation may outweigh the benefits. This result may help explain the failure of uncovered interest parity.
  Remarks: An electronic version of this paper is not available. If you want to the printed copy of the paper, you can simply follow the instruction in this site: http://www.rba.gov.au/PublicationsAndResearch/RDP/RDP9103.html
   
Untitled Document

Long-Horizon Uncovered Interest Rate Parity

  Author: Guy Meredith, Menzie D. Chinn
Book: NBER Working Paper
  Year: November 1998 Vol: No. W6797
  Uncovered interest parity (UIP) has been almost universally rejected in studies of exchange rate movements, although there is little consensus on why it fails. In contrast to previous studies, which have used relatively short-horizon data, we test UIP using interest rates on longer-maturity bonds for the G-7 countries. These long-horizon regressions yield much more support for UIP -- all the coefficients on interest differentials are of the correct sign, and almost all are closer to the UIP value of unity than to the zero coefficient implied by the random walk hypothesis. We then use a small macroeconomic model to explain the differences between the short- and long-horizon results. Regressions run on data generated by stochastic simulations replicate the important regularities in the actual data, including the sharp differences between short- and long-horizon parameters. In the short run from risk premium shocks in the face of endogenous monetary policy. In the long run, in contrast, exchange rate movements are driven by the "fundamentals," leading to a relationship between interest rates and exchange rates that is more consistent with UIP.
  Remarks: The full version of the paper in PDF format can be downloaded at: http://papers.nber.org/papers/W6797
   
Untitled Document

Purchasing Power Parity and Interest Parity in the Laboratory

  Author: Eric O™N. Fisher, Department Of Economics, The Ohio State University
Book:
  Year: 10 April 2001
  This paper analyzes purchasing power parity and uncovered interest parity in the laboratory. It finds strong evidence that purchasing power parity, covered interest parity, and uncovered interest parity hold. Subjects are endowed with an intrinsically useless (green) currency that can be used to purchase another useless (red) currency. Green goods can be bought only with green currency, and red goods can be bought only with red currency. The foreign exchange markets are organized as call markets. In the treatment analyzing purchasing power parity, the price of the red good varies. In a second treatment, the interest rate on red currency varies. In a third treatment, the interest rate on red currency varies, and the price of the red good is random. The paper is 35-page long and can be downloaded at: http://econ.ohio-state.edu/efisher/pppuip.pdf
  Remarks:
   
Untitled Document

Risk, Policy Rules, and Noise: Rethinking Deviations from Uncovered Interest Parity

  Author: Nelson Mark, Ohio State University Yangru Wu, West Virginia University
Book:
  Year:
  This paper attempts to understand why the forward premium helps to predict the future change in the exchange rate, but with the wrong (negative) sign. A corollary to the negative forward premium bias is that the rational deviation from uncovered interest parity (DUIP) is negatively correlated with the rationally expected rate of depreciation. These facts have long posed a challenge to international economic theory. In this paper, they explore three approaches to explain these puzzles: (i)the standard representative-agent asset pricing model, (ii)a monetary-policy rule model with exchange-rate feedback, and (iii)a model of noise trading. They begin by presenting some stylized facts that characterize the problem. They obtain implied values of the rational DUIP and the rationally expected depreciation from a vector error correction model (VECM) for log spot and forward exchange rates and demonstrate the credibility of the estimates of these unobserved series by showing that they match a number key sample moments. With these credible estimates of the rational DUIP in hand, They then ask if they behave like risk premia implied by the standard representative agent asset pricing approach. The answer to this question is no. The risk premium is a conditional covariance between the intertemporal marginal rate of substitution of money and the payoff from forward currency speculation. Since the rational DUIP fluctuates between positive and negative values, according to the risk premium hypothesis, this conditional covariance must also. Our empirical analysis shows, however, that required conditional correlations required by the theory are largely absent from the data. Next, they re-examine a recent contribution by McCallum~(1994), who develops a non-risk interpretation of the rational DUIP. There, monetary policy involves the setting of the interest differential according to a rule that partially offsets the contemporaneous depreciation of the domestic currency. The feedback of the contemporaneous depreciation to the interest differential induces an error in the variables problem in the regression of the future depreciation on the forward premium and perfectly negatively correlated rational DUIPs and rationally expected depreciations. The error in the variables problem is the source of the forward premium bias in this model. Their investigation of McCallum's model uncovers suggests two reasons to apply his results with caution. First, they report econometric estimates of the policy rule parameters which have the wrong sign required to explain the forward premium bias. The second reason is that the results are not robust to a reasonable reformulation of the policy rule. In the original formulation, the interest rate differential depends on the contemporaneous rate of depreciation. A trading sequence that rationalizes this rule is that the foreign exchange market closes before the monetary policy authorities determine the current period interest differential. But an alternative and equally plausible sequence is to have the authorities determine the interest differential prior to the opening of the foreign exchange market. Under the alternative sequence, the interest rate rule depends on the lagged depreciation and the forward premium bias vanishes. The third approach that they explore is the Delong et. al. noise trader model. This model combines rational investors with noise traders who hold distorted beliefs concerning future currency returns. They model this distortion in beliefs in a particular way by building in Frankel and Froot's (1989) finding that foreign exchange traders place excessive weight on the forward premium in forming their expectations of the future depreciation. Their model of noise-trader beliefs also induces an error in the variables problem into the forward premium regression which forms the basis of the noise trader model's explanation of the forward premium bias. Trading volume is induced entirely by the presence of noise traders and the rational DUIP is not compensation for risk. In addition to the forward premium bias, the noise-trader model provides an explanation for the apparent short-term overreaction of exchange rate changes and the gradual adjustment towards its (economic) fundamental value in the long run that has been documented in recent empirical work.
  Remarks: The paper is not available in the Internet, JEL classification is available -- F31, F47
   
Untitled Document

Co-Movements in Long-Term Interest Rates and the Role of PPP-Based Exchange Rate Expectations

  Author: Jan Marc Berk and Klaas H.W. Knot
Book:
  Year: April 1999
  They investigate international co-movements in bond yields by testing for uncovered interest parity. They supplement existing work by focussing on long instead of short-term interest rates, and, related to that, by employing exchange rate expectations derived from purchasing power parity instead of actual outcomes. For the major floating currencies over the period 1975-97, they cannot support the notion of further increases in co-movement beyond that associated with the wave of financial market liberalization and deregulation in the early 1980s. Given the similarity between PPP-based UIP tests and those employing actual exchange rate outcomes, the value added of the former mainly lies with their ready availability.
  Remarks:
   
Untitled Document

Testing Uncovered Interest Parity at Short and Long Horizons

  Author: Menzie Chinn, University of California Guy Meredith, IMF and HKMA
Book:
  Year: July 11, 2000
  The unbiasedness hypothesis -- the joint hypothesis of uncovered interest parity (UIP) and rational expectations -- has been almost universally rejected in studies of exchange rate movements. In contrast to previous studies, which have used short-horizon data, we test this hypothesis using interest rates on longer-maturity bonds for the G-7 countries. The results of these long-horizon regressions are much more positive — the coefficients on interest differentials are of the correct sign, and almost all are closer to the predicted value of unity than to zero. These results are robust changes in data type and to base currency (i.e., Deutschemark versus US dollar). We appeal to an econometric interpretation of the results, which focuses on the presence of simultaneity in a cointegration framework.
  Remarks: The full version of the paper can be download at: http://econ.ucsc.edu/faculty/chinn/UIP_empr.pdf
   
Untitled Document

"Purchasing Power Parity and Interest Parity in the Laboratory"

  Author: Eric O™N. Fisher, Department Of Economics, The Ohio State University
Book:
  Year: 10 April 2001
  This paper analyzes purchasing power parity and uncovered interest parity in the laboratory. It finds strong evidence that purchasing power parity, covered interest parity, and uncovered interest parity hold. Subjects are endowed with an intrinsically useless (green) currency that can be used to purchase another useless (red) currency. Green goods can be bought only with green currency, and red goods can be bought only with red currency. The foreign exchange markets are organized as call markets. In the treatment analyzing purchasing power parity, the price of the red good varies. In a second treatment, the interest rate on red currency varies. In a third treatment, the interest rate on red currency varies, and the price of the red good is random.
  Remarks: The full version of the paper can be downloaded at: http://economics.sbs.ohio-state.edu/efisher/pppuip.pdf
   
Untitled Document

An Empirical Investigation into the Causes of Deviations from Covered Interest Parity across the Tasman

  Author: Moosa, Imad A.
Book: New Zealand Economic Papers
  Year: 1996 Vol: 30(1), pages 39-54.
  This paper examines deviations from the equilibrium condition implied by covered interest parity as applied to the exchange rate between the Australian and New Zealand dollars over the period 1985 to 1994. Formal empirical evidence shows that spot and forward speculation do not play any role in determining the forward exchange rate. The significant deviations in 1985 are attributed to political risk. Further shrinkage of the deviations in the 1990s is attributed to a possible reduction in transaction costs resulting from financial deregulation.
  Remarks:
   
Untitled Document

Exchange Controls, Political Risk and the Eurocurrency Market: New Evidence from Tests of Covered Interest Rate Parity

  Author: Cody, Brian J.
Book: International Economic Journal
  Year: 1990 Vol: 4(2), pages 75-86.
  This study employs daily data to examine the effects on Eurocurrency and onshore returns of the May 21, 1981 imposition of exchange controls by French President Mitterand. Prior to this time, transaction costs explain the average onshore deviations from covered parity; however, these averages ignore short-lived political risk premia which emerged just before the imposition of controls. As expected, there is no evidence of political risk on Eurocurrency markets. Yet when exchange controls were in effect, premia in excess of transaction costs surfaced on nonfranc Eurocurrency deposits at the time of devaluations of the franc within the EMS.
  Remarks:
   
Untitled Document

Forward and Spot Exchange Rates

  Author: Fama, Eugene F.
Book: Journal of Monetary Economics
  Year: 1984 Vol: 14(3), pages 319-38.
  In this study Fama decomposes the forward premium into a risk premium and an expected depreciation premium based on the information set available. By constructing a statistical model on this relation, he finds the relative importance of the risk premium and the expected depreciation premium.
  Remarks:
   
Untitled Document

Exchange Rate Forecasting Techniques, Survey Data, and Implications for the Foreign Exchange Market

  Author: Frankel, Jeffrey A.; Froot, Kenneth
Book: International Monetary Fund Working
  Year: 1990 Vol: Paper: WP/90/43, pages 26.
  This paper examines the dynamics of the foreign exchange market. The first half addresses a number of key questions regarding the forecasts of future exchange rates made by market participants, by means of updated estimates using survey data. Here the authors follow most of the theoretical and empirical literature in acting as if all market participants share the same expectation. The second half then addresses the possibility of heterogeneous expectations, particularly the distinction between "chartists" and "fundamentalists," and the implications for trading in the foreign exchange market and for the formation of speculative bubbles.
  Remarks:
   
Untitled Document

A Multivariate GARCH Model of Risk Premia in Foreign Exchange Markets

  Author: Malliaropulos, Dimitrios
Book: Economic Modelling
  Year: 1997 Vol: 14(1), pages 61-79.
  This paper investigates the existence of time-varying risk premia in deviations from uncovered interest parity based on the market capital asset pricing model. The empirical analysis is conducted using a broad data set of seven major currencies against the US dollar, and a world equity index in order to approximate the benchmark portfolio. The conditional covariance matrix of excess returns is modelled as a multivariate GARCH process. The results indicate significant conditional systematic risk. Estimated conditional beta coefficients are very similar across currencies and behave uniformly over time. The explanatory power of the model is significantly higher compared to the constant beta CAPM specification. Furthermore, estimation results suggest that (1) expected excess returns are less volatile in foreign exchange markets compared to stock markets, and (2) including nominal dollar assets in international equity portfolios can reduce overall portfolio risk.
  Remarks:
   
Untitled Document

International Financial Relations under the Current Float: Evidence from Panel Data

  Author: Lothian, James R.; Simaan, Yusif
Book: Open-Economies-Review
  Year: 1998 Vol: 9(4), pages 293-313.
  This paper uses multi-country data for the period 1973-94 to investigate five key equilibrium conditions in international finance--purchasing power parity, the Fisher equation, uncovered interest parity, and the equity-return analogues of the latter two. The results are largely consistent with theoretical expectations. Over the long run, purchasing power parity, uncovered interest parity and the Fisher effect prove to be rather good first approximations. The equity-return relations, though somewhat less so are nevertheless much better behaved than past studies would lead one to expect. Average rates of equity returns keep pace with inflation within countries in almost all instances; across countries, they are positively correlated with average rates of inflation. This is particularly the case when the data period is extended to include earlier decades.
  Remarks:
   
Untitled Document

An Alternative Approach to Testing Uncovered Interest Parity

  Author: Bhatti, Razzaque H.; Moosa, Imad A.
Book: Applied-Economics-Letters
  Year: 1995 Vol: 2(12), pages 478-81.
  Supportive evidences of UIP hypothesis through a cointegration analysis. The authors compare the Treasury bill rates denominated in 11 currencies to the U.S. dollar, and find a long-run relationship in all cases.
  Remarks:
   
Untitled Document

Uncovered Interest Parity in Crisis: The Interest Rate Defense in the 1990s

  Author: Flood, Robert P; Rose, Andrew K.
Book:
  Year: 2001 Vol: This paper is available online at http://haas.berkeley.edu/~arose/UIPC.pdf
  This paper tests for uncovered interes parity (UIP) using daily data for twenty-three developing and developed countries through the crisis-strewn 1990s. The authors find that UIP works better on average in the 1990s than previous eras in the sense the slope coefficient from a regression of exchange rate changes on interest differentals yields a positive coefficient (which is sometimes insignificantly different from unity). UIP works systematically worse for fixed and flexible exchange countries than for crisis countries, but we find no significant differences between rich and poor countries. Finally, the authors find evidence that varies considerably across countries and time, but is usually weakly consistent with an effective "interest defense" of the exchange rate.
  Remarks:
   

© 2000 The Chinese University of Hong Kong