The relative size of exchange rate and interest rate responses to news: An empirical investigation

This paper examines the relative size of the effects of macroeconomic news on the spot exchange rate, and interest rate differentials (2- and 5-year swap rate differentials), and the synthetic forward exchange rate schedule, for the high-frequency New Zealand data. We find that the spot exchange rate and 5-year swap rates respond by a similar magnitude to monetary surprises, implying there is little response of the forward exchange rate to this type of news. In contrast, the spot exchange rate responds by nearly three times as much as 5-year interest rates to CPI and GDP surprises, implying that forward rates appreciate to higher than expected CPI or GDP news. This is in contrast to standard theoretical models and US evidence. Lastly, we show that exchange rates but not interest rates respond to current account news. The implications of these results for monetary policy are considered.     

Model‐free evaluation of directional predictability in foreign exchange markets

We examine directional predictability in foreign exchange markets using a model‐free statistical evaluation procedure. Based on a sample of foreign exchange spot rates and futures prices in six major currencies, we document strong evidence that the directions of foreign exchange returns are predictable not only by the past history of foreign exchange returns, but also the past history of interest rate differentials, suggesting that the latter can be a useful predictor of the directions of future foreign exchange rates. This evidence becomes stronger when the direction of larger changes is considered. We further document that despite the weak conditional mean dynamics of foreign exchange returns, directional predictability can be explained by strong dependence derived from higher‐order conditional moments such as the volatility, skewness and kurtosis of past foreign exchange returns. Moreover, the conditional mean dynamics of interest rate differentials contributes significantly to directional predictability. We also examine the co‐movements between two foreign exchange rates, particularly the co‐movements of joint large changes. There exists strong evidence that the directions of joint changes are predictable using past foreign exchange returns and interest rate differentials. Furthermore, both individual currency returns and interest rate differentials are also useful in predicting the directions of joint changes. Several sources can explain this directional predictability of joint changes, including the level and volatility of underlying currency returns. Copyright © 2007 John Wiley & Sons, Ltd.     

S&P 500 futures market and the normal backwardation hypothesis

This paper examines the behavior of near term S&P 500 index futures contract prices in the context of the theory of normal backwardation. Daily S&P 500 futures prices for 41 contracts over the 1982–1992 period are examined. There is no evidence that S&P 500 futures prices are biased estimates of the expected future spot price on expiration. Daily futures prices usually lie below the expected future spot price on expiration and usually rise over the contract period, but these price movements are not statistically significant. The surprising result of this study is the number of observations where backwardation appears not to hold. Furthermore, changes in the U.S. dollar exchange rates, the Tax Reform Act of 1986 and the switching of S&P 500 contracts quarterly expiration day had no significant effect on the behavior of S&P 500 futures prices.     

Real exchange rate,stationarity, and economic fundamentals

Using monthly data for the US/UK real exchange rate over the period 1921–2002, we find evidence that the mean reverting tendency of the real exchange rate is stochastic, and regime-dependent. There is one regime over which PPP holds as a long-run equilibrium relation, i.e. a stationary PPP regime, and another regime over which PPP does not hold, i.e. a non-stationary PPP regime. The transition from the non-stationary to the stationary regime is found to be affected by the real interest rate differential, and by the volatility of the nominal exchange rate. The real output differential does not appear to affect the transition probability.     

资本管制有效性与中国汇率制度改革

本文在利率平价框架下考察了近十年中国资本管制的效力。我们采用比较类似金融工具在国内外市场的收益率、检验未抛补利率平价理论偏差的平稳性两种方法进行分析。研究表明,尽管资本管制的效力随时间推移有所下降,但境内外美元利差的持续存在以及未抛补利率平价理论偏差的非平稳性仍然足以证明中国的资本管制基本有效。资本管制的有效性在盯住制框架下确保了汇率稳定和一定的货币政策自主性,并且使未来汇率制度弹性化改革可以渐进地推进。     

A framework for stabilizing the euro/yen/dollar triplet

The current debate on exchange rate regimes is shaped by the so-called inconsistency triangle. In this paper I show that the discussion has overlooked a “third way” which combines capital mobility with monetary policy autonomy, and an exchange rate path determined by interest rate differentials. My scheme relies on interventions that are always carried out by the central bank with the strong currency, and a full sterilization of interventions with the instrument of a deposit facility. Thus the G3 central banks could set a band for their bilateral exchange rates with the floor and the ceiling defended by the respective strong central bank. As exchange rates bands are adjusted according to short-term interest rate differentials, there are no sterilization costs for the intervening central bank. Over the medium and long run interest rates are mainly determined by inflation differentials. Thus, the exchange rate band would follow a PPP path.     

Experimental evidence on trading behavior,market efficiency and price formation in double auctions with unknown trading duration

The reasons for the highly efficient market outcomes observed under the double auction remain unclear. This paper presents a series of experimental financial markets designed to investigate the importance of unknown trading period duration on trading behavior and the convergence tendencies of such markets. Using panel data techniques the results support the conclusions that individuals generally display more aggressive trading strategies, trading earlier in a period, and that markets exhibit reduced levels of informational efficiency when unknown duration is present. Markets with imperfect information structures are also studied and, in a unique result, are associated with significantly slower rates of trade, as traders become more cautious over their trading strategies. Investigation of the price formation process provides evidence that the pricing error varies over time and the estimation of a fixed effects model provides unique support that learning effects and unknown trading period duration influence the price formation process. Future refinement of theoretical models of the price formation process or institutions of exchange should recognize the effect of unknown trading period duration on market behavior, along with potential learning effects. Copyright © 2005 John Wiley & Sons, Ltd.     

Uncovering uncovered interest parity during the classical gold standard era, 1888–1905

This paper examines the uncovered interest parity hypothesis using the dollar-sterling exchange rate during the gold standard era. This period is interesting because the exchange rate was seasonal, because transactions costs were high, and because occasions when uncovered interest rate speculation did not occur can be identified. The paper shows UIP speculation frequently did not occur, that speculation was most active in response to expected exchange rate changes not interest differentials when it did occur, and that profitability varied systematically with interest rate differentials. The estimated UIP equations are substantially improved by distinguishing occasions when sterling was borrowed not lent.     

Testing the purchasing power parity through I(2) cointegration techniques

This paper contributes to the empirical literature on the purchasing power parity (PPP) over the post‐Bretton Woods period by providing a time‐series based interpretation of the controversial evidence characterizing the dynamics of real exchange rates. It is shown that the persistence of deviations from the PPP between a set of European countries and the United States may be empirically attributed to the presence of I(2) stochastic trends in prices using Consumer Price Indices. Interestingly, the slow adjustment towards the equilibrium can be modelled through ‘integral‐proportional’ equilibrium correction models and this evidence can be partly reconciled with theories where the inflation rate reduces the markup of profit‐maximizing firms acting on imperfectly competitive markets. Copyright © 2005 John Wiley & Sons, Ltd.     

Carry-trades on the yen and the Swiss franc: are they different?

Using monthly data from 1986 to 2009 for 11 major currencies against the U.S. dollar (USD), we find that interest rate differentials between nine of these currencies are generally positive (sample mean of 0.86%) but are strongly negative for Japan (mean of ?2.78%) and for Switzerland (mean of ?2.22%). Investigating empirical models of nominal exchange rate changes we find for all panels that about 2% of real exchange rate misalignments are corrected in the following month. We also find important differences across samples and for the two carry-trade currencies the key results are as follows. First, interest rate differentials have a negative impact on exchange rates: higher paying currencies should appreciate, contrary to the ex-ante uncovered interest rate parity (UIP) condition. We find that this result is very robust to money supply (M1) differentials serving as instrumental variables to inflation rates. In addition, these two currencies depreciate slightly when money supply (M1) differentials increase. Second, dummy variables for periods of market turmoil suggest a particularly strong appreciation of these currencies against the USD, consistent with the unwinding of carry-trade activities.     

我国总体并购活动与宏观经济变量的关联性研究——对我国并购浪潮成因的分析

本文对我国总体并购活动与GDP增长率、货币供应量、利率、股价及汇率的关联性实证研究结果表明，并购周期与经济周期具有较强的相关性，具有长期均衡关系；货币供应量、利率、股价和汇率等与总体并购活动具有长期稳定的关系，但短期内，利率与并购活动显著地负相关；货币供应量对总体并购活动有微弱的正相关关系；股价指数和汇率对总体并购活动有负影响，且影响程度很弱。这说明，经济周期和利率是我国并购浪潮形成的主要原因。     

On the Empirical Failure of Purchasing Power Parity Tests

Empirical research on the validity of the purchasing power parity (PPP) condition is generally based on real exchange rates built using the consumer price index (CPI), but fails to provide clear support to PPP. In this paper we show theoretically that, even if the law of one price (LOP) holds for traded goods, CPI‐based real exchange rates are not mean reverting, and are neither stationary nor integrated. Therefore, both unit root and stationarity tests should reject their null. Our theoretical results are validated both by simulations and an empirical application. Copyright © 2014 John Wiley & Sons, Ltd.     

Smooth-transition error-correction in exchange rates

Recent research has increasingly suggested that exchange rates may be characterized by non-linear behavior. This paper examines whether such non-linear behavior is evident, not in rates themselves, but in the adjustment of rates back to fundamental equilibrium. Thus, we examine whether a series of four spot and forward exchange rates exhibit smooth transition non-linear error-correction dynamic behavior. Our results are supportive of this model, particularly in-sample, and suggest some salient differences in the mean-reverting behavior of spot and forward rates, which may be of use to policy authorities and model builders. However, out-of-sample forecast errors between the two models appear insignificantly different from each other.     

An exploratory empirical inquiry into the impact of federal budget deficits on the ex post real interest rate yield on ten year Treasury notes over the last half century

Using over a half century of data, this exploratory empirical study adopts a simple loanable funds to investigate the impact of the federal budget deficits on the ex post real interest rate yield on 10 year Treasury notes. For the period 1960–2012, an autoregressive 2SLS estimate finds that the ex post real interest rate yield on 10 year U.S. Treasury notes is an increasing function of the ex post real interest rate yield on Moody’s Baa-rated corporate bonds, the ex post real interest rate yield on 3 year Treasury notes, and the ex post real interest rate yield on high grade municipal bonds. This exploratory analysis also finds that federal budget deficit (relative to the GDP level) exercised a positive and statistically significant impact on the ex post real interest rate yield on 10 year Treasury notes, a finding consistent with a number of earlier studies of shorter time periods     

The credibility of the Colombian exchange rate target zone: Its impact over the volatility of interest rate differentials

This paper analyzes the credibility of Colombia’s exchange rate target zone, and in particular its impact on the volatility of interest rate differentials. Bertola and Caballeros’ (1995) model of a target zone with imperfect credibility is used to derive the impact of a reduction in credibility over the variance of the interest rate differential. It is theoretically shown, that as credibility decreases the variance of the interest rate differential increases. This theoretical argument is used to estimate credibility in Colombia’s exchange rate target zone. Using a SWARCH model, the probability of being in a regime with high interest rate volatility is estimated, and is related with events in the exchange rate market. Results suggest that there is evidence of lack of credibility even before the recent international financial turmoil was triggered.     

The Yen Real Exchange Rate may be Stationary after all: Evidence from Non‐linear Unit‐root Tests*

The empirical literature that tests for purchasing power parity (PPP) by focusing on the stationarity of real exchange rates has so far provided, at best, mixed results. The behaviour of the yen real exchange rate has most stubbornly challenged the PPP hypothesis and deepened this puzzle. This paper contributes to this discussion by providing new evidence on the stationarity of bilateral yen real exchange rates. We employ a non‐linear version of the augmented Dickey–Fuller test, based on an exponentially smooth‐transition autoregressive model (ESTAR) that enhances the power of the tests against mean‐reverting non‐linear alternative hypotheses. Our results suggest that the bilateral yen real exchange rates against the other G7 and Asian currencies were mean reverting during the post‐Bretton Woods era. Thus, the real yen behaviour may not be so different after all but simply perceived to be so because of the use of a restrictive alternative hypothesis in previous tests.     

Real exchange rate behaviour: evidence from black markets

The behaviour of real exchange rates (relative to the US dollar) is examined using monthly data obtained from the black markets for foreign exchange of eight Asian developing countries. The data span is 31 years. The black market real exchange rates do not show excess volatility during the recent float which is in sharp contrast to the results reported elsewhere. Unit root tests in heterogeneous panels and variance ratio tests confirm their stationarity. Thus, we find support for PPP but not for the ‘survivorship’ bias (Froot and Rogoff, 1995 ). There is little evidence of segmented trends. Issues raised by Rogoff ( 1996 )—of whether PPP would hold across countries with differing growth experience—and Lothian and Taylor ( 1996 )—of whether the degree of relative price volatility may bias results in favour of mean reverting real exchange rates—are addressed. Copyright © 2000 John Wiley & Sons, Ltd.     

Capitalization of local fiscal differentials: Inferences from a disequilibrium market model

This study analyzes tax capitalization within the framework of a disequilibrium market model. In particular, this study examines whether local fiscal differentials influence the rate of change in neighborhood house prices over time. Local fiscal differentials existing in 1970 are found to have no influence on the rate of change in neighborhood house prices over the period 1970–1972; therefore, the study concludes that, other things being equal, these local fiscal differentials have been completely capitalized in price levels.     

The Theory of Exchange Rate Target Zones

The theory of exchange rate target zones focuses on the role of exchange rate expectations in determining exchange rate behaviour and interest rate differentials in currency bands. This paper analyses earlier models of the target zone research programme as well as more recent developments including endogenous realignment expectations, price rigidities and alternative monetary feedback rules by means of a unified approach. Target zones may be the cause of stabilizing or destabilizing exchange rate expectations, the determinants of which crucially depend on the within-band central bank policy as well as the credibility of the central banks' commitment to defend the target zone. The paper closes with a discussion of the relative merits of implementing a target zone and some suggestions for further research.     

Monetary convergence to the Euro

This special issue of Economic Systems includes seven papers about various aspects of monetary convergence to the Euro. It includes both policy discussion papers examining a wide range of issues and empirical studies evaluating specific areas of monetary convergence. From a policy strategy view, the selected papers examine the ways of combining the two key objectives of monetary convergence, i.e., price stability and exchange rate stability. In addition, the papers analyze the interplay between monetary policies and financial market stability. The findings provide new insights on monetary policy transmission channels, market equilibrium exchange rates, interest rates pass through effects, the importance of real relative to nominal convergence, and other intricacies encountered on the passage toward the Euro.