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Foreign Exchange Intervention |
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What is
Foreign Exchange Intervention?
Definition and the Legal
Status of Intervention
Foreign exchange intervention is defined generally as foreign exchange transactions
conducted by the monetary authorities with the aim of influencing exchange rates.
It is the process by which the monetary authorities attempt to influence market
conditions and/or the value of the home currency on the foreign exchange market.
Intervention usually aims to promote stability by countering disorderly markets,
or in response to special circumstances.
In Japan, the Minister
of Finance is legally authorized to conduct intervention as a means to achieve
foreign exchange rate stability. In the United States, the Government and Federal
Reserve Board (FRB); in Euro Area, the European Central Bank (ECB); in the United
Kingdom, the Bank of England (BOE) operates it.
General
Ideas of Foreign Exchange Market
Foreign Exchange Market
To invest in other countries or to buy foreign products, firms and individuals
may first need to acquire the currency of the country with which they intend
to deal with. In addition, exporters may demand to be paid for their goods and
services either in their own currency or in U.S. dollars, which are accepted
worldwide. The Foreign Exchange Market, or "Forex" market, in which
international currencies trades take place, is called foreign exchange market.
Exchange Rate
Each country has a currency in which the prices of goods and services are quoted
- the dollar in the United States, the euro in Germany, the pound sterling in
Britain, the yen in Japan, etc. Exchange rates play a central role in international
trade because they allow us to compare the prices of goods and services produced
in different countries.
A foreign exchange rate is the relative value between two currencies. In particular,
it is the quantity of one currency required to buy or sell one unit of the other
currency. The exchange rate can be quoted in 2 ways: as the price of the foreign
currency in terms of home currency (direct terms) or as the price of home currency
in terms of foreign currency (indirect terms).
Three Exchange Rate
Regimes
In theory, there are three exchange rate regimes, namely flexile, intermediate
and fixed. Under a flexible currency regime, the external value of a currency
is determined more or less by the force of market supply and demand. Because
floating exchange rate permitting enough flexibility to adjust fundamental disequilibria
under international supervision, it can prevent competitive depreciation. On
the other hand, under a fixed exchange rate arrangement, the monetary authority
pegs the domestic currency to one or a basket of foreign currencies. Exchange
rates between currencies that are set at predetermined levels and do not move
in response to changes in supply and demand. The authority has to intervene
in the foreign exchange market whenever the prevailing rate deviates from the
specific one. Immediate exchange rate arrangement has a medium flexibility lying
between flexible and fixed.
The arguments in favor
of purely floating exchange rate regime:
- A simple laissez-faire
view - exchange rate should be determined by private demand and supply without
government interference.
- A parallel view - the
exchange rate is easier to be adjusted to respond to the new development of
the economy than wages and prices, which are always assumed to be sticky.
- Policy independence
- floating exchange rate is said to be able to equilibrate the trade balance
by altering the relative price of imports and exports, hence the amount of
imports and exports. So, the countries can pursue their internal economics
goal such as full employment, low inflation, independently.
The arguments in favor
of purely fixed exchange rate:
- Certainty of exchange
rate - the exchange rate volatility is low under the fixed exchange rate regime.
This reduces the investment risk resulted in larger imports, exports, lending
and borrowing. Thus, stable exchange rate promotes international trade.
- Nominal anchor - fixed
exchange rate is an effective way of providing a nominal anchor to monetary
policy. Pegging the exchange rate will convince people that inflation is unlikely.
Lower inflation expectation yields a lower actual inflation rate.
Role of
Central Bank Under Different Exchange Rate Regimes
Under a fixed exchange
rate regime
For those countries with a fixed rate regime, operations in the foreign exchange
market are largely passive, with the central bank automatically clearing any
excess demand or supply of foreign currency to maintain a fixed exchange rate.
When there is an increase in the demand of foreign currency, central bank purchases
the local currency against foreign currency. When there is increase in the demand
of foreign currency, central bank sells foreign currency for local currency.
Interest rates in the inter-bank market adjust to clear the market. Under this
system, both the stock and the flow of the monetary base must be fully backed
by foreign reserves. Hence, any change in the monetary base must be matched
by a corresponding change in reserves and the central bank is passive in intervening
in the market.
Under a flexible exchange
rate regime
Although central banks in countries adopt flexible exchange rate regimes, they
have still retained discretion to intervene in the foreign exchange market.
Governments concern on FX rates because changes in the rates affect the value
of products and financial instruments. As a result, unexpected or large changes
can affect the health of nations' markets and financial systems, as well as
inflation and economic growth. For example, if the Japanese yen rises in value
compared with the dollar, U.S. exports become less expensive for the Japanese
to buy; that could lead to an increase in U.S. exports and a boost to U.S. employment.
At the same time, the lower value of the dollar compared with the yen could
raise U.S. import prices and act as an inflationary influence in the United
States.
Why Central
Banks Intervene in the Foreign Exchange Market?
Minimizing Overshooting
Effect
The motivation for intervention decision has been widely researched and often
discussed. There is a general consensus that intervention may be warranted to
stabilize the exchange rate and provide liquidity to the market; and to correct
an overshoot, in either direction, in the exchange rate. Foreign exchange intervention
is a tool used in the short-term to smooth the transition in the exchange rate
by minimizing overshooting when economic conditions are changing or when the
monetary authority believes that the market has misinterpreted economic signals.
Reducing Exchange Rate
Volatility
Limiting the volatility in the exchange rate may be important due to the adverse
effects it can have on sentiment both within financial markets and the economy.
Especially, when the management of the exchange rate is the major tool for implementing
monetary policy, excessive short-term volatility can erode the market's confidence
in the regime.
Central bank wants to reduce
the volatility because volatility may impede international investment flows.
By adding risk to the rate of return on a foreign asset, exchange rate volatility
may reduce investment in foreign financial assets. In addition, companies may
be reluctant to build a new plant or purchase a foreign company if exchange
rate uncertainty reduces the expected profits from such projects. As a result,
exchange rate volatility creates a disincentive for domestic investment and
inefficient allocation of resources in the world economy.
Another reason why authorities
may want to reduce volatility is that it may adversely affect international
trade. Stable currency can facilitate international trade by reducing investment
risk. Because volatile exchange rates create uncertainty about the revenues
to be earned on international transactions, such volatility could force companies
to add a risk premium to the costs of goods they sell abroad. If these costs
are passed on to consumers in the form of higher prices, the demand for traded
goods could decrease. In addition, firms themselves may be more reluctant to
engage in international trade if exchange rate volatility adds an extra risk
to their profits.
A final reason to reduce
exchange rate volatility is that it could spill over into the financial markets.
If exchange rate volatility increases the risk of holding domestic assets, the
prices of these assets could also become more volatile. The increased volatility
of financial markets could threaten the stability of the financial system and
make monetary policy goals more difficult to attain.
Leaning-against-the-wind
Research and official pronouncements support the idea that monetary authorities
with floating exchange rates most often employ intervention to resist short-run
trends in exchange rates. The central bank intervenes the disorderly market
to moderate the movements of the exchange rate by providing support to either
domestic or foreign currency. This kind of intervening strategy is called "leaning-against-the-wind".
Correct Misalignment
of Exchange Rate
Another motivation of is to correct medium-term "misalignments" of
exchange rates away from "fundamental" values. Where the exchange
rate depart from fundamentals - such as moving the inflation rate outside of
a target range - it may be appropriate to intervene in the market. The stabilizing
role that a central bank can bring to the market may be sufficient to alter
investor sentiment and move the exchange rate back towards equilibrium.
Profitability of Intervention
There have been several empirical studies on the profitability of intervention
for major countries. One of the first was that published by Taylor (1982), which
examined nine industrial countries early in the floating period, from the early
1970s to the end of 1979.5 According to his estimates, central banks lost more
than $US11 billion over the whole period.
Several subsequent studies
challenged Taylor's results, reworking his calculations using several refinements.
By lengthening the sample period and taking account of the interest differential
between investing in foreign currencies and the local currency, Argy (1982),
Jacobson (1983), and the Bank of England (1983) found that these large losses
were in fact profits. For the US, for instance, Jacobson estimated that total
losses are around $US500 million for the 1973-79 period, but over the entire
1973-1981 period, net profits amounted to almost $US300 million. Moreover, including
a measure of net interest earnings increased profits by up to $US470 million
over the longer period.
The goal of foreign exchange
intervention is to maintain orderly market conditions - to help achieve macroeconomic
goals like price stability or full employment. Therefore, profitability of foreign
exchange intervention is not a necessary condition for intervention.
Technical Trading Rule
Profitability
A strong and consistent result in international finance is the evidence that
technical trading rules - rules that use the information on past price to determine
trading decisions - can generate persistent profits in dollar exchange rate
markets.
Among the trading rules,
moving average is the one that receives most attention. The rule attempts to
filter the data to discover trends in exchange rates. It is also called double
moving-average rules (MA rules). A double moving average prescribes buying an
asset - e.g. a foreign currency-denominated bank deposit - if a moving average
of past exchange rates over a short time window is greater than a moving average
of past exchange rates over a longer time window. Conversely, if the short moving
average is less than the long moving average, the rule instructs that the trader
should sell the asset.
Evidence has accumulated
in recent years that technical analysis can be useful in the foreign exchange
market (Sweeney (1986), Levich and Thomas (1993), Neely, Weller and Dittmar
(1997)). This finding has challenged the efficient markets hypothesis, which
holds that exchange rates reflect information to the point where the potential
excess returns do not exceed the transactions costs of acting (trading) on that
information (Jensen (1978)).
Causes
of Volatility
In the previous section,
we mentioned that one of the objectives of foreign exchange intervention is
to smooth the exchange rate volatility. But what are the causes and consequences
of this volatility?
Exchange rate volatility is often attributed to three factors: volatility in
market fundamentals, changes in expectations due to new information, and speculative
"bandwagons".
Volatility in Market
Fundamentals
Volatility in market fundamentals, such as the money supply, income, and interest
rates, affects exchange rate volatility because the level of the exchange rate
is a function of these fundamentals. For example, large changes in the money
supply can lead to changes in the level of the exchange rate. Changes in the
level of the exchange rate in turn imply exchange rate volatility.
Changes in Expectations
Changes in expectations about future market fundamentals or economic policies
also affect exchange rate volatility. When market participants receive new information,
they alter their forecasts of future economic conditions and policies. Exchange
rates based on these forecasts will also change, thereby leading to exchange
rate volatility. For example, news about a change in monetary policy may cause
market participants to revise their expectations of future money supply growth
and interest rates, which could alter the level and hence the volatility of
the exchange rate.
Degree of Confidence
In addition to being affected by expectations of future fundamentals and policies,
volatility is also affected by the degree of confidence with which these expectations
are held. Exchange rate volatility tends to rise with increases in market uncertainty
about future economic conditions and tends to fall when new information helps
resolve market uncertainty.
Speculative Bandwagons
Finally, exchange rate volatility can be caused by speculative bandwagons, or
speculative exchange rate movements unrelated to current or expected market
fundamentals. For example, if enough speculators buy dollars because they believe
the dollar will appreciate, the dollar could appreciate regardless of fundamentals.
If speculators then think that the market fundamentals will not sustain, active
selling by the same speculators could cause the dollar to depreciate. Fluctuation
in the value of the dollar arising from such speculative forces will contribute
to exchange rate volatility.
Types of
Foreign Exchange Intervention
Entrustment Intervention
"Entrustment Intervention" means intervention that is conducted in
overseas markets with funds of local monetary authorities. It is different from
the intervention that is conducted in overseas markets with funds of respective
foreign monetary authorities.
Reverse-Entrustment
Intervention
Similarly, when foreign monetary authorities need to intervene in a country's
foreign exchange market, say Tokyo market, the central bank of Japan can conduct
interventions on their behalf upon request. This is called "Reverse-Entrustment
Intervention"
Concerted or Coordinated Intervention
There are cases where two or more monetary authorities implement intervention
jointly by using their own funds at the same time or in succession. This is
called "Concerted or Coordinated Intervention." For instance, the
Plaza Agreement in 1985 (a G5 meeting) and the Louvre Accord in 1987 (a G7 meeting)
were held for the discussion of multilateral intervention to depreciate the
overvalued US dollar and to restore equilibrium in current account. These kinds
of interventions are called concerted or coordinated intervention.
Sterilization and Non-sterilization
Studies of foreign exchange intervention generally distinguish between intervention
that does or does not change the monetary base. The former type is called non-sterilized
intervention while the latter is referred to as sterilized intervention. Central
banks sometimes carry out equal foreign and domestic assets transaction in opposite
directions to nullify the impact of their foreign exchange operations on the
domestic money supply. When a monetary authority buys (sells) foreign exchange,
its own monetary base increases (decreases) by the amount of the purchase (sale).
In order to prevent the money stock from increasing (decreasing), the monetary
authorities can sterilize the effect of the exchange market intervention by
selling (buying) short-term domestic assets to (from) the banking system leaving
the monetary base of the country unchanged. Since sterilized intervention does
not affect the money supply, it does not affect prices or interest rate and
so does not influence the exchange rate. Rather, sterilized intervention might
affect the foreign exchange market through two routes: the portfolio-balance
channel and the signaling channel.
According to the portfolio-balance
channel, it is assumed that risk-averse wealth holders diversify their portfolio
across assets denominated in different currencies. Let's use the United States
and Japan as an example. The portfolio balance channel theory holds that sterilized
purchases of yen raise the dollar price of yen because investors must be compensated
with a higher expected return to hold the relatively more numerous U.S. bonds.
To produce a higher expected return, the yen price of the U.S. bonds must fall
immediately. That is, the dollar price of yen must rise.
In contrast, the signaling
channel assumes that intervention affects exchange rates by providing the market
with new relevant information, under an implicit assumption that the authorities
have superior information to other market participants. The authorities are
willing to reveal this information through their actions in the foreign exchange
market. Because private agents may change their exchange rate expectation after
intervention, the exchange rate then will be expected to change immediately
after the effect occurs.
Spot and Forward Markets
for Intervention
There are two primary types of transactions in the FX (Foreign Exchange) market.
An agreement to buy or sell currency at the current exchange rate is known as
a spot transaction. By convention, spot transactions are settled two days later.
In a forward transaction, traders agree to buy and sell currencies for settlement
at least three days later, at predetermined exchange rates. The forward market
transaction is often used by businesses to reduce their exchange rate risk.
The previous example used in sterilization section is implicitly assumed that
the Federal Reserve Bank of New York conducted its purchase of yen in the spot
market-the market for delivery in two days or less. Other than intervention
in spot market, it also may be carried out in the forward market. Because the
forward price is linked to the spot price through covered interest parity, intervention
in the forward market can influence the spot exchange rate.
Forward market interventions-the
purchase or sale of foreign exchange for delivery at a future date-have the
advantage that they do not require immediate cash outlay. If a central bank
expects that the need for intervention will be short-lived and will be reversed,
then a forward market intervention may be conducted discreetly - with no observable
effect on foreign exchange reserves.
Both the spot and forward
markets may be used simultaneously. A transaction in which a currency is bought
in the spot market and simultaneously sold in the forward market is known as
a currency swap. While a swap itself will have little effect on the exchange
rate, they can be used as part of an intervention. Some central banks used the
swaps market to sterilize spot interventions. In these transactions, the spot
leg of the swap is conducted in the opposite direction to the spot market intervention,
leaving the sequence equivalent to a forward market intervention.
The Options Market and
Intervention
The options market has also been used by central banks for intervention. A European
style call (put) option confers the right, but not the obligation to purchase
(sell) a given quantity of the underlying asset on a given date. Usually, the
option contract specifies the prices for which the asset may be bought or sold,
called the strike or exercise price. Monetary authorities seeking to prevent
depreciation or devaluation of their currency may sell put options on the domestic
currency or call options on the foreign currency.
Indirect Intervention
Recall that while official intervention is generally defined as foreign exchange
transactions of monetary authorities designed to influence exchange rates, it
can also refer to other (indirect) policies for that purpose. There are innumerable
methods of indirectly influencing the exchange. These methods involve capital
controls (taxes or restrictions on international transactions in assets like
stocks or bonds) or exchange controls (the restriction of trade in currencies)
Effectiveness
of Central Bank Intervention
Most of the interventions were aiming at stabilizing the disorderly exchange
rate market; unfortunately, many studies revealed that intervention could not
smooth the exchange rate movement.
Intervention may Decrease
Volatility
Central bank intervention may reduce exchange rate volatility if it resolves
uncertainty by market participants about future monetary policy. For example,
if the market is uncertain about the stance of monetary policy, then intervention
to halt a drop in the dollar may signal that the Federal Reserve is committed
to a tight monetary policy. The resolution of uncertainty about future monetary
policy may then lead to less exchange rate volatility.
Central bank intervention
may also reduce exchange rate volatility by reducing the likelihood of a speculative
bandwagon. Suppose the dollar exchange rate falls from
￥120/$ to ￥115/$. As speculators see the dollar falling, they may jump on the
bandwagon thinking the dollar may fall further to ￥110/$. Under this scenario,
speculators who sell $1 million at ￥115/$ could make a profit if the dollar
falls to
￥110/$ and they reacquired dollars at the lower value. However, if the central
bank intervenes at ￥115/$ and pushes the dollar back to ￥120/$, then speculators
could suffer a loss. Speculators may therefore become reluctant to push the
dollar down too rapidly if they believe the central bank will intervene to prevent
the dollar from falling. By reducing selling pressure when the dollar starts
to fall, central bank intervention could reduce speculative bandwagons and thereby
reduce volatility.
Intervention may Increase
Volatility
Central bank intervention could actually increase exchange rate volatility if
intervention increases private sector uncertainty about central bank policies.
Suppose the central bank surprises traders by intervening to increase the value
of the dollar but announces neither the intervention's magnitude nor its motivation.
In making their trades, foreign exchange traders have to guess the meaning of
the intervention and attempt to infer the implications of the action for future
policy. Because their trades are based on incomplete information, traders will
need to revise their currency positions once more information about intervention
policy becomes available. These changes in currency positions imply changes
in the exchange rate and hence greater exchange rate volatility.
Market uncertainty about
the likelihood of future central bank intervention could also lead to greater
exchange rate volatility. Because central banks do not announce their plans
for intervention, foreign exchange traders must base their currency positions
on their best guesses of whether and when central banks will intervene. These
currency positions and hence exchange rates will change over time as traders
reassess the likelihood of central bank intervention. Uncertainty over central
bank intervention policy can contribute to exchange rate volatility.
Central bank intervention
can also increase exchange rate volatility by increasing the likelihood of speculative
bandwagons. For instance, intervention might increase volatility if market participants
think the central bank is unable or unwilling to prevent speculative forces
from pushing the exchange rate in a particular direction. Suppose the dollar
exchange rate falls from ￥120/$ to ￥115/$ and that speculators expect the dollar
to fall further to ￥110/$. As before, a speculator selling the dollar at ￥115/$
might expect to realize a profit if the dollar falls to ￥110/$. The expected
profit opportunity encourages other speculators to jump on the bandwagon, thereby
actually pushing down the dollar. Since the traders are uncertain about the
intervention policy. The uncertainty about intervention policy may encourage
speculation and cause price changes and exchange rate volatility to be higher
than in the absence of such intervention.
However, there is still
much evidence that interventions are effective in stabilizing the market and
influencing the exchange rate if the interventions are:
- Large in amount - The
larger the amount of interventions, the greater the possibility of success.
- Coordinated - Evidence
suggests that coordinated intervention is more effective than the individual
intervention. It is because where the monetary authorities for both the undervalued
and overvalued currencies participate; the coordinated signals offered by
the intervention may view as more credible.
- In series - spread
out the intervention transaction over a number of days to maximize the effects
of intervention through the signaling channel. The intervention stance may
be perceived to be more credible to market participants if they see a series
of intervention transaction rather a one-off entry into market. Publicized
- reported interventions are the most effective central bank action because
it is regarded as a credible source of information about the future monetary
policy while secret interventions have little effect on exchange rate.
- Publicized - reported
interventions are the most effective central bank action because it is regarded
as a credible source of information about the future monetary policy while
secret interventions have little effect on exchange rate.
Draft Guidelines
for Foreign Exchange Reserve Management
Although each country is free to manage its foreign reserve, management of foreign
exchange reserves is important because reserves are a key determinant of a country's
ability to avoid economic and financial crisis. Therefore, since 2000 the IMF
- in collaboration with the Bank for International Settlements (BIS), World
Bank, and many member countries - has been engaged in the development of a set
of Draft Guidelines for Foreign Exchange Reserve Management. For further information,
we can approach to the IMF site http://www.imf.org/external/np/mae/ferm/eng/ |
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Keywords:
Central Bank Intervention, Foreign exchange intervention, Exchange Rate |
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Intraday Technical Trading in the Foreign Exchange Market
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Author:
hristopher J. Neely and Paul A. Weller
Book: |
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Year:
January 2001 |
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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.
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Remarks:
This paper is downloaded at:
http://www.stls.frb.org/docs/research/wp/99-016B.pdf |
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Untitled Document
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Technical Analysis and Central Bank Intervention
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Author:
Christopher Neely and Paul Weller
Book: |
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Year:
Feburary 2000 |
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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.
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Remarks:
This paper is downloadable at:
http://www.stls.frb.org/docs/research/wp/97-002c.pdf |
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Untitled Document
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Foreign Exchange Market Trading Volume and Federal Reserve Intervention
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Author:
Alain Chaboud, Federal Reserve, Board of Governors
Book: |
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Year:
July 1999 |
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The authors find a large positive correlation between daily trading volume in currency futures
markets and foreign exchange intervention by the Federal Reserve over the period 1979-1996. Neither contemporaneous nor predicted volatility can fully account for the increases in trading activity. Whether or not the intervention operation is publicly reported appears to be an
important determinant of trading volume. |
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Remarks:
This paper is downloadable at:
http://www.unet.brandeis.edu/~blebaron/wps/volpap.pdf |
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Untitled Document
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Fed Intervention, Dollar Appreciation, and Systematic Risk
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Author:
Richard J. Sweeney
Book: |
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Year:
August 2000 |
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This paper is the first to investigate intervention effects in asset pricing models that relate appreciation to
risk-factor realizations. Fed foreign-currency sales show economically and statistically significant association with increases in beta risk in the dollar's appreciation rate and thus with the dollar's ex ante appreciation rate. But intervention’s ex post effects may be unreliable: they depend on the size of world-asset-market movements, and the size of intervention’s association with beta varies importantly from year to year. Even successful intervention to
strengthen the dollar may be costly: By increasing the dollar’s systematic risk, it makes U.S. investments less attractive relative to foreign investments. Further, uncertainty about the timing and size of Fed intervention makes it harder for investors to select appropriate risk-adjusted discount rates and to forecast the dollar value of cash flows, and thus may induce resource misallocation. This paper’s results are consistent with both portfolio balance and signaling channels. |
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Remarks:
The full text is downloadable at:
http://www.msb.georgetown.edu/faculty/sweeneyr/wp/effects.new.intervention.pdf |
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Does Central Bank Intervention Stabilize Foreign Exchange Rates?
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Author:
Catherine Bonser-Neal
Book: Federal Reserve Bank of Kansas City |
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Year:
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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. |
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Remarks:
The paper is downloadable at:
http://www.kc.frb.org/publicat/econrev/pdf/1q96bons.pdf |
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The Market Microstructure of Central Bank Intervention
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Author:
Kathryn M. Dominguez
Book: NBER Working Paper Series No. 7337 |
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Year:
September 1999 |
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One of the great unknowns in international finance is the process by which new information influences exchange rate behavior. This paper focuses on one important source of information to the foreign exchange markets, the intervention operations of the G-3 central banks. Previous studies using daily and weekly foreign exchange rate data suggest that central bank intervention operations can influence both the level and variance of exchange rates, but little is known about how exactly traders learn of these operations and whether intra-daily market conditions influence the effectiveness of central bank interventions. This paper uses high-frequency data to examine the relationship between the efficacy of intervention operations and the "state of the market" at the moment that the operation is made public to traders. The results indicate that some traders know that a central bank is intervening at least one hour prior to the public release of the information in newswire reports. Also, the evidence suggests that the timing of intervention operations matter – interventions that occur during heavy trading volume and that are closely timed to scheduled macro announcements are the most likely to have large effects. Finally, post-intervention mean reversion in both
exchange rate returns and volatility indicate that dealer inventories are affected by market reactions to
intervention news. |
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Remarks:
The full text is downloadable at:
http://papers.nber.org/papers/W7337.pdf |
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Further evidence on technical analysis and profitability of foreign exchange intervention
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Author:
Simón Sosvilla-Rivero, Julián Andrada-Félix and Fernando Fernández-Rodríguez
Book: |
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Year:
1999 |
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In this paper the authors present new evidence on the positive correlation Between returns from technical trading rules and periods of central bank intervention. To that end, they evaluate the profitability of a trading strategy based on nearest-neighbour (nonlinear) predictors, which may be viewed as a generalisation of graphical methods widely used in financial markets. The authors use daily data on the US Dollar/Deutsche mark and US Dollar/Japanese Yen covering the 1 February 1982-31 December 1996 period. The results suggest that the exclusion of days of US intervention implies a substantial reduction in all profitability indicators (net returns, ideal profit measure, Sharpe ratio and directional forecast), being the reduction grater in the US Dollar-Deustchmark case than in the US Dollar-Japanese yen case. |
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Remarks:
The text is downloadable at:
ftp://ftp.fedea.es/pub/Papers/1999/DT99-01.pdf |
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Smoke and Mirrors in the Foreign Exchange Market
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Author:
Willem H. Buiter and Anne C. Sibert
Book: |
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Year:
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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. |
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Remarks:
The text is downloadable at:
http://www.nber.org/~wbuiter/observer.pdf |
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Untitled Document
References related to Foreign exchange intervention
(26 references
are shown.)
Untitled Document
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Does Foreign Exchange Intervention Work?
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Author:
Kathryn M. Dominguez and Jeffrey A. Frankel
Book: Book Title:
Does Foreign Exchange Intervention Work? |
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Year:
September 1993 |
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Following the Versailles G-7 summit of 1982, most government officials and academic analysts downplayed the potential impact of exchange market intervention unless such intervention was permitted to affect national monetary policies. This study challenges the conventional wisdom. Using previously unavailable data on daily intervention by the US Federal Reserve and the German Bundesbank, the authors find to the contrary that even "sterilized" intervention can have an effect, especially if it is known to the markets. Implications are drawn for intervention policy and its role in the international coordination process. |
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Remarks:
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An Intraday Analysis of the Effectiveness of Foreign Exchange Intervention
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Author:
Neil Beattie and Jean-François Fillion
Book: |
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Year:
February 1999 |
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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. |
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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
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Author:
John Murray, Mark Zelmer, and Shane Williamson
Book: Technical Report No. 53 |
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Year:
March 1990 |
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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.
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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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Untitled Document
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Official Intervention in the Foreign Exchange Market: Is It Effective, and, If So, How Does It Work?
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Author:
Lucio Sarno and Mark P Taylor
Book: |
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Year:
February 2001 |
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This paper is provided by Centre for Economic Policy Research. In this Paper we assess the progress made by the profession in understanding whether and how exchange rate intervention works. To this end, we review the theory and evidence on official intervention, concentrating primarily on work published within the last decade or so. Our reading of the recent literature leads us to conclude that, in contrast with the profession's consensus view of the 1980s, official intervention can be effective, especially through its role as a signal of policy intentions, and especially when it is publicly announced and concerted. We also note, however, an apparent empirical puzzle concerning the secrecy of much intervention and suggest an additional way in which intervention may be effective but which has so far received little attention in the literature, namely through its role in remedying a coordination failure in the foreign exchange market. |
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Remarks:
The full text can be downloaded at http://www.cepr.org/pubs/new-dps/dplist.asp?dpno=2690 |
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Foreign Exchange Intervention, Policy Objectives and Macroeconomic Stability
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Author:
Paolo Vitale
Book: |
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Year:
July 2001 |
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Within a simple model of monetary policy for an open economy, it studies how foreign exchange intervention may be used to condition agents' beliefs of the objectives of the policymakers. Differently from cheap talk foreign exchange intervention guarantees a unique equilibrium. Foreign exchange intervention does not bring about a systematic policy gain, such as an increase in employment or a reduction in the inflationary bias. It can, however, stabilise the national economy, for it drastically reduces the fluctuations of employment and output. Foreign exchange intervention is profitable, but a trade-off exists between these profits and the stability gain it brings about. Finally, an important normative conclusion of our analysis is that foreign exchange intervention and monetary policy should be kept separated, in that a larger stability gain is obtained when these two instruments of policy making are under the control of different governmental agencies. |
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Remarks:
The full text is downloadable at
http://www.cepr.org/pubs/new-dps/dplist.asp?dpno=2886 |
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The Practice of Central Bank Intervention: Looking Under the Hood
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Author:
Christopher J. Neely
Book: |
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Year:
October 2000 |
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This article first reviews methods of foreign exchange intervention and then presents evidenceocusing on survey resultsn the mechanics of such intervention. Types of intervention, instruments, timing, amounts, motivation, secrecy and perceptions of efficacy are discussed.
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Remarks:
The paper can be downloaded at:
http://www.stls.frb.org/docs/research/wp/2000-028.pdf |
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The Temporal Pattern of Trading Rule Returns and Central Bank Intervention: Intervention Does Not Generate Technical Trading Rule Profits
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Author:
Christopher J. Neely
Book: |
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Year:
November 2000 |
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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.
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Remarks:
This paper is downloadable at:
http://www.stls.frb.org/docs/research/wp/2000-018C.pdf |
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Untitled Document
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Intraday Technical Trading in the Foreign Exchange Market
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Author:
hristopher J. Neely and Paul A. Weller
Book: |
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Year:
January 2001 |
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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.
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Remarks:
This paper is downloaded at:
http://www.stls.frb.org/docs/research/wp/99-016B.pdf |
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Untitled Document
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Is Technical Analysis in the Foreign Exchange Market Profitable? A Genetic Programming Approach
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Author:
Christopher Neely, Paul Weller and Robert Dittmar
Book: |
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Year:
August 1997 |
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Using genetic programming techniques to find technical trading rules, the authors find strong evidence of economically significant out-of-sample excess returns to those rules for each of six exchange rates ($/DM, $/¥, $/SF, $/£, ¥/DM, SF/£), over the period 1981-1995. Further, then the $/DM rules were allowed to determine trades in the other markets, there was a significant improvement in performance in all cases except for the ¥/DM. Betas calculated for the returns according to four international benchmark portfolios provide no evidence that the returns to these rules are compensation for bearing systematic risk. Bootstrapping results on the $/DM indicate that the trading rules are detecting patterns in the data that are not captured by standard statistical models.
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Remarks:
The paper is downloadable at:
http://www.stls.frb.org/docs/research/wp/96-006c.pdf |
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Untitled Document
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Foreign Exchange Market Trading Volume and Federal Reserve Intervention
|
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Author:
Alain Chaboud, Federal Reserve, Board of Governors
Book: |
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Year:
July 1999 |
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The authors find a large positive correlation between daily trading volume in currency futures
markets and foreign exchange intervention by the Federal Reserve over the period 1979-1996. Neither contemporaneous nor predicted volatility can fully account for the increases in trading activity. Whether or not the intervention operation is publicly reported appears to be an
important determinant of trading volume. |
| |
Remarks:
This paper is downloadable at:
http://www.unet.brandeis.edu/~blebaron/wps/volpap.pdf |
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Untitled Document
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The Determinants of Foreign Exchange Intervention by Central Banks: Evidence from Australia
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Author:
Suk-Joong Kim and Jeffrey Sheen
Book: |
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Year:
December 1999 |
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This paper is a working series of the University of New South Wales.
Intervention by the Reserve Bank of Australia on foreign exchange markets from 1983 to 1997 is conjectured to
have been determined by exchange rate trend correction, exchange rate volatility smoothing and profitability
considerations. Using Probit and friction models, we show that these factors were significant influences on
intervention behaviour. Consistent with the constraint of intervening only when a clear trend is apparent, we find
that above average measures of deviations from trend and of volatility muted the response of the Reserve Bank. |
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Remarks:
This paper is downloadable at:
http://banking.web.unsw.edu.au/workpap/wp1_00.pdf |
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Are changes in foreign exchange reserves well correlated with official intervention?
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Author:
Christopher J. Neely
Book: Review - Federal Reserve Bank of St. Louis |
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Year:
Sept/Oct 2000 Vol: Vol. 82, Iss. 5; pg. 17, 15 pgs |
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This review is writtne by Christopher J. Neely, a senior economist at the Federal Reserve Bank of St. Louis. It's about why countries hold international reserves, correlations between Central Bank intervention and changes in reserves. |
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Remarks:
This article is downloadable at:
http://www.stls.frb.org/docs/publications/review/00/09/0009cn.pdf |
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Untitled Document
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Why intervention rarely works?
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Author:
Owen F Humpage and William P Osterberg
Book: Federal Reserve Bank of Cleveland. Economic Commentary; Cleveland; |
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Year:
Feb 2000 Vol: pg. 1, 4 pgs |
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In the late 1980s, the US frequently intervened in the foreign-exchange market. Unconvinced of the effectiveness of such operations and worried about possible conflicts with monetary policy, the US curtailed its interventions during the early part of the last decade. Calls for action are being heard again, however. Most economists now regard foreign-exchange-market intervention as generally ineffectual. Intervention cannot systematically affect a nation's exchange rates when undertaken independent of its monetary policy, and when undertaken as a goal of monetary policy, exchange rate-management can compromise price stability and create confusion about long-term policy objectives. Central banks cannot regularly influence day-to-day exchange-rate movements through sterilized intervention because they do not customarily possess an information advantage over private-sector traders.
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Remarks:
The full text is downloadable at:
http://global.umi.com/pqdweb?Did=000000052108260&Fmt=4&Deli=1&Mtd=1&Idx=45&Sid=1&RQT=309 |
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Untitled Document
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Is intervention a signal of future monetary policy? Evidence from the federal funds futures market
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Author:
Rasmus Fatum and Michael Hutchison;
Book: Journal of Money, Credit, and Banking; Columbus; |
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Year:
Feb 1999 Vol: Vol. 31, Iss. 1; pg. 54, 16 pgs |
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Sterilized foreign exchange market intervention may affect the exchange rate if it signals future monetary actions. Signaling will be effective if the central bank backs up intervention with predictable changes in the stance of monetary policy and, in turn, affects current expectations. This paper investigates whether intervention operations in the US are related to changes in expectations over the stance of future monetary policy, where expectations are proxied by federal funds futures rates. This relatively new futures market instrument has proved to be an efficient and unbiased predictor of the future spot federal funds rate. Estimates obtained from a GARCH time-series model over the 1989-1993 period using daily data do not support the signaling hypothesis.
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Remarks:
The full text is downloadable at:
http://global.umi.com/pqdweb?Did=000000038722171&Fmt=4&Deli=1&Mtd=1&Idx=77&Sid=1&RQT=309 |
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Untitled Document
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On the effectiveness of sterilized foreign exchange intervention
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Author:
Rasmus Fatum
Book: ECB Working Paper No. 10 |
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Year:
February 2000 |
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This paper addresses the question of whether sterilized Central Bank intervention systematically affect exchange rates. Furthermore, the paper analyze whether the central bank can conduct its intervention operations in a specific manner, in order to increase the likelihood of achieving its objectives. |
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Remarks:
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Untitled Document
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Fed Intervention, Dollar Appreciation, and Systematic Risk
|
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Author:
Richard J. Sweeney
Book: |
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Year:
August 2000 |
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This paper is the first to investigate intervention effects in asset pricing models that relate appreciation to
risk-factor realizations. Fed foreign-currency sales show economically and statistically significant association with increases in beta risk in the dollar's appreciation rate and thus with the dollar's ex ante appreciation rate. But intervention’s ex post effects may be unreliable: they depend on the size of world-asset-market movements, and the size of intervention’s association with beta varies importantly from year to year. Even successful intervention to
strengthen the dollar may be costly: By increasing the dollar’s systematic risk, it makes U.S. investments less attractive relative to foreign investments. Further, uncertainty about the timing and size of Fed intervention makes it harder for investors to select appropriate risk-adjusted discount rates and to forecast the dollar value of cash flows, and thus may induce resource misallocation. This paper’s results are consistent with both portfolio balance and signaling channels. |
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Remarks:
The full text is downloadable at:
http://www.msb.georgetown.edu/faculty/sweeneyr/wp/effects.new.intervention.pdf |
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Untitled Document
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The Foreign-Exchange Costs of Central Bank Intervention: Evidence from Sweden
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Author:
Boo Sjöö and Richard J. Sweeney
Book: |
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Year:
September 1999 |
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This study presents evidence on risk-adjusted profits for the Swedish central bank. Estimated profits can
be quite sensitive as to whether rates of return are risk-adjusted or not, and how the risk-adjustment is done. Various
ways of adjusting for abnormal returns, and extracting buy-sell signals, are tried. Results, on daily data, support the view that Riksbank intervention did not make risk-adjusted losses over the period 1986-1990. The results might be
challenged as arising from inappropriate risk adjustment. |
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Remarks:
The full text is downloadable at:
http://www.msb.georgetown.edu/faculty/sweeneyr/wp/JIMFPA44.pdf |
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Is Sterilized Foreign Exchange Intervention Effective After All? An Event Study Approach
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Author:
Rasmus Fatum and Michael Hutchison
Book: |
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Year:
February 1999 |
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Central banks actively engage in sterilized foreign exchange market intervention despite
numerous empirical studies indicating that these operations do not systematically affect the
exchange rate. Are these policies misguided and central bankers irrational? Or is evidence
showing the effectiveness of sterilized intervention being overlooked? This paper argues the
latter, providing evidence on the effectiveness of sterilized intervention using an event study
approach linking intervention with systematic exchange rate changes. We argue that this is an
important methodological innovation since studies using time-series techniques are limited by the
nature of the data: intense and sporadic bursts of intervention activity juxtaposed against
exchange rates that change almost continuously on a daily basis. The event study framework used
in standard finance studies, by contrast, is ideally suited to this circumstance. Focusing on daily
US official intervention operations, we identify separate intervention “episodes” and analyze the
subsequent effect on the exchange rate. Using the matched-sample mean test and the nonparametric
sign test of the median, we find strong evidence that sterilized intervention
systemically affects the exchange rate. These results are especially strong when episodes are
distinguished by the intervention currency, the form of intervention (sales or purchases of foreign
exchange), and exchange rate developments immediately prior to the intervention activity. |
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Remarks:
The paper can be downloaded from:
http://www.econ.ku.dk/epru/files/wp/wp9909.pdf |
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Untitled Document
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Foreign Exchange Intervention for Internal Balance
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Author:
Kyung Soo Kim
Book: International Economic Journal
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Year:
2000 Vol: Volume 14, Number 4, Winter 2000 |
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This paper is concerned with the optimal combination of sterilization and wage indexation in a small open economy subject to various disturbances. In most cases the effects of these policy instruments are interdependent such that they act like a single instrument. At the optimum, in addition to the well-known substitutability of foreign exchange intervention and wage indexation, the complementarity of foreign exchange
intervention and sterilization is obtained. The relationship between the degree of capital mobility and the optimal combination of the policy instruments is also examined. |
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Remarks:
The paper is downloadable at:
http://gias.snu.ac.kr/wthong/IEJ/00winter/00-W3.PDF |
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Untitled Document
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Sterilized Central Bank Intervention in the Foreign Exchange Market
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Author:
Paolo Vitale
Book: |
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Year:
Feb 1997 |
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In this paper we study the signalling role of sterilised central bank intervention. Through a market micro-structure framework, we show that in some circumstances sterilised intervention may represent an independent tool of policy and an instrument to influence exchange rates. Central bank intervention in the foreign exchange market also has important effects on the efficiency and liquidity of the market, the volume of trading and the conditional volatility of the exchange rate. Our results also question the general opinion that visible intervention should be preferred to secret one.
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Remarks:
The full text is downloadable at:
http://fmg.lse.ac.uk/download/fmgdps/dp0259.pdf |
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Untitled Document
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Treasury and Federal Reserve Foreign Exchange Operations
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Author:
Kos,-Dino and Schwarz,-Krista
Book: Federal-Reserve-Bulletin |
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Year:
June 2001 Vol: 87(6), pages 394-99.
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During the first quarter of 2001, the dollar appreciated 7.3 percent against the euro and 10.3 percent against the yen in an atmosphere of increased market uncertainty about the extent and duration of global economic slowing. On a trade-weighted basis, the dollar ended the quarter 7.4 percent stronger against an index of major currencies. The U.S. monetary authorities did not intervene in the foreign exchange markets during the quarter.
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Remarks:
The text is downloadable at:
http://www.federalreserve.gov/pubs/bulletin/2001/0601forex.pdf |
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The Rise and Fall of Foreign Exchange Market Intervention as a Policy Tool
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Author:
Schwartz,-Anna-J.
Book: Journal-of-Financial-Services-Research |
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Year:
December 2000 Vol: 18(2-3), December 2000, pages 319-39..
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The premise of the paper is that the fervor for foreign exchange market intervention by U.S., and European monetary authorities has ebbed in recent years. A pattern of initial belief in the effectiveness of foreign exchange market intervention has recently been eroded, as is revealed by the absence of intervention in circumstances that in earlier times would have invoked it. Only the Bank of Japan among central banks of the developed world has not thus far abandoned its faith that intervention can change the relative value of the yen as determined by market forces to conform with its notion of what that value should be. To explain why U.S. and European monetary authorities no longer believe that intervention is a tool that works, the author reviews the equivocal record of past episodes, the inconclusive results of empirical research, and the problems of implementation that intervention advocates ignore.
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Remarks:
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Untitled Document
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Government Intervention and Adverse Selection Costs in Foreign Exchange Markets
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Author:
Naranjo, Andy and Nimalendran, M.
Book: Review-of-Financial-Studies; 13(2), Summer 2000, pages 453-77.
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Year:
Summer 2000 |
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An important group of traders in the foreign exchange market is governments who often adhere to a foreign exchange rate policy of occasional interventions with otherwise floating rates. In this article we provide a theoretical model and empirical evidence that government foreign exchange interventions create significant adverse selection problems for dealers. In particular, our model shows that the adverse selection component of the foreign exchange spread is positively related to the variance of unexpected intervention and that expected intervention has no impact on the spread. After controlling for inventory and order processing costs, we find that bid-ask spreads increase with U.S. dollar and German deutsche mark foreign exchange rate intervention during the period 1976-94. Furthermore, when the intervention is decomposed into expected and unexpected components, we find a statistically and economically significant increase in spreads with the variance of unexpected intervention, while expected intervention has no significant impact on spreads.
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Remarks:
The text is found in EconLit. It can be found after clicking 'check for CUHK holdings' |
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Untitled Document
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Smoke and Mirrors in the Foreign Exchange Market
|
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Author:
Willem H. Buiter and Anne C. Sibert
Book: |
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Year:
|
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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 |
| |
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iMarket Microstructure Effects of Government Intervention n the Foreign Exchange Market
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Author:
Peter Bossaerts and Pierre Hillion
Book: Review of Financial Studies
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Year:
1991 Vol: vol. 4, issue 3, pages 513-41
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An asymmetric information model of the bid-ask spread is developed for a foreign exchange market subject to occasional government interventions. Traditional tests of the unbiasedness of the forward rate as a predictor of the future spot rate are shown to be inconsistent when the rates are measured as the average of their respective bid and ask quotes. Larger bid-ask spreads on Fridays are documented. Reliable evidence of asymmetric bid-ask spreads for all days of the week, albeit more pronounced on Fridays, are presented. The null hypothesis that the forward rate is an unbiased predictor of the future spot rate continues to be rejected. The regression slope coefficients increase toward unity, however, indicating a less variable risk premium. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies. |
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Order is required. |
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Should the European Central Bank Intervene in the Foreign Exchange Market?
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Author:
Prof. Dr. Sylvester C.W. Eijffinger (CentER, Tilburg University and CEPR)
Book: |
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Year:
November 2000 |
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After the co-ordinated intervention of the G7 countries on 22 September 2000, the European (System of) Central Bank(s) decided to intervene unilaterally in the foreign exchange markets on 3 and 6 November 2000. The European Central Bank intervened in the foreign exchange market “…owing to its concern about the global and domestic repercussions of the exchange rate of the euro, including its impact on price stability” The European Central Bank confirmed then its view that the external value of the euro did not reflect the favourable conditions of the euro area. The consequences of these foreign exchange interventions
were negligible for the euro-dollar exchange rate. One could ask the question: should the European
Central Bank intervene in the foreign exchange market, in particular on its own? In other words, what is the effectiveness of co-ordinated and unilateral foreign exchange intervention
by a central bank? In order to answer this question, the authors have to analyse the various transmission
channels of foreign exchange intervention both in theory and practice. |
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Remarks:
The paper in pdf format is downloadable at: http://www.europarl.eu.int/comparl/econ/pdf/emu/speeches/20001123/eijfinger/default_en.pdf |
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References related to Exchange Rate
(51 references
are shown.)
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China's exchange rate policy
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Author:
Xu, Yingfeng
Book: China Economic Review |
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Year:
2000 Vol: Vol. 11 |
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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. |
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Fear of Floating
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Author:
Guillermo A. Calvo
University of Maryland and NBER
Carmen M. Reinhart*
University of Maryland and NBER
Book: |
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Year:
September 25, 2000 Vol: 63 pages |
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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.
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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
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Author:
Guillermo A. Calvo - University of Maryland
Book: |
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Year:
May 16, 1999 Vol: 17 pages |
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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. |
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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
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Author:
Dani Rodrik
Book: |
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Year:
Sep 2000 Vol: 20 Pages |
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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 |
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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
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Author:
John Murray, Mark Zelmer and Zahir Antia
Book: Technical Report |
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Year:
April 2000 Vol: No. 88 |
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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. |
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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
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Author:
Ralph C. Bryant, Senior Fellow, Economic Studies
Book: Brookings Discussion Papers in International Economics |
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Year:
1995 |
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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. |
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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
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Author:
Patrick Osakwe and Lawrence Schembri
Book: Bank of Canada Review article |
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Year:
Autumn 1998 |
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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.
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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
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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 |
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Year:
October 1999 Vol: October 1999, Vol. 122, No. 10 |
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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.
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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?
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Author:
David Gruen, Gordon Menzies
Book: Publication of Reserve Bank of Australia |
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Year:
May 1991 |
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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.
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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
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Author:
Guy Meredith, Menzie D. Chinn
Book: NBER Working Paper |
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Year:
November 1998 Vol: No. W6797
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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. |
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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
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Author:
Eric O™N. Fisher, Department Of Economics, The Ohio State University
Book: |
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Year:
10 April 2001 |
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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 |
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Haircuts or Hysteresis? Sources of Movements in Real Exchange Rates
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Author:
Rogers,John H.; Jenkins, Michael
Book: Journal of International Economics |
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Year:
1995 Vol: 38(3-4), pages 339-60. |
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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.
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Risk, Policy Rules, and Noise: Rethinking Deviations from Uncovered Interest Parity
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Author:
Nelson Mark, Ohio State University
Yangru Wu, West Virginia University
Book: |
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Year:
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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.
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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
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Author:
Jan Marc Berk and Klaas H.W. Knot
Book: |
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Year:
April 1999 |
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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. |
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Testing Uncovered Interest Parity at Short and Long Horizons
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Author:
Menzie Chinn, University of California
Guy Meredith, IMF and HKMA
Book: |
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Year:
July 11, 2000 |
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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. |
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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"
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Author:
Eric O™N. Fisher, Department Of Economics, The Ohio State University
Book: |
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Year:
10 April 2001 |
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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.
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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
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Author:
Nathan S. Balke
Book: Empirical Economics |
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Year:
1998 Vol: Pages: 535-559
Volume: 23
Issue: 4 |
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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. |
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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
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Author:
Alan M. Taylor
Book: NBER Working Paper |
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Year:
November 2000 Vol: No. W8012 |
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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.
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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
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Author:
Beatrice Kalinda Mkenda
Book: Scandinavian Working papers in Economics |
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Year:
April 30, 2001 Vol: No 39 |
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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. |
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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
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Author:
Steven M. Suranovic
Book: International Finance Theory & Policy |
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Year:
Vol: Chapter 30 |
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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!!
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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.
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Author:
Holmes, Mark J
Book: Oxford University Press in its journal Journal of African Economies |
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Year:
March 2000 Vol: Pages: 63-78
Volume: 9
Issue: 1 |
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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.
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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
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Author:
MIGUEL D. RAMIREZ AND SHAHRYAR KHAN
Book: International Advances
in Economic Research
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Year:
August 1999 Vol: VOLUME 5
NUMBER 3
Pages 369-385 |
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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. |
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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
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Author:
Jeffrey A. Frankel, Andrew K. Rose
Book: NBER Working Paper |
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Year:
February 1995 Vol: No. W5006
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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.
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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
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Author:
Shantayanan Devarajan, Jeffrey D. Lewis, and Sherman Robinson
Book: The World Bank Economic Review
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Year:
January 1993 Vol: Volume 7, Number 1 |
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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.
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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
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Author:
Matthew Higgins and Egon Zakrajk
Book: Staff report of Federal Reserve Bank of New York. |
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Year:
June 1999 Vol: Number 80 |
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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. |
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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
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Author:
Alan M. Taylor
Book: NBER Working Paper |
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Year:
March 2000 Vol: No. W7577 |
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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.
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Remarks:
The paper is downloadable at: http://papers.nber.org/papers/W7577 |
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Deviations from Purchasing Power Parity: The Australian Case
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Author:
Adrian Blundell-Wignall, Marilyn Thomas
Book: Reserve Bank of Australia
Discussion Paper |
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Year:
September 1987 Vol: RDP8711 |
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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.
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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
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Author:
Michelle A. Vachris and James Thomas
Book: Monthly Labor Online review |
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Year:
October 1999 Vol: Vol. 122, No. 10 |
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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.
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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
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Author:
David C. Parsley and Helen A. Popper
Book: Journal of Money, Credit and Banking |
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Year:
March 2000 |
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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. |
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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)
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Author:
Aizenman, Joshua
Book: NBER Working Paper |
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Year:
1984 Vol: NBER Working Paper:1475 |
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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.
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Monopolistic Competition and Deviations from PPP
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Author:
Aizenman, Joshua
Book: NBER Working Paper |
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Year:
1985 Vol: NBER Working Paper:1552 |
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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.
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Idiosyncratic Tastes in a Two-Country Optimizing Model: Implications of a Standard Presumption
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Author:
Warnock, Francis E.
Book: Board of Governors of the Federal Reserve System, International Finance Discussion Paper |
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Year:
1998 Vol: 631, pages 21 |
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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.
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Beyond the Purchasing Power Parity: Testing for Cointegration and Causality between Exchange Rates, Prices, and Interest Rates
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Author:
Cheng, Benjamin S.
Book: Journal of International Money and Finance |
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Year:
1999 Vol: 18(6), pages 911-24. |
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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. |
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Does PPP Hold between Asian and Japanese Economies? Evidence Using Panel Unit Root and Panel Cointegration
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Author:
Azali, M.; Habibullah, M. S.; Baharumshah, A. Z.
Book: Japan and the World Economy |
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Year:
2001 Vol: 13(1), pages 35-50. |
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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.
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An Empirical Investigation into the Causes of Deviations from Covered Interest Parity across the Tasman
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Author:
Moosa, Imad A.
Book: New Zealand Economic Papers |
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Year:
1996 Vol: 30(1), pages 39-54. |
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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.
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Exchange Controls, Political Risk and the Eurocurrency Market: New Evidence from Tests of Covered Interest Rate Parity
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Author:
Cody, Brian J.
Book: International Economic Journal |
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Year:
1990 Vol: 4(2), pages 75-86.
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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.
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Forward and Spot Exchange Rates
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Author:
Fama, Eugene F.
Book: Journal of Monetary Economics |
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Year:
1984 Vol: 14(3), pages 319-38.
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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. |
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Remarks:
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Exchange Rate Forecasting Techniques, Survey Data, and Implications for the Foreign Exchange Market
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Author:
Frankel, Jeffrey A.; Froot, Kenneth
Book: International Monetary Fund Working
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Year:
1990 Vol: Paper: WP/90/43, pages 26. |
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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.
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A Multivariate GARCH Model of Risk Premia in Foreign Exchange Markets
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Author:
Malliaropulos, Dimitrios
Book: Economic Modelling |
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Year:
1997 Vol: 14(1), pages 61-79. |
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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.
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International Financial Relations under the Current Float: Evidence from Panel Data
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Author:
Lothian, James R.; Simaan, Yusif
Book: Open-Economies-Review |
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Year:
1998 Vol: 9(4), pages 293-313.
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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.
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An Alternative Approach to Testing Uncovered Interest Parity
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Author:
Bhatti, Razzaque H.; Moosa, Imad A.
Book: Applied-Economics-Letters |
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Year:
1995 Vol: 2(12), pages 478-81.
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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. |
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Uncovered Interest Parity in Crisis: The Interest Rate Defense in the 1990s
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Author:
Flood, Robert P; Rose, Andrew K.
Book: |
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Year:
2001 Vol: This paper is available online at http://haas.berkeley.edu/~arose/UIPC.pdf |
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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. |
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An Intraday Analysis of the Effectiveness of Foreign Exchange Intervention
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Author:
Neil Beattie and Jean-François Fillion
Book: |
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Year:
February 1999 |
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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. |
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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
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Author:
John Murray, Mark Zelmer, and Shane Williamson
Book: Technical Report No. 53 |
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Year:
March 1990 |
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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.
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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
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Author:
Christopher J. Neely
Book: |
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Year:
November 2000 |
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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.
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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
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Author:
hristopher J. Neely and Paul A. Weller
Book: |
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Year:
January 2001 |
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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.
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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
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Author:
Christopher Neely and Paul Weller
Book: |
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Year:
Feburary 2000 |
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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.
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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?
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Author:
Sushil Wadhwani
Book: Bank of England. Quarterly Bulletin; London |
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Year:
Aug 2000 Vol: Vol. 40, Iss. 3; pg. 297-306, 10 pgs |
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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.
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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
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Author:
Lui,Yu Hon; Mole, David
Book: Journal of International Money and Finance |
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Year:
1998 Vol: 17(3), pages 535-45.
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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.
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Does Central Bank Intervention Stabilize Foreign Exchange Rates?
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Author:
Catherine Bonser-Neal
Book: Federal Reserve Bank of Kansas City |
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Year:
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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. |
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Remarks:
The paper is downloadable at:
http://www.kc.frb.org/publicat/econrev/pdf/1q96bons.pdf |
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Smoke and Mirrors in the Foreign Exchange Market
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Author:
Willem H. Buiter and Anne C. Sibert
Book: |
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Year:
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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. |
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Remarks:
The text is downloadable at:
http://www.nber.org/~wbuiter/observer.pdf |
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