Random perturbations of deterministic equilibria

This paper examines whether a small random deviation from a non-random policy process will destabilize the equilibrium exchange rate. The results focus on exchange rate dynamics when the government maintains a target zone or makes unanticipated deviations from a policy rule. With rational expectations small random shocks do not create large deviations from the policy rule exchange rate. If agents are approximately rational large deviations between exchange rates are possible.     

Exchange Rate Dynamics in a Multilateral Target Zone

This paper presents a model of exchange rate behaviour in a multilateral target zone. The model produces new economic insights beyond the well-known bilateral model of Krugman (1991), which is obtained as a special case. The paper also introduces a new class of stochastic processes in economics, namely multidimensional reflected diffusion processes.
Two main features characterize the economics of exchange rates in a multilateral target zone. (i) The restrictions on interventions imposed by cross-currency constraints: when one country changes its money supply, say because its exchange rate with a second country has hit its band, all exchange rates involving the currency of that particular country will be affected, regardless of their position within their respective bands. (ii) Cooperation in sharing the intervention burden: in general, the exchange rate between any two countries will depend on the fundamentals of third countries in a multilateral target zone. This is because if the monetary authorities intervene together, a shock in the fundamentals of any country will induce a revision of the expectation of future interventions of other countries.
The model reverts the counterfactual predictions of the bilateral model that the exchange rate steady-state density should be U-shaped and that its volatility should be a decreasing function of the distance of the exchange rate to the limits of its band. Thus, accounting for the multilateral feature of real-world target zones allows us to reconcile target zone models with the most salient empirical features of exchange rate behaviour.     

A MODEL OF INFLATION TRANSMISSION IN AN EXCHANGE RATE TARGET ZONE

I incorporate an exchange rate target zone with intramarginal interventions in a small open economy model. Using the method of undetermined coefficients, I solve for the price level and the nominal exchange rate to determine how price shocks from the large economy affect the small open economy. The results show that the behaviour of inflation transmission within the band differs from the behavior of inflation transmission at the edge of the band of the target zone. Foreign shocks can affect local prices in both cases but the central bank can respond through market interventions within the band while it cannot do so at the edge. Near the edge of the band, a central bank has to intervene to stop the exchange rate from breaching the band. My model predicts that if the interventions are robust, then the exchange rate is mean reverting and an exchange rate target zone can insulate an economy from foreign price shocks. Based on the model, central bank interventions contribute to long‐run price stability in a target zone regime. Finally, I empirically test the model using unit root and cointegration tests, and present some policy implications.     

Do real exchange rates really follow threshold autoregressive or exponential smooth transition autoregressive models?

Nonlinear models, especially threshold autoregressive [TAR] and exponential smooth transition autoregressive [ESTAR] classes, are widely applied for modeling real exchange rates in order to examine the validity of purchasing power parity [PPP]. Even though the nonlinear models are theoretically well-motivated, some of the recent findings cast doubts on their relevance for real exchange rates. In particular, the nonlinear models do not necessarily yield improved out-of-sample forecasts over linear models and add little value in resolving the well-documented PPP puzzle. Utilizing a nonparametric entropy measure of dependence proposed by Granger et al. (2004), we show, in this study, that the real exchange rates from four major countries had exhibited quite strong nonlinear serial dependence, which linear autoregressive models fail to replicate. Furthermore, the nonlinear TAR and ESTAR models estimated for the real exchange rates also have some difficulty in generating significant serial dependence structure actually observed in the data. Overall, other nonlinear models than the currently entertained TAR and ESTAR should be considered to study the dynamics of the real exchange rates.     

ERM Realignment Risk and its Economic Determinants as Reflected in Cross-rate Options

This paper uses data on over-the-counter options between the mark and the pound, lira, French franc, and peseta to investigate the credibility of exchange rate target zones within the ERM. We compare empirical implications for the relation between option prices and the spot's position within the band for three classes of target zone models: those with full credibility, those with exogenous realignment risk, and those with endogenous realignment risk. Empirically, implied volatility from these options attains a maximum near the edges of an exchange rate band rather than its centre, even three to six months prior to realignment.     

The Target Zone Model, Non-Linearity and Mean Reversion: is the Honeymoon Really Over?

We estimate a target zone model for three ERM exchange rates for 1983–6 and 1987–91 by the method of simulated moments, taking account of the continuous time specification by using daily data with the interruptions of holidays and weekends. Specification tests are unable to reject the model. The estimates imply, however, an essentially linear relationship between the exchange rate and the fundamentals, with a very limited 'honeymoon effect'. Using Monte Carlo simulations, calibrated on the estimates, we find that standard tests for mean reversion of the exchange rate would largely reject the target zone model when, in fact, it held.     

克鲁格曼汇率目标区理论评述

布雷顿森林体系瓦解之后，世界进入了以浮动汇率为主的混合体制时期，但浮动汇率制也带来诸多问题，经济学家和政府官员开始寻求更为合理的汇率制度。汇率目标区正是这种寻求的结果之一。本文采取一种综述的形式，对汇率目标区理论，主要是对克鲁格曼的汇率目标区模型进行了介绍。     

The impact of interest rate and exchange rate volatility on banks' stock returns and volatility: Evidence from Turkey

This paper investigates the effects of interest rate and foreign exchange rate changes on Turkish banks' stock returns using the OLS and GARCH estimation models. The results suggest that interest rate and exchange rate changes have a negative and significant impact on the conditional bank stock return. Also, bank stock return sensitivities are found to be stronger for market return than interest rates and exchange rates, implying that market return plays an important role in determining the dynamics of conditional return of bank stocks. The results further indicate that interest rate and exchange rate volatility are the major determinants of the conditional bank stock return volatility.     

人民币汇率形成机制探索

本文分析了人民币汇率形成机制与特点,指出了现行汇率制度存在的缺陷,说明在我国金融进一步开放的背景下,汇率制度的重新选择是我国汇率制度的内在要求,并对我国汇率制度选择路径进行了分析。指出从短期来看,“不可能三角理论”揭示了在资本管制的情况下,我国汇率制度的选择是维持汇率的稳定;从中长期来看,资本项目开放是大势所趋,汇率目标区是中国金融进一步开放中比较适合的汇率制度,也符合中国渐进式的发展改革道路;最后进一步从中心汇率和波动区间的确定、汇率干预等方面提出了实施汇率目标区的具体设想。     

Out‐of‐Sample Exchange Rate Forecasting and Macroeconomic Fundamentals: The Case of Japan

This study explores the respective out‐of‐sample exchange rate forecasting abilities of five macroeconomic fundamental models in comparison to a naïve random walk model for Japan during the post‐Bretton Woods era. To assess the influence of major economic changes, we estimate both linear and nonlinear models for all the macroeconomic fundamentals. Overall, most structural exchange rate models outperform a naïve random walk model in terms of forecasting accuracy in the short horizon. When the fundamentals are only linearly modelled, the forecasting ability of the Taylor rule is generally superior to other fundamental models. When the fundamentals are nonlinearly specified, the predictability of some other models rises dramatically to match that of the Taylor rule models in short and/or long horizons. Of importance, we determine that the yen/dollar exchange rate forecasting performance effectively improves in several fundamental models when influential economic changes are incorporated.     

A new approach to the effect of intervention frequency on the foreign exchange market: evidence from Japan

This article estimates and analyses the effect of intervention frequency on the yen/dollar market, using daily intervention data. We examine using a nonlinear methodology, with the frequency of intervention from April 1991 to December 2005 as a focal explanatory variable. In this article, we also introduce a flexible target zone model that is capable of characterizing the dynamic behaviour of an exchange rate implied by the original target zone model of Krugman and its modifications. The empirical results show the importance of considering the threshold effect when analysing the effect of intervention due to the presence of asymmetry in the foreign exchange market. Moreover, we show that a high frequency intervention stabilizes the exchange rate by reducing exchange rate volatility, especially when the yen appreciates.     

Soft versus hard targets for exchange rate intervention

Exchange rate intervention by monetary authorities should defend a band not for the spot exchange rate, but for a moving average of its recent values. This target zone is soft, in that it allows greater short-run flexibility, but also rigorous: it still precludes any sustained easing of monetary policy. In comparison with conventional hard target zones for the spot exchange rate, we find considerable advantages for the rule we propose. In particular, without compromising long-run discipline, it increases resilience against speculative attacks, especially when shocks to exchange rate fundamentals are transitory.     

INSIDE THE IMPOSSIBLE TRIANGLE: MONETARY POLICY AUTONOMY IN A CREDIBLE TARGET ZONE

This paper examines the trade-off between exchange rate stability and monetary autonomy for a target zone. Using the guilder-mark target zone in the pre-Economic and Monetary Union period as a case study, we empirically estimate how much policy discretion the Dutch central bank still enjoyed and how much had been ceded to the German central bank. The sum of these two measures is an estimate of the policy autonomy under a free float. We find that the narrow guilder-mark target zone still permitted a modest degree of policy independence. This result suggests that intermediate exchange rate regimes may offer an attractive trade-off compared to the corner solutions (free float and monetary union), which is consistent with the "fear of floating" phenomenon. ( JEL E52, F33, F41, F42)     

Exchange rates and target zone width

This paper looks at the effect on the exchange rate, in a target zone regime, of changing the width of the band. The main result of the paper is that the exchange rate moves in the same direction as the closest edge of the band does. This effect is stronger, the closer the exchange rate is to the edges of the band.     

The impacts of economic sanctions on exchange rate volatility

This research empirically analyzes the impact of various instruments of economic sanctions on official exchange rate volatility by employing data from a panel of 23 target countries covering the period 1996–2015 and using the Least Squares Dummy Variable Corrected (LSDVC) model. Our findings suggest that economic sanctions do significantly influence the target countries’ exchange rate volatility. Specifically, we are able to see different sanction present its different effects on exchange rate volatility. Furthermore, the robustness evidence of the eliminating country as Iran, eliminating variable of political ideology, intercepting time period, cross-sectional regression analysis, using real exchange rate volatility as proxy variable and a new sanctions database, are basically consistent with the previous finding. Overall, our empirical findings offer implications for those sanctioned countries about how to stabilize their exchange rate when facing sanctions.     

AN EXAMPLE OF AN OPTIMAL FORECAST EXHIBITING DECREASING BIAS WITH INCREASING FORECAST HORIZON

Motivated by a central banker with an inflation target, we show that the optimal forecast bias under non‐quadratic loss functions and non‐normal forecast errors can decrease or initially increase and then decrease with the forecast horizon. We initially proof that, if the variable to forecast can be described by a generalized Rayleigh distribution, its conditional mean does in general not constitute the optimal prediction under a symmetric target zone loss function. Subsequently, we approximate the target zone loss function to show the potential for variation in optimal bias over the forecast horizon.     

Overnight exchange rate risk based on multi-quantile and joint-shock CAViaR models

Overnight risk of exchange rate is more and more important because the exchange rate trading time of various countries is inconsistent. Drawing on the multi-quantile CAViaR model for two markets, this study proposes a multi-quantile CAViaR model for three markets and a multi-quantile CAViaR model for joint shock. The two new models are used to measure the impact of the U.S. Dollar index and the Euro on the overnight risk for the exchange rate of the Japanese Yen, Hong Kong Dollar, and Chinese Renminbi. The results show that, first, a lag risk affects the overnight risk of the three exchange rates, of which the Renminbi exchange rate is subject to the largest risk. Second, the U.S. Dollar index and Euro exchange rate risks impact the overnight risk of the three exchange rates and this effect is highest for the overnight risk of the Yen's exchange rate. In addition, the impact of the U.S.Dollar index risk is greater than that of the Euro. Third, the Euro and U.S.Dollar index produce a joint shock on the overnight risk of the three exchange rates, and here, the Yen's exchange rate suffers the biggest shock. Finally, the multi-quantile CAViaR model for joint shock is more accurate than that for three markets, particularly when the Hong Kong Dollar exchange rate has a 5% VaR. These empirical results have meaningful implications for regulatory authorities.     

Nonfundamental FX trading and excess volatility in credible target zones Theory and empirical evidence

This paper presents a target zone model with imperfect asset substitutability in which exchange rates are driven both by expectations regarding the credible defense of the currency band and foreign exchange traders' stop-loss trading strategies. The model generates excess volatility and nonuniqueness in the density function of the exchange rate. These results obtain independently of whether the stop-loss strategies are known to the market. In an empirical section, the authors find support for the existence of excess volatility for selected countries of the European monetary system (EMS) during the stable EMS period.     

A CUSUM test for a long memory heterogeneous autoregressive model

A CUSUM test is proposed for testing structural breaks in a long-memory heterogeneous autoregressive model. The limiting distribution of the CUSUM test is shown to be a simple function of a standard Brownian bridge, contrasting with the nuisance parameter dependent asymptotics of other CUSUM tests based on fractional integration models. A Monte-Carlo experiment investigates finite sample size and power of the test. The proposed test is applied to a set of daily realized volatilities of the log-return of the Korean Won US Dollar exchange rate to reveal some evidence of a break in addition to a long-memory.     

Exchange rate misalignments and the external balance under a pegged currency system

This paper analyzes the link between the exchange rate misalignments and the external balance under a pegged currency system focusing on the former French colonies of Africa (the CFA zone). Having discussed and chosen an appropriate analytical framework, it addresses the issue of model uncertainty regarding the equilibrium exchange rate model before estimating currency misalignments. The results show that misalignments have a negative and asymmetric impact on the current account. While overvaluation of the CFA franc deteriorates the current account, undervaluation does not improve it. Finally, our results highlight that the export concentration tends to exacerbate the overall negative impact of currency misalignments.