Exchange rate dynamics and US dollar-denominated sovereign bond prices in emerging markets

Using data on Brazil, Colombia, Mexico, the Philippines, Russia and Turkey, our empirical results show that the exchange rates of their currencies have adequate explanatory power in explaining their US dollar-denominated sovereign bonds, particularly in the post-global financial crisis period. We develop a two-factor pricing model with closed-form solutions for the sovereign bonds in which the correlated factors are foreign exchange rates and US risk-free interest rates that follow a double square-root process relevant in the low interest rate environment. The numerical results and associated error analysis show that the model credit spreads can broadly track the market credit spreads.     

The relationship between oil prices,the stock market and the exchange rate: Evidence from Mexico

This paper analyzes the variables of oil price, exchange rate and stock market index to explain how they interact with each other in the Mexican economy. The examined period includes monthly data from January 1992 to June 2017. A Vector Autoregressive Model (VAR) is implemented that includes oil prices, the nominal exchange rate, the Mexican stock market index, and the consumer price index. Results indicate that the exchange rate has a negative and statistically significant effect on the stock market index; this indicates that an appreciation of the exchange rate is related to an increase in the stock market index. It is also found that the consumer price index has a positive effect on the exchange rate and a negative effect on the stock market index. The results also indicate that oil prices are statistically significant against the exchange rate, concluding that an increase in oil prices creates an appreciation of the exchange rate. In addition, the impulse-response functions show that the effects found tend to disappear over time.     

The nexus between country risk and exchange rate regimes: A global investigation

Using a sample of 110 countries over the period 1984–2013, this paper examines the impacts of country risks on choosing a specific exchange rate regime (first by utilizing the Levy-Yeyati and Sturzenegger de facto classification and then robusting it by the IMF de jure measurement) relative to other regimes via the panel multinomial logit approach. Empirical findings are as follows. First, in the full samples case we provide evidence that government is more likely to implement a flexible regime, but less likely to adopt a fixed regime, under a low level of composite and financial risk. Second, we find that Eurozone countries are more likely to choose a fixed exchange rate regime with a decrease in the level of country risk and favor a flexible regime in response to a shock from an increase of risk, which is opposite to non-Eurozone countries. Third, we note that high-risk countries are more likely to choose a fixed regime with a low level of composite and political risk in the government, but do not adjust the exchange rate regime as a shock absorber when facing economic and financial risks. It is interesting to see that those countries with relatively low risk display almost opposite results versus high-risk economies. Overall, we believe that it is critically important to account for political economy variables in a government’s exchange rate policy decisions, especially for country risks. All results are robust to the panel ordered probit model.     

The impact of offshore exchange rate expectations on onshore exchange rates: The case of Chinese RMB

This paper examines the impact of offshore RMB exchange rate expectations on onshore RMB (CNY) exchange rates. Employing data for the period of 2005–2018, we show that overall offshore market expectations influence onshore RMB rates, but this effect is significant only for the period after the “Second exchange rate regime reform” in 2010. The non-uniform nature of this impact is also confirmed by the existence of a threshold effect of the expectations in the same period. The study improves our understanding of how the offshore RMB market influences onshore RMB spot rates as a result of the marketization reform of the RMB exchange rate regime.     

Identifying the true nature of price discovery and cross-market informational flow in the investment grade CDS and equity markets

We examine the comparative efficiency of systematic investment grade credit default swap (CDS) and equity markets using a time-varying coefficient vector autoregression. This modeling framework enables a view of cross-market informational flow along each point in the time-period under investigation by taking into account parameter instability. We obtain smoothing estimates of parameters capturing such flow between CDS and equity markets using daily data from 2004 to 2019, and measure the strength of flow via relative predictive gains. In contrast to prior studies, we find a two-way interactive effect in which certain types of information are captured more efficiently in prices by each market. We also find that the time-varying coefficient vector autoregression results in superior forecasting gains relative to models not accounting for price discovery. These results have implications for systematic investors, arbitrageurs and stakeholders who monitor systematic markets for their informational content.     

Detecting contagion in Asian exchange rate markets using asymmetric DCC-GARCH and R-vine copulas

This study uses asymmetric DCC-GARCH models and copula functions to study exchange rate contagion in a group of twelve Asia-Pacific countries. Using daily data between November 1991 and March 2017, we show that extreme market movements are mainly associated with the high degree of interdependence registered by countries in this region. Evidence of contagion is scarce. Asymmetries do not appear to be important. Specifically, currency co-movements are statistically identical during times of extreme market appreciation and depreciation, indicating that phenomena such as the fear of “appreciation” do not appear to be relevant in the region’s foreign exchange markets.     

Exchange rate regimes and market integration: evidence from the dynamic relations between renminbi onshore and offshore markets

The Chinese renminbi (RMB) has been on the way of becoming a major international currency. This paper examines the impact of the RMB exchange rate regime and policy on the integration and information flows between RMB onshore and offshore markets. We employ a long sample of daily data encompassing multiple times of RMB exchange rate regime change (peg to managed float in 2005, re-peg in 2008, re-float in 2010, and the central parity reform in 2015), and study the dynamic conditional correlations and spillovers between RMB onshore spot market and offshore non-deliverable forward (NDF) market. It is found that the switch from exchange rate peg to managed float and a widening of the floating band strengthen cross-market correlation and information flows (especially offshore-to-onshore spillovers). A market-learning explanation is offered for the observation that the correlation collapse in the re-peg period was not as prompt as the correlation take-off in the 2005 reform period. These findings have important implications for China’s monetary and foreign exchange policies and shed light on the integration of China’s financial markets with the rest of the world.     

Spillovers of currency carry trade returns,market risk sentiment,and U.S. market returns

This paper examines the link between spillovers of currency carry trade returns and U.S. market returns. Following Tse and Zhao (2012), this paper hypothesizes that the magnitude of spillovers of currency carry trade returns is positively correlated with market risk sentiment and, therefore, has an impact on market returns. Using the G10 currencies and S&P 500 index futures, the empirical results present a high magnitude of spillover effects of currency carry trade markets. The empirical findings also show a significantly positive relationship between spillovers of currency carry trade returns and subsequent market returns. Furthermore, the results indicate that this relationship is stronger in bear markets than in bull markets. Finally, our findings show that spillovers of currency carry trade returns significantly affect the subsequent transition probabilities of market returns.     

The symmetrical and positive relationship between crude oil and nominal exchange rate returns

This paper investigates both the static and dynamic relationships between daily crude oil returns and US dollar exchange rate returns using a test for symmetrical exceedance correlations and two mixture copulas. Empirical results demonstrate that the exceedance correlations between oil and exchange rate returns are both positive and symmetrical, indicating that the two return rates move in the same direction and that the relationship between them is symmetrical for the upper and lower quantiles. The crude oil-exchange rate relationship is sensitive to the sample period investigated. Before the 1998 financial crisis, exceedance correlations are close to zero, showing almost no correlation between the oil and exchange rate markets. However, the positive co-movement has significantly increased since the 2008 financial crisis. Furthermore, Kendall's tau coefficients of two symmetrized copulas greatly increase after the 2008 financial crisis, revealing that the probability of both returns moving in the same direction is higher than it is in the opposite direction.     

Analysis of asymmetric response of exchange rate to interest rate differentials: The case of African Big 4

Using the case of four leading African economies, namely Algeria, Egypt, Nigeria and South Africa, this paper explores the possibility of asymmetric relationship between exchange rate and interest rate differential. In addition, it also tests whether accounting for structural breaks matters for the nexus. The results vary for the four countries based on the choice of exchange rate regime and countries involved in full-fledged floating or managed floating seem to respond more to variations in interest rate differential. Also, accounting for both asymmetries and structural breaks should not be disregarded when modelling this nexus.     

The effects of exchange rate fluctuations on the stock market and the affecting mechanisms: Evidence from BRICS countries

Using data from BRICS countries, we apply the TVP-VAR model to analyze the effects of exchange rate fluctuations on their stock markets and the mechanisms leading to those effects. We find that for BRICS countries, there are similarities as well as differences in the extent, direction, and duration of the effects of exchange rate changes on the stock market. As for the affecting mechanisms, Brazil is almost entirely driven by the financial account, while the current account is dominant for Russia, whereas India, China, and South Africa depend on both mechanisms.     

The dynamic relationship between stock,bond and foreign exchange markets

This paper investigates whether the deviation of a currency from its fundamentally determined rate of return affects the relationship between interest rates and stock market yields. A time-varying transition probability, the Markov-switching vector autoregressive (MS-VAR) model, is utilized for this purpose. Wald and likelihood ratio tests are computed and used as model adequacy measures. In order to analyze the link between the variables, impulse–response functions are employed. A sticky price exchange rate model is used to show the fundamentally determined rate of return of currencies. States are defined as either overvalued or undervalued, depending on the position of the observed exchange rate compared to its fundamentally determined rate. The model is applied to four major currencies: the Australian Dollar, the Canadian Dollar, the Japanese Yen, and the British Pound. Transition between the states is linked to the risk-adjusted excess return (the Sharpe ratio) of the debt and equity markets of the respective currencies in order to understand whether over- and undervaluation is connected to the returns in these markets. The results provide evidence that the relationship between economic fundamentals and nominal exchange rates are subject to change depending on the over- or undervaluation of the currencies relative to their fundamentally determined rate of return. An extension of this result shows that the Sharpe ratios of debt and equity investments in the currencies influence the evolution of the transitional dynamics of the exchange rates’ deviation from their fundamental values.     

Time-frequency effect of crude oil and exchange rates on stock markets in BRICS countries: Evidence from wavelet quantile regression analysis

This study examines the effects of oil prices and exchange rates on stock market returns in BRICS countries (Brazil, Russia, China, India and South Africa) from a time–frequency perspective over the period 2009–2020. We use wavelet decomposition series to develop a threshold rolling window quantile regression to detect time–frequency effects at various scales. The empirical results are as follows. First, our findings confirm that the effects of both crude oil prices and exchange rates on BRICS stock returns are asymmetric. Positive shocks of crude oil have a greater impact on a bull market, whereas negative shocks have a greater impact on a bear market. Second, there is a short-term enhancement effect of crude oil and exchange rate on BRICS stock markets. In addition, volatility in the macro financial environment also exacerbates the impacts of oil prices and exchange rates on the stock market, and these fluctuations are heterogeneous. Overall, these findings provide useful insights for international investors and policy makers.     

Noise trading and autocorrelation interactions in the foreign exchange market: Evidence from developed and emerging economies

This paper seeks to empirically determine whether feedback trading strategies result in stabilization or destabilization in the foreign exchange market and if such strategies are a distinctive characteristic of an emerging economy or they are a common element to both developed and emerging economies. These hypotheses are tested via the use of a feedback model augmented with a generalized autoregressive conditional heteroskedasticity (GARCH) process for modeling the errors. The results suggest presence of both positive and negative feedback trading and asymmetric behavior in both types of economies. Irrespective of the nature of feedback trading, presence of asymmetric behavior implies that market traders rely on central banks to intervene so they can realize short-term profits. Finally, in cases of a positive first-order autoregressive parameter presence of the bandwagon effect is implied, whereby past currency movements are followed by expectations of currency movements in the same direction.

Sovereign default risk,debt uncertainty and fiscal credibility: The case of Brazil

Since Credit Default Swaps spreads reflect the sovereign risk and, thus, the uncertainties related to government solvency, the goal of this study is to examine the relation between sovereign risk and debt uncertainty (measured by the disagreement in expectations about public debt) in an important developing country – Brazil. Furthermore, the paper analyzes whether fiscal credibility plays a key role in mitigating the effect of debt uncertainty on sovereign risk. The results suggest the disagreement in expectations about public debt affects the sovereign risk, and fiscal credibility plays a twofold role, it reduces sovereign risk, and it mitigates the effect of debt uncertainty on sovereign risk. Besides, quantile regression estimates reveal that fiscal credibility improvements are even more important when sovereign risk levels are higher.     

Adaptive market hypothesis: The story of the stock markets and COVID-19 pandemic

Since the level of markets’ information efficiency is key to profiteering by strategic players, Shocks; such as the COVID-19 pandemic, can play a role in the nature of markets’ information efficiency. The martingale difference and conditional heteroscedasticity tests are used to evaluate the Adaptive form of market efficiency for four (4) major stock market indexes in the top four affected economies during the COVID-19 pandemic (USA, Brazil, India, and Russia). Generally, based on the martingale difference spectral test, there is no evidence of a substantial change in the levels of market efficiency for the US and Brazilian stock markets in the short, medium, and long term. However, in the long term, the Indian stock markets became more information inefficient after the coronavirus outbreak while the Russian stock markets become more information efficient. Intuitively, these affect the forecastability and predictability of these markets’ prices and/or returns. Thereby, informing the strategic and trading actions of stock investors (including arbitrageurs) towards profit optimization, portfolio asset selection, portfolio asset adjustment, etc. Similar policy implications are further discussed.     

The effect of nominal exchange rate volatility on real macroeconomic performance in the CEE countries

This paper analyzes the relation between nominal exchange rate volatility and several macroeconomic variables, namely real output growth, excess credit, foreign direct investment (FDI) and the current account balance, in the Central and Eastern European EU member states. Using panel estimations for the period between 1995 and 2008, we find that lower exchange rate volatility is associated with higher growth, higher stocks of FDI, higher current account deficits, and higher excess credit. At the same time, the recent evidence seems to suggest that following the global financial crisis, “hard peg” countries may have experienced a more severe adjustment process than “floaters”. The results are economically and statistically significant and robust.     

Heterogeneity dependence between oil prices and exchange rate: Evidence from a parametric test of Granger causality in quantiles

This paper re-examines the nexus between crude oil price and exchange rate by investigating their heterogeneity dependence structure within the framework of Granger causality in quantiles for a sample of developed and emerging economies (namely UK, Canada, Brazil, Russia, Mexico, Norway, India, Japan, South Africa, South Korea and European Union (EU)). The results indicate no distinct causality between the crude oil price changes and the real exchange rate returns for all countries besides Russia at the median of the conditional distribution. Besides, the crude oil price changes influence the exchange rate returns in all countries, except Norway and EU, particularly around the tails of the conditional distributions of exchange rate returns. This suggests that the oil price changes influence the real exchange rate returns when the real exchange rate returns are either in extreme appreciation or depreciation. Moreover, the crude oil price movement can be explained by the exchange rate returns for most oil importers only when the crude oil market is bearish or bullish. By contrast, the real exchange rate can permanently affect the crude oil price for most oil-importing countries irrespective of the crude oil market's state. Finally, our findings provide an essential reference for managing the extreme risk dependence between the exchange rate market and the crude oil market.     

Impact of China's currency valuation and labour cost on the US in a trade and exchange rate model

Ricardian dynamic general equilibrium analyses show that under free trade arrangements a low income country with lower wage cost and large endowment of labour has comparative advantage in trade. Efficiency gains from this enhance economic growth and welfare of households simultaneously in both low income and advanced economies. Theoretical predictions are empirically validated here with structural VAR analysis based on quarterly data over the time period 1995:1 to 2009:1 on China's relative wage cost, interest rate differential, real effective exchange rate (REER), relative GDP and the US current account balance. It is shown how the relative prices of labour, capital and the currency affect the economic activity in China and current account balance in the US. With free capital inflows and outflows and restrictions on labour mobility, comparative advantage of China and the trade deficit of the US will both be minimised if China allows real appreciation of the Yuan and complete adjustment in prices. Higher production cost and prices in China could reduce welfare of Chinese households and the trade imbalance of the US, while higher relative GDP of China lowers the current account balance for the US.     

The effect of exchange rate volatility on U.S. bilateral trade with Africa: A symmetric and asymmetric analysis

The impact of exchange rate volatility on U.S. trade with the world or on U.S. trade with major partners has been assessed by many researchers, but none have considered the case of U.S. trade with African nations. We fill this gap by assessing the symmetric and asymmetric impact of the real bilateral exchange rate volatility between the U.S. dollar and each African partner’s currency on the U.S. trade flows with each of the 20 partners from Africa. We found asymmetric short-run effects of exchange rate volatility on almost all U.S. exports to and imports from each of the 20 countries. In addition, significant long-run asymmetric effects were discovered in the case of U.S. exports to 15 countries and U.S. imports from 12 countries. Our findings are partner-specific.