Capital Inflows,Exchange Rate Flexibility and Credit Booms

Historically, capital flow bonanzas have often fueled sharp credit expansions in advanced and emerging market economies alike. Focusing primarily on emerging markets, this paper analyzes the impact of exchange rate flexibility on credit markets during periods of large capital inflows. It is shown that bank credit is larger and its composition tilts to foreign currency in economies with less flexible exchange rate regimes, and that these results are not explained entirely by the fact that the latter attract more capital inflows than economies with more flexible regimes. The findings thus suggest countries with less flexible exchange rate regimes may stand to benefit the most from regulatory policies that reduce banks' incentives to tap external markets and to lend/borrow in foreign currency; these policies include marginal reserve requirements on foreign lending, currency‐dependent liquidity requirements and higher capital requirement and/or dynamic provisioning on foreign exchange loans.     

Strategic Privatization in Developing Countries

Privatization of state‐owned enterprises may have important welfare implications, in particular in less developed economies where markets are small and domestic firms are typically relatively weak, both technologically and financially. In these environments, a high‐tech foreign investor acquiring the state‐owned assets may end up dominating the local market, thereby harming local consumer and producer interests. A foreign investor, however, is likely to be both willing and able to offer a higher bid for the assets than local investors. This paper addresses the trade‐off for local governments between privatization revenues and foreign market power. The authors find that there may be an incentive to privatize “strategically” by selling the state‐owned firm to a local (less advanced) investor at a lower price in order to achieve a more competitive post‐privatization market structure.     

Does One Soros Make a Difference? A Theory of Currency Crises with Large and Small Traders

Do large investors increase the vulnerability of a country to speculative attacks in the foreign exchange markets? To address this issue, we build a model of currency crises where a single large investor and a continuum of small investors independently decide whether to attack a currency based on their private information about fundamentals. Even abstracting from signalling, the presence of the large investor does make all other traders more aggressive in their selling. Relative to the case in which there is no large investor, small investors attack the currency when fundamentals are stronger. Yet, the difference can be small, or non-existent, depending on the relative precision of private information of the small and large investors. Adding signalling makes the influence of the large trader on small traders' behaviour much stronger.     

The Role of Foreign Bond Issuance: The Case of Australia

We examined the recent development of the foreign bond—termed Kangaroo bond—market in Australia. Overwhelmingly, issuers in this market are of high credit quality and comprise sovereign, supranational and major international financial institutions. Local institutional investors have a preference for simple, fixed‐rate pricing structures, with foreign issuers reliant upon converting their Australian dollar‐denominated bond proceeds into the currency and coupon type of choice using cross‐currency swaps. The Kangaroo bond issuers provide a natural counterparty to Australian residents issuing in foreign currency in offshore markets, where cross‐currency swaps allow them to easily convert their proceeds into Australian dollars.     

International investment positions revisited: Investor heterogeneity and individual security characteristics

This paper contributes to the literature by empirically documenting the importance of investor heterogeneity and security level characteristics for international investment positions. We estimate a standard gravity model to explain holdings in individual bonds and stocks for euro area investors covering 2013Q4–2018Q4. First, our results confirm the importance of market size and distance, but there are significant differences between banks, insurance companies and pension funds, investment funds, households and other investors. Second, we show the statistical significance and economic relevance of security characteristics such as currency, bond maturity and dividend yield. Third, the results are robust to including domestic holdings.     

Currency interdependence and dollarization

This paper constructs a search model of currency interdependence, and uses it to examine how in dollarized economies the foreign currency reacts to various shocks to the domestic currency. Currency interdependence is generated by allowing sellers to take into account their outside option of trading with the domestic currency while bargaining with buyers holding the foreign currency. The shocks consist in movements in the domestic interest rate, domestic inflation and the domestic currency’s market power. We show that if the purchasing power of the domestic currency is low, any shock that increases its value, such as a higher domestic interest rate, translates into a depreciation of the foreign currency. However, the result is opposite when the purchasing power of the domestic currency is high. We show that when money is indivisible these shocks can drive in or out the foreign currency. When money is divisible, this currency substitution effect is more limited. We use our results to discuss the opportunity of various de-dollarization policies and show that some can be counterproductive.     

对外开放和经济波动的关联性检验——中国和东亚新兴市场国家的案例

本文运用研究非对称性冲击问题的实证方法考察和比较了东亚4国(韩国、印尼、泰国和中国)在经济开放过程中内外金融资源的相对价格——实际利差的变化及由此引起的宏观经济(产出、货币和银行信贷)的波动特征。这一研究的政策意义在于通过区分外部因素的基本面(mean)变化和突发性的波动(volatility)对本国经济所产生的不同性质的溢出效应(spillover),为政府制定不同的针对性措施提供理论根据。通过引入非对称“时变波动”(asymmetrictimevaryingvolatility)特征的二元EGARCHVAR实证模型,论文得到了三个主要结论第一,虽然为维持名义汇率的稳定,各国政府都积极地干预外汇市场,由此影响了当期内外利差的收敛,但包括中国在内的4个国家金融的实际开放程度都在不断加大。第二,除上世纪90年代国际资本移动的鼎盛阶段外,各国的经济波动并不是由外部冲击直接带来的,而是国内经济的不确定因素导致的。第三,比较各国经济波动特征,可以发现汇率制度、金融市场的开放程度以及资本市场的发展状况对经济波动有很大的影响。     

Currency crises and the stock market: empirical evidence for another type of twin crisis

We explore the dependency between currency crises and the stock market in emerging economies. Our focus is two-fold. First, the risk of a currency crisis rises as the foreign stake in the domestic stock market increases. Successful economies with high capital flows into their booming stock markets especially are prone to stock market-induced currency crises. Second, we apply the dividend growth model to show that stock markets crash in the run-up to a currency crisis. This new type of twin crisis is empirically tested by employing a logit framework using quarterly data for 33 emerging economies for 1994Q1–2007Q4.     

Investor attention and currency performance: international evidence

This article investigates the relationship between investor attention measured by Google search volume index and the performance of several currencies. We find that currency performance is remarkably responsive to changes in investor attention. These impacts, generated rapidly, are present over the relatively long term, especially for emerging currencies, and are intensified during periods of high uncertainty. We also demonstrate that there is a prominent asymmetric effect for the impact of attention, as past currency performance also influences attention. Typically, past currency performance can determine the magnitude of the impact on current currency performance. Moreover, we confirm that investor attention has a predictive power for forecasting emerging currency performance in the out-of-sample analysis. Further, these forecasts generate substantial economic value in the framework of asset allocation. By contrast, statistical predictability and economic value do not exist in the currencies from developed markets. These results indicate that investor attention can alter currency performance and its predictability. More broadly, our study emphasizes the potential of employing investor attention for emerging currency performance forecasting applications.     

Assessing Recent Determinants of Borrowing Costs in Sub‐Saharan Africa

This study explores macroeconomic implications of the sovereign bond rush that has been taking place in sub‐Saharan Africa since 2006. The focus is on the sub‐Saharan sovereign bond yields as proxies for the region's ability to raise new funds on international markets. Despite the subcontinent's tour‐de‐force entrance to the international bond market, this paper reveals that recent (since early 2000s) borrowing in foreign currency is not without macroeconomic risk. Empirically this paper finds that sovereign bond yields are significantly influenced by global volatility, commodity prices and global liquidity—all factors that are out of the control of the sub‐Saharan economies in question. These findings suggest that portfolio repositioning by institutional investors prompted by improved growth prospects and implicit monetary policy tightening in the advanced economies or heightened risk perceptions, are likely to result in increased borrowing costs for the sub‐Saharan bond issuers and affect their ability to raise funds in international markets. Furthermore, a change in borrowing costs might lead to higher debt‐service costs and policy uncertainty, which in turn could lead to suboptimal investment levels and, ultimately, hinder economic development.     

The Impact of U.S. Individual and Institutional Investor Sentiment on Foreign Stock Markets

This study examines the degree to which U.S. individual and institutional investor sentiments are propagated abroad. Previous studies construe investor sentiments as fully irrational; we find contrary evidence that individual and institutional investor sentiments are driven by both rational and irrational factors, with distinct effects on domestic and international stock market returns. The generalized impulse response functions from VAR model estimations show that U.S. institutional investor sentiments have varying degrees of impact on the equity markets of the U.K., Mexico, and Brazil, and no effect on Chile. Specifically, the individual investor sentiment effect is statistically significant only for the U.K market. Not surprisingly, the two classes of investor sentiments have a strong significant effect on the U.S. stock market returns. The response of the U.S. to individual investor sentiments is relatively more erratic, while the response to institutional investor sentiments is smoother. This difference in pattern becomes more visible when we consider the response of the foreign stock markets. We find significant effects of rational sentiments of institutional investors on the U.S., the U.K., Mexico, and Brazil. However, there is an insignificant effect of the irrational sentiments on the same set of countries. A direct implication of our empirical evidence is that it is important for international asset pricing models to consider the role of rational sentiments of institutional and individual investors on developed and emerging markets.     

Transmission of monetary policy and exchange rate shocks under foreign currency lending

This paper analyses the differences in reaction of domestic and foreign currency lending to monetary and exchange rate shocks, using a panel VAR model estimated for the three biggest Central and Eastern European countries (Poland, the Czech Republic and Hungary). Our results point toward a drop in domestic currency loans and an increase of foreign currency credit in reaction to monetary policy tightening in Poland and Hungary, suggesting that the presence of foreign currency debt weakens the transmission of monetary policy. A currency depreciation shock leads to an initial decline in foreign currency lending, but also in loans denominated in domestic currency as central banks react to a weaker exchange rate by increasing the interest rates. However, after several quarters, credit in foreign currency accelerates, indicating that borrowers start using it to substitute for depressed domestic currency lending.     

Manias,Panics and Crashes in Emerging Markets: An Empirical Investigation of the Post-2008 Crisis Period

ABSTRACT

Because of their economic importance, international bond markets are thought to be the likely location for the operation of financial market pressures on emerging market (EM) government policy. An important but unresolved debate that runs through the literature is the relative importance of domestic factors specific to the country receiving the capital flows (pull factors), versus push factors exogenous to the receiving country, in driving portfolio flows to EMs. Through extensive interviews with financial market participants, and analysis of the financial press between January 2008 and 2013, this paper argues that not only were market participants fully aware of the importance of push factors over the cycle, but that their perceptions of the domestic fundamentals themselves were influenced by these push factors. The paper provides evidence on the micro-foundations of investment decision making that make investors susceptible to influence by the push factors, and adds to a growing body of evidence that financial market borrowing costs are even less in the control of emerging market governments than previously assumed, because even when investors pay attention to domestic fundamentals, their assessments can be divorced from reality. This means that government efforts to attract foreign capital through implementing investors' preferred policies may be ultimately futile.     

The demand for money and the real exchange rate misalignments in emerging European countries: A nonlinear approach

This paper investigates the extent to which domestic and foreign money balances in emerging European countries are influenced by foreign exchange considerations. A well-specified and stable relationship between real money demand and the exchange rate can be perceived as an important part of a successful monetary policy. This study examines the long-run determinants of real exchange rates (RERs) associated with the behavioral equilibrium exchange rate (BEER) approach and identifies currency misalignments in these countries. The misalignment is later used to test the nonlinear behavior of the demand for money. The results indicate that the RER misalignments have a significant impact on domestic money demand. When the currencies are overvalued, there is a reduction in domestic money demand, and when they are undervalued, there is an increase in domestic money demand. Furthermore, it can be concluded that overvaluation causes an increase in foreign money demand indicating a shift of preference from domestic to foreign currency.     

DOLLARIZATION IN DEVELOPING COUNTRIES: RATIONAL REMEDY OR DOMESTIC DILEMMA?

This paper reviews the policy implications of dollarization in developing economies. It outlines channels of U.S. currency access abroad and illustrates progressing stages of dollarization for various country examples. It analyzes the costs of large seigniorage losses facing domestic governments vis-a-vis the U.S. issuer. Finally, it provides three explanations for the observed inertia in dedollarization following domestic stabilization policies: (i) high transactions costs of switching monies, (ii) dollar revenues related to illegal commercial activities, and (iii) network externalities associated with foreign currency usage.     

Exchange rate exposure, foreign currency derivatives and the introduction of the euro: French evidence

We investigate the impact of the introduction of the Euro on exchange rate exposures for French corporations and examine the corporate use of foreign currency derivatives to hedge exchange rate exposure post-Euro. Our findings indicate that the introduction of the Euro is associated with both a reduction in the number of firms that have significant exchange rate exposure and the absolute size of exposure. Consistent with these reduced exposures, French firms use foreign currency derivatives less intensively. Furthermore, the use of foreign currency derivatives is found to be associated with lower exchange rate exposure but there is insufficient evidence that these instruments are more effective in the post-Euro environment.     

Convergence of bank competition in Central and Eastern European countries: do foreign and domestic banks go hand in hand?

Following the massive entry of foreign banks into the Central and Eastern European (CEE) banking markets, one may wonder whether their competitive behaviour differs from that of their domestic counterparts, possibly leading to the segmentation of these markets at the regional and national levels. We find that the competitive behaviour of foreign and domestic banks differs, with foreign banks having less market power until the recent financial crisis and more market power after this financial turmoil. Despite this difference, banks tend to behave similarly, and their market power converges to a similar level. The tendency towards similar competitive behaviour is observed at the regional and national levels and for both foreign and domestic banks, although foreign institutions that enter these markets through the acquisition of domestic banks have slightly more market power. Our findings suggest the regional integration of CEE banking markets and no segmentation between foreign and domestic institutions.     

Monetary and macroprudential policy with foreign currency loans

In a number of countries a substantial proportion of mortgage loans is denominated in foreign currency. In this paper we demonstrate how their presence affects economic policy and agents’ welfare. To this end we construct a small open economy model with financial frictions, where housing loans can be denominated in domestic or foreign currency. The model is calibrated for Poland - a typical small open economy with a large share of foreign currency loans (FCL). We show that the presence of FCLs negatively affects the transmission of monetary policy and deteriorates the output-inflation volatility trade-off it faces. The trade-off can be improved with macroprudential policy but the outcomes are still worse than under this same policy mix applied to an economy with domestic currency debt. We also demonstrate that a high share of FCLs is harmful for social welfare, even if financial stability considerations are not taken into account. Finally, we show that regulatory policies that discriminate against FCLs may have a negative impact on economic activity and discuss the redistributive consequences of forced currency conversion of household debt.     

Gross substitution, Gresham's law, and Hayek's free currency system

Professor Hayek has advocated that citizens be free to use foreign currency as a means of payment in order to put a check on national governments' tendency to rely on the seigniorage for fiscal purposes. His proposed scheme is based on an intuitive reasoning that being able to use foreign currencies makes demand for domestic currency more elastic, thus reducing the monopoly power of national governments on currency issue. This paper demonstrates that this would be true if and only if the foreign currency were a gross substitute for the domestic currency. The paper also shows that the same condition holds for Gresham's law to be valid.     

Currency Options and Export-Flexible Firms

This paper examines the production and hedging decisions of a globally competitive firm under exchange rate uncertainty. The firm is risk averse and possesses export flexibility in that it can distribute its output to either the domestic market or a foreign market after observing the realized spot exchange rate. To hedge against its exchange rate risk exposure, the firm can trade fairly priced currency call options of an arbitrary strike price. We show that both the separation and the full‐hedging results hold if the strike price of the currency call options is set equal to the ratio of the domestic and foreign selling prices. Otherwise, neither result holds. Specifically, we show that the optimal level of output is always less than that of an otherwise identical firm that is risk neutral. Furthermore, an under‐hedge (over‐hedge) is optimal whenever the strike price of the currency call options is below (above) the ratio of the domestic and foreign selling prices.