Forward and spot exchange rates in a bivariate TAR framework

Structural exchange rate models explain only a small part of the movements in dollar exchange rate. Recent empirical work has focused on the failure to account for nonlinearities in the data generating mechanism, as an explanation of this bad performance. Here two bivariate threshold autoregressive models for the spot and forward exchange rates are considered. In the first model the regimes are determined by the log difference of the two rates; in the second one the regimes are driven by the forward spot no-arbitrage condition. These processes are able to capture the ‘swing’ behaviour observed in the exchange rate market. Finally the forecasting ability of the models for the dollar/DM exchange rate is evaluated by stochastic simulation.     

Forward exchange rates as predictors of future spot rates and the efficiency of the foreign exchange market

The theory of informationally efficient markets (EMIT) is applied to the foreign exchange market and some of its operational implications are illustrated. The EMIT is joined with alternative models of the equilibrium return on the foreign exchange market: the Pure Expectations Hypothesis, the Modern Theory and tentative formulations of return as a function of risk. The alternative joint Hypotheses are rejected by the data but this does not necessarily imply the rejection of EMIT. The rejection may be due to the inadequacies of the equilibrium return models used, notwithstanding the fact that the risk premium has been captured, to a certain extent, in the empirical tests and the evidence against the EMIT weakened.     

Some alternative tests of forward exchange rates as predictors of future spot rates

The paper provides empirical analysis on the issue of forward premiums as predictors of future exchange depreciations. The need to specify an alternative to the null hypothesis, other than its complement is emphasized. Two such alternatives are considered: the random walk model and the possibility of excessive or insufficient exchange rate volatility to accord with the efficiency of exchange markets.     

Economic news,exchange rates and interest rates

The paper examines the post-October 1979 response of exchange rates and interest rates to the new information contained in the first announcement of fifteen US macroeconomic series. Markets respond primarily to monetary news, but also to news about the trade deficit, domestic inflation, and variables that reflect the state of the business cycle. For all fifteen macroeconomic variables, an increase (decrease) in interest rates is accompanied by an appreciation (depreciation) of the dollar, which is consistent with models that stress price rigidity and absence of purchasing power parity.     

Foreign exchange intervention and equilibrium real exchange rates

Monetary authorities intervene in the currency markets in order to pursue a monetary rule and/or to smooth exchange rate volatility caused by speculative attacks. In the present paper we investigate for possible intervention effects on the volatility of nominal exchange rates and the estimated equilibrium behaviour of real exchange rates. The main argument of the paper is that omission of intervention effects – when they are significant – would bias the ability to detect any PPP-based behaviour of the real exchange rates in the long run. Positive evidence for this argument comes from the experience of six Central and Eastern European economies, whose exchange markets are characterised by frequent interventions.     

Rational speculation and exchange rates

Models of exchange rates have typically failed to produce results consistent with the key fact that real and nominal exchange rates move in ways not closely connected to current (or past) macroeconomic variables. Models that rely on the same shocks to drive fluctuations in macroeconomic variables and exchange rates typically imply counterfactually-strong co-movements between them. We develop a model in which new information leads agents to change their rational beliefs about risk premia on foreign exchange markets. These changes in risk premia work through asset markets to cause real and nominal exchange rates to change without corresponding changes in GDP, productivity, money supplies, and other key macro variables.     

Spot rates,forward rates and exchange market efficiency

This paper examines the relationship between forward exchange rates and subsequently observed spot rates. No evidence is found for a liquidity premium on forward exchange, indicating that the forward rate can be used as a proxy of the market's expectations and that open exchange positions involve little systematic risk. It is also shown that forward exhange is priced as if the exchange rate could be characterized by a diffusion process with a trend, although there is some evidence such a process does not adequately characterize the exchange rate in all cases.     

Wages, exchange rates and competitiveness

Conclusion Wage growth in west Germany has, over the longer term and with few exceptions, been far more closely oriented towards macroeconomic productivity growth than in the majority of its competitor countries. Even after adjusting for exchange rate movements, it is evident that unit labour costs in west Germany have, in general, growth significantly less strongly and in most cases are lower in absolute terms than abroad. The fact that, in spite of this, Germany has repeatedly faced foreign trade problems, is due to the volatility of exchanges rates. The demand—in such cases seemingly self-evident, although usually not explicitly formulated—that collective wage bargainers ought to orient wage growth not only towards productivity growth but also towards exchange rates would mean standing the economy on its head, however. A rational alternative to this is to stabilise exchange rates or indeed their partial abolition, as is the aim of European Monetary Union. It would be irrational, on the other hand, to abolish the wage determination system which, on the whole, has proved its effectiveness in orienting average wage increases towards macroeconomic productivity growth.     

Interest rates and exchange rates: Some new empirical results

This paper presents indirect evidence on the behavior on the real interest rate by studying the correlations between changes in nominal interest rates and in exchange rates. These correlations are examined both before and after October 6, 1979. The empirical evidence supports the views that monetary shocks affect the real rate and that the change in Fed monetary policy on October 6 led to greater variation in the real rate.     

Regime-switching models for exchange rates

This study provides evidence of periodically collapsing bubbles in the British pound to US dollar exchange rate in the post-1973 period. We develop two- and three-state regime-switching (RS) models that relate the expected exchange rate return to the bubble size and to an additional explanatory variable. Specifically, we consider six alternative explanatory variables that have been proposed in the literature as early warning indicators of a currency crisis. Our findings suggest that the RS models are, in general, more accurate than the Random Walk model in terms of both statistical and especially economic evaluation criteria for exchange rate forecasts. Our three-state RS model outperforms the two-state models and among the variables considered in our analysis, the short-term interest rate is the optimal variable, closely followed by imports. Results are more promising for one-month predictions and are qualitatively robust over sample spans. However, various robustness checks based on other exchange rates show that the optimal bubble measures and optimal predictors critically depend on the exchange rate.     

Semi-parametric real exchange rates dynamics

Review of Quantitative Finance and Accounting - A flexible semi-parametric augmented Dickey Fuller (ADF) regression is proposed to explore real exchange rate dynamics for 16 countries over the...     

Real exchange rates and time-varying trade costs

This paper re-examines the empirical modeling of Purchasing Power Parity (PPP) deviations in the presence of commodity market frictions. First, we show that a specific type of smooth transition models can closely approximate the functional form of the theoretical adjustment mechanism derived by Dumas (1992) [Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World, Review of Financial Studies,5:2153-180] for the case of constant as well as changing trade costs. Second, we develop, for the first time, an empirical model of the real exchange rate which allows for changes in the degree of market integration. By employing a long span of data on the Dollar-Sterling real exchange rate and a micro-founded proxy for trade frictions, we provide novel evidence of a significant relationship between the persistence of the real exchange rate and the level of trade costs. This finding suggests that both the difficulty of detecting PPP and the extend of Rogoff’s puzzle vary over time with the degree of trade restrictiveness. Finally, we highlight policy repercussions of our results.     

Modeling the dynamics of Chinese spot interest rates

Using the daily data of Chinese 7-day repo rates from January 1, 1997 to December 31, 2008, this paper tests a variety of popular spot rate models, including single-factor diffusion, GARCH, Markov regime-switching and jump-diffusion models. We document that Chinese spot rates are subject to both market forces and administrative forces. GARCH, regime-switching and jump-diffusion models capture some important features of the dynamics of Chinese spot rates, but all models under study are overwhelmingly rejected. We further explore possible sources of model misspecification using diagnostic tests.     

Clustering and psychological barriers in exchange rates

Contemporary press frequently attaches significance with specific numerical values in exchange rates. This research empirically tests for the presence of clustering and “psychological barriers” (transgressional effects) on various exchange rates involving the Australian dollar. Overall, we find a widespread clustering effect, which accordingly means there is partial information content in the actual numbers of the exchange rates themselves. Furthermore, there is some, but not strong, evidence that perceived “psychological barriers” do exist. Surprisingly, the location and form of both the clustering and transgressional effects and hence the information content differ across different exchange rates and in most instances, they are not in the expected direction.     

Bond price representations and the volatility of spot interest rates

A common approach to modeling the term structure of interest rates in a single-factor economy is to assume that the evolution of all bond prices can be described by the current level of the spot interest rate. This article investigates the restrictions that this assumption imposes. Specifically, we show that this Markovian restriction, together with the no-arbitrage requirement, curtails the relationship of forward rates and their volatilities relative to spot-rate volatilities. Among such Markovian models, only a few provide simple analytical relationships between bond prices and the spot interest rate. This article identifies the class of spot-rate volatility specifications that permit simple analytical linkages to be derived between bond prices and interest rates. Included in the class are the volatility structures used by Vasicek and by Cox, Ingersoll, and Ross. Surprisingly, no other volatility structures permit simple analytical representations.     

Triangular arbitrage in the spot and forward foreign exchange markets

Imad Moosa shows that the effect of triangular arbitrage in the forward market is similar to the combined effect of triangular arbitrage in the spot market and covered interest arbitrage. He also shows that when the forward rates are inconsistent then this implies inconsistency of the spot rates and/or the violation of covered interest parity. When the bid-offer spreads are allowed for, the equilibrium conditions hold only approximately.     

The high-frequency response of exchange rates and interest rates to macroeconomic announcements

The joint movements of exchange rates and U.S. and foreign term structures over short-time windows around macro announcements are studied using a 14-year span of high-frequency data. In order to evaluate whether the joint effects can be reconciled with conventional theory, the implications of these joint movements for changes in expected future exchange rates and changes in foreign exchange risk premia are deduced. For several real macro announcements, a stronger than expected release appreciates the dollar today, and must either (i) lower the risk premium for holding foreign currency rather than dollars, or (ii) imply net expected dollar depreciation over the ensuing decade.     

Monetary policy under dual exchange rates

This paper finds that the introduction of dual exchange rates gives the monetary authority greater independence from external constraints than it would otherwise enjoy. The monetary authority is able to influence the level of aggregate demand in the short run and to sterilize the effects of temporary foreign disturbances. In addition, the paper finds that dual rates insulate the domestic economy fully from foreign interest rate changes but do not provide insulation from speculative disturbances.     

The behavior of intra-daily exchange rates

The behavior of exchange rates is examined as they evolve continuously over time. The data consist of Swiss franc/U.S. dollar rates for nine days during the years 1978–1980 as quoted by a major Swiss dealer operating on the interbank market. Since this market is highly organized, the observations are market prices at the same time. The distributions of relative changes in exchange rates measured over one minute are highly leptokurtic. The normal distribution is rather rapidly approached when the measurement interval is lengthened from one up to ten minutes. Time series analysis reveals that the natural logarithms of exchange rates are adequately described by a random walk, the same stochastic process as has been found for daily, weekly, monthly and quarterly observations. For short time intervals, significant autocorrelations sometimes occur at the first few lags, which are, however, not stable enough over time to form a basis for reliable forecasts.     

Risk appetite,carry trade and exchange rates

Using exchange rate data from four different countries (time zones), we examine the relationship between the Yen exchange rate against major currencies (i.e. USD/JPY, EUR/JPY, GBP/JPY, AUD/JPY and NZD/JPY) and measures of risk appetite (i.e. the S&P500 index, Dow Jones Industrial Average index and the VIX index). Our results show that the equity indexes, especially the Dow Jones Industrial Average, play a more important role in the determination of the Yen cross rates than VIX. The popular carry-trade currencies, i.e. NZD/JPY, AUD/JPY and GBP/JPY, are more affected by the US equity market than USD/JPY and EUR/JPY. While the long-term relationships are consistent across the four different time zones, the short-term dynamics are different. We find that the response of NZD/JPY, AUD/JPY and GBP/JPY to changes in the US stock market is much greater in the New Zealand and Australian zones than in the UK or US. Although the short-term relationship between exchange rates and the equity index is quite strong, the error correction speed is very sluggish. We also find evidence of asymmetric adjustment in the response of exchange rates to changes in global risk aversion. Carry trade currencies tend to appreciate gradually when conditions are favorable but fall sharply when market risk increases.