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Dual foreign currency markets and the role of expectations: Evidence from the Pacific Basin countries
Authors:Panayiotis F Diamandis  Georgios P Kouretas  Leonidas Zarangas
Institution:aDepartment of Business Administration, Athens University of Economics and Business, GR-10434 Athens, Greece;bDepartment of Economics, University of Crete, University Campus, GR-74100 Rethymno, Greece;cDepartment of Finance and Auditing, Technological Educational Institute of Epirus, 210 Ioanninon Ave., GR-48100 Preveza, Greece
Abstract:This paper analyzes the role of expectations about the government policy in the official foreign currency market in determining the black market premium. We use data for the recent float from six emerging markets of the Pacific Basin where active black markets for foreign currency exist, namely, Indonesia, Korea, Malaysia, the Philippines, Singapore and Thailand. To test the impact of anticipated and unanticipated shocks to the official exchange rate on the black market premium, we employ the two-step procedure of Hoffman et al. Hoffman, D.L., Low, S.A., Schlagenhauf, D.E., 1984. Tests of rationality, neutrality and market efficiency: a Monte Carlo analysis of alternative test statistics. J. Monet. Econ. 14, 339–363] which provides corrected F-statistics and allows us to draw valid inference in the presence of generated regressors. The main finding of our analysis is that anticipated and unanticipated shocks to the official exchange rate have an impact on the black market premium in all six Pacific Basin countries. These results suggest that portfolio balance models provide the suitable theoretical framework for analyzing the behaviour of the black market premium in the markets for foreign currency in the Pacific Basin countries. Furthermore, this implies that economic agents in these countries are sensitive to expected returns in foreign exchange.
Keywords:Black market premium  Generated regressors  Cointegration analysis  Anticipated shocks  Expectations  Portfolio balance models
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