Emerging floaters: Pass-throughs and (some) new commodity currencies

In spite of early skepticism on the merits of floating exchange rate regimes in emerging markets, 8 of the 25 largest countries in this group have now had a floating exchange rate regime for more than a decade. Using parsimonious VAR specifications covering the period of floating exchange rates, this study computes the dynamics of exchange rate pass-throughs to consumer price indices. We find that pass-throughs have typically been moderate even though emerging floaters have seen considerable nominal and real exchange rate volatilities. Previous studies that set out to estimate exchange rate pass-throughs ignored changes in policy regimes, making them vulnerable to the Lucas critique. We find that, within the group of emerging floaters, estimated pass-throughs are higher for countries with greater nominal exchange rate volatilities and that trade more homogeneous goods. These findings are consistent with the pass-through model of Floden and Wilander (2006) and earlier findings by Campa and Goldberg (2005), respectively. Furthermore, we find that the Indonesian Rupiah, the Thai Baht and possibly the Mexican Peso are commodity currencies, in the sense that their real exchange rates are cointegrated with international commodity prices.     

Forecast bias and accuracy of exchange rates in emerging markets

This study assesses the forecast bias and accuracy of the three commonly used forecast methods for 12 different emerging market currencies. We find that each forecast method commonly exhibits a forecast bias. The random walk method outperformed the forward rate and ARIMA methods for some emerging market currencies, and was not outperformed by these alternative methods. In general, it appears that the incorporation of expectation components by the implicit forward and ARIMA methods do not improve the forecast, and actually reduce forecast accuracy in some cases. Furthermore, the Latin American currencies were typically forecast with more error.     

Forward premium anomaly of the British pound and the euro

Using pooled data, we study the forward discount bias (FDB) of 24 British pound and 24 euro exchange rates. The results show a FDB during “non-crisis” periods, which is more pronounced for advanced than emerging economies. This finding is especially striking during the period of the European sovereign debt crisis (2010 to 2013), for which we find a FDB for the currencies of advanced economies versus the pound, but not versus the euro. The differences between the results for advanced and emerging country currencies are mainly related to whether the period under investigation is classified as a crisis period or not. Our findings support the literature that relates carry trade activities to the FDB; as such activities are assumed to decrease during times of uncertainty. Further, our study shows evidence for asymmetric behavior with respect to the forward premium, as well as, to the overvaluation and undervaluation of the currency. We find negative slope coefficients for advanced country currencies during crisis periods when the pound and the euro are overvalued and sell at a premium. This suggests that even during crisis periods carry trade activities are present, which may be related to investors' assumptions of higher returns when an overvalued pound or euro is expected to move back to equilibrium.     

Investment intensity of currencies and the random walk hypothesis: Cross-currency evidence

This paper studies the cross-currency and temporal variations in the random walk behavior in exchange rates. We characterize currencies with relatively large investment flows as investment intensive and conjecture that the more investment intensive a currency is, the closer its exchange rate adheres to random walk. Using 29 floating bilateral USD exchange rates, we find that the higher the investment intensity, the less likely it is to reject random walk and the smaller the deviation from random walk is. However, the effect of investment intensity is non-monotonic. Application of threshold models shows that after investment intensity reaches the estimated thresholds, the level of investment intensity has no further effect on the deviation from random walk. These findings help reconcile the previous conflicting results on the random walk in exchange rates by focusing on the effect of cross-currency and temporal variations in investment intensity.     

Currency crisis and the forward discount bias: Evidence from emerging economies under breaks

This paper investigates the effects of two financial crises (the 1997 Asian currency crisis and the 2000 Turkish financial crisis) on the forward discount bias in 14 emerging-market economies using a robust two-stage procedure. This unique sample of less researched currencies displays: (i) high persistence in forward discount equations; and (ii) varying variance ratios between changes in exchange rates and the forward premium. The findings provide new insights into the forward discount puzzle: financial crises exert considerable power on the forward discount bias and uphold the forward rate unbiasedness hypothesis (FRUH) by reverting the negative sign into positive.     

Exchange rate volatility across financial crises

This paper studies the impact of global financial turmoil on the exchange rate policies in emerging countries. Spillovers from advanced financial markets to currencies in emerging countries are likely to be exacerbated during crisis periods. To test this hypothesis, we assess the exchange rate policies by currencies’ volatility and investigate their relationship to a global financial stress indicator, measured by the volatility on global markets. We introduce the possibility of nonlinearities by running smooth transition regressions over a sample of 21 emerging countries from January 1994 to September 2009. The results confirm that exchange rate volatility does increase more than proportionally with the global financial stress, for most countries in the sample. We also evidence regional contagion effects spreading from one emerging currency to other currencies in the neighboring area.     

The existence and severity of the forward premium puzzle during tranquil and turbulent periods: Developed versus developing country currencies

In this paper we investigate the forward premium bias (FPB) puzzle for a number of developed and developing country currencies. Our main objective is to examine the possible variations in the existence and severity of the bias for different currency sets over two sample periods which can be categorized as calm and turbulent periods. We find significant evidence that the FBP tend to vary over time and across currency sets. We also find that the global financial crisis has been a turning point in the variation of the existence and severity of the bias for our currency sets. The results show that different currency sets have been affected by the crisis in different patterns. While the bias disappeared prominently for developed country currencies with the peak of the crisis, it survived and became more pronounced for some high-yielding developing country currencies. The results imply that the FPB is time-varying and its existence and severity vary across and within currency sets depending on the time period under consideration. Overall, the findings of the paper suggest that both time period-specific characteristics as well as currency-specific factors play a vital role for the existence and severity of the FPB.     

Implied volatility linkages among major European currencies

This paper examines linkages in expected future volatilities among major European currencies. For that purpose, volatility expectations implied by currency options on the euro, British pound, and Swiss franc quoted against the U.S. dollar are analysed. Vector autoregressive modelling is applied to ascertain the dynamics of the implied volatilities across currencies. The results show that the market expectations of future exchange rate volatilities are closely linked among major European currencies. Furthermore, it is found that the implied volatility of the euro significantly affects the volatility expectations of the British pound and the Swiss franc.     

Does the Exchange Rate Respond to Monetary Policy in Mexico? Solving an Exchange Rate Puzzle in Emerging Markets

This paper argues that the null or weak response of emerging market currencies to domestic monetary policy documented in the literature is the result of wide event windows. An event study with intraday data for Mexico shows that an unanticipated tightening appreciates the currency and flattens the yield curve, consistent with the evidence for advanced economies. With daily event windows, however, only the yield curve responds to monetary policy. Noise in daily exchange rate returns explains the lack of response of the currency. Such noise gives rise to a bias that declines after controlling for potential omitted variables.     

How do the Renminbi and other East Asian currencies co-move?

This paper investigates the degree and the nature of exchange rate co-movements between the Renminbi and a set of seven East Asian currencies by estimating Markov switching models with regime-dependent correlations and time-varying transition probabilities. These models have several advantages. First, exchange rate co-movements can vary across different depreciation and appreciation regimes. Second, the Renminbi can act as a transition variable that provides information regarding how the exchange rates evolve over time. After controlling for global effects and exchange market pressures, the results yield robust evidence of the Renminbi’s rising role in East Asia as a significant factor in currency fluctuations. A key result is that regional currencies tend to overreact when the Renminbi depreciates and underreact when it appreciates, suggesting that East Asian economies are not willing to allow their currency to substantially appreciate against the Chinese currency.     

The forward discount puzzle and market efficiency

We argue that the forward discount puzzle is primarily a statistical phenomenon and that statistical rejections of Uncovered Interest Parity do not necessarily constitute valid rejections of market efficiency. We find by using a Taylor expansion a theoretical negative bias in existing regressions of UIP. We propose two alternative tests for market efficiency, one of which is designed to measure the degree of market inefficiency. Our results from these tests indicate that for all four of the bilateral dollar parities studied the foreign exchange market is efficient despite decisive clear rejections of UIP using the conventional regression approach.     

Are carry,momentum and value still there in currencies?

We show that carry, momentum and value predictability in currencies is associated with mispricing. Specifically, investment performance disappears subsequent to published evidence showing portfolio returns are not fully explained by risk. Replicating these studies, we show that the average out-of-sample Sharpe ratio decreases from +0.39 to −0.32. Cross sectional tests show that currencies no longer respond to interest rate and real exchange rate differentials. During this period currency excess returns do not exhibit autocorrelation. Our results are consistent with investors learning about mispricing from academic research.     

中国银行间市场开创卢布交易业务完善市场功能

1994年人民币汇率形成机制改革以来,中国银行间外汇市场挂牌了美元、欧元、日元、英镑和港币等五种国际储备货币。本轮国际金融危机以来,主要货币汇率波动加大,微观主体出于节约汇兑成本的需要,对人民币与新兴市场货币兑换交易的需求不断上升。为满足经济主体的需求,中国人民银行积极探索在银行间外汇市场挂牌人民币对新兴市场货币交易。2010年11月22日,中国银行间外汇市场挂牌人民币对卢布交易。挂牌以来,中国银行间外汇市场人民币对新兴市场货币交易健康发展,报价日益活跃,成交快速增长。截至2011年9月末,银行间外汇市场人民币对卢布成交53.10亿元人民币,2011年下半年以来的交易量也已超过了人民币对英镑的交易量。在我国银行间市场挂牌人民币对卢布交易一周年之际,本刊特推出四家人民币对卢布做市商相关经验与感想的专题文章,供市场参考。     

Currency Hedging Using the Mean-Gini Framework

The mean-Gini framework has been suggested as a robust alternative to the portfolio approach to futures hedging given its optimality under general distributional conditions. However, calculation of the Gini hedge ratio requires estimation of the underlying price distribution. We estimate minimum-Gini hedge ratios using two widely-used estimation procedures, the empirical distribution function method and the kernel method, for three emerging market and three developed market currencies. We find that these methods yield different Gini hedge ratios. These differences increase with risk aversion and are statistically significant for all developed market currencies but only one emerging market currency. In-sample analyses show that the empirical distribution function method is more effective at risk reduction than the kernel method for developed market currencies, whereas the kernel method is superior for emerging market currencies. Post-sample analyses strengthen the superiority of the empirical distribution function method for developed market and, in several cases, for emerging market currencies.JEL Classification: F31, G15     

Policy coordination and risk premium in foreign exchange markets for major EU currencies

This study investigates cointegration, policy coordination and the risk premium in foreign exchange markets for major EU currencies since the inception of the EMU in January 1999. The results show that only the krone and the pound are cointegrated with the euro. Tests of inflation convergence and analyses of reduced-form and structural VARs indicate that the cointegration evidence reflects the relatively stronger degree of monetary policy coordination and at least the de facto fixed exchange rate regime of Denmark and the U.K. with the EMU. Additionally, cointegration of spot exchange rates can be considered one of the factors that represent the time-varying risk premium due to its explanatory power for the return to forward speculation.     

The “forward premium puzzle” and the sovereign default risk

Carry-trade strategies which consist of buying forward high-yield currencies tend to yield positive excess returns when global financial markets are booming, whereas they generate losses during crises. Firstly, we show that the sovereign default risk, which is taken on by investing in high-yield currencies, may increase the magnitude of the gains during the boom periods and the losses during crises. We empirically test for this hypothesis on a sample of 18 emerging currencies over the period from June 2005 to September 2010, the default risk being proxied by the sovereign credit default swap spread. Relying on smooth transition regression (STR) models, we show that default risk contributes to the carry-trade gains during booms, and worsens the losses during busts. Secondly, we turn to the “Fama regression” linking the exchange-rate depreciation to the interest-rate differential. We propose a nonlinear estimation of this equation, explaining the puzzling evolution of its coefficient by the change in the market volatility along the financial cycle. Then, we introduce the default risk into this equation and show that the “forward bias”, usually evidenced by a coefficient smaller than unity in this regression, is somewhat alleviated, as the default risk is significant to explain the exchange-rate change.     

世界主要货币的国际化经验

2008年爆发的国际金融危机暴露出当前国际货币体系的种种弊端,并为加快推进多元化国际货币制度改革提供契机。该文通过考察美元、欧元、日元的国际化历程,从政策支持、汇率机制稳定和以成熟金融市场为依托等方面总结了世界主要货币的国际化特点及经验,并就进一步促进人民币跨境使用提出相关政策建议。     

What moves international stock and bond markets?

We study the relation between international mutual fund flows and the different return components of aggregate equity and bond markets. First, we decompose international equity and bond market returns into changes in expectations of future real cash payments, interest rates, exchange rates, and discount rates. News about future cash flows, rather than discount rates, is the main driver of international stock returns. This evidence is in contrast with the typical results reported only for the US. Inflation news instead is the main driver of international bond returns. Next, we turn to the interaction between these return components and international portfolio flows. We find evidence consistent with price pressure, short-term trend chasing, and short-run overreaction in the equity market. We also find that international bond flows to emerging markets are more sensitive to interest rate shocks than equity flows.     

Volatility transmission in emerging European foreign exchange markets

This paper studies the dynamics of volatility transmission between Central European (CE) currencies and the EUR/USD foreign exchange using model-free estimates of daily exchange rate volatility based on intraday data. We formulate a flexible yet parsimonious parametric model in which the daily realized volatility of a given exchange rate depends both on its own lags as well as on the lagged realized volatilities of the other exchange rates. We find evidence of statistically significant intra-regional volatility spillovers among the CE foreign exchange markets. With the exception of the Czech and, prior to the recent turbulent economic events, Polish currencies, we find no significant spillovers running from the EUR/USD to the CE foreign exchange markets. To measure the overall magnitude and evolution of volatility transmission over time, we construct a dynamic version of the Diebold–Yilmaz volatility spillover index and show that volatility spillovers tend to increase in periods characterized by market uncertainty.     

Performance of Currency Trading Strategies in Developed and Emerging Markets: Some Striking Differences

Expanding the currency investment universe makes a lot of sense from a diversification point of view. Nevertheless, 60% of the total foreign exchange turnover is still only traded in three currency pairs (USD/EUR, USD/JPY and USD/GBP). The share of trading in local currencies in emerging markets is only around 5%. This can be explained by the fact that some currency managers fear investing in emerging market currencies. Many believe that political risk is the most dominant driver in these markets and that traditional investment rules do not work. In this paper, I apply four technical trading strategies for the developed market currencies and for the most traded emerging market currencies. The empirical results show some striking differences. They suggest that trend-following rules work better for emerging market currencies, while carry trading strategies perform better across developed market currencies. Nevertheless, it seems that conventional techniques could be successfully applied to both developed and emerging market currencies. I conclude that currency managers should not be afraid to diversify into emerging market currencies. They should, however, adjust their trading style accordingly.