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.     

Forward rates as predictors of future spot rates

When adjusted for variation through time in expected premiums, the forward rates of interest that are implicit in Treasury Bill prices contain assessments of expected future spot rates of interest that are about as good as those that can be obtained from the information in past spot rates. Moreover, in setting bill prices and forward rates, the market reacts appropriately to the negative autocorrelation in monthly changes in the spot rate and to changes through time in the degree of this autocorrelation. This evidence is consistent with the market efficiency proposition that in setting bill prices, the market correctly uses the information in past spot rates.     

Forward exchange rates in general equilibrium

This paper develops a two-country, overlapping-generations model of an economy with a forward market in foreign exchange. The equilibrium forward rate exhibits the conventional decomposition into the expected future spot rate, a convexity term and a risk premium. Unlike partial equilibrium models, however, the model expresses these terms as functions of the primitive structural parameters of the economy. It thus provides insights into the structure of the premium which may facilitate interpretation of empirical studies of the forward markets. In particular, it suggests that time-varying risk premia may arise from changes in the distribution of wealth between countries over time.     

On the informational content of spot and forward exchange rates

In foreign exchange markets, efficiency tests have typically been applied to the forward rate on the argument that the forward rate should be a good proxy for the unobservable market expectations of future spot rates. The present study offers innovations in two directions. First we utilize a data set which consists of daily observations on spot and forward exchange rates. This allows us to match the forward contract with the exact settlement date and to create a large number of non-overlapping data sets. Second, and more importantly, we show that in general the current spot rate is a ‘better’ predictor of the future spot rate than is the current forward rate of appropriate maturity.     

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.     

Macroeconomic news and exchange rates

This paper examines the relationship between macroeconomic news and the dollar–Mark and dollar–Yen exchange rates. We employ high-frequency observations for a 10-year period. We investigate whether exchange rate observations need to be sampled at a high frequency in order to detect significant effects from news announcements on mean returns and volatility. We examine the linearity and symmetry of the responses to news and also allow the effects of the news announcements to vary across states of the economy. We find that news indicating a stronger U.S. economy causes an appreciation of the U.S. dollar, that the responses are essentially complete within 5 min, and that measuring the responses over 6-h intervals eliminates the statistical significance of the news. The effects of news appear linear and symmetric but there is some evidence that the effects depend on the state of the economy.     

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.     

Real exchange rates and skills

Recent developments in trade theory strongly emphasize that international trade requires an intensive use of skilled workers. Against this background, we explore in this paper whether labor skills are a key determinant of real exchange rates in the long run. Using panel regressions covering 22 countries over the period 1950–2010, we find that labor skills are indeed a structural determinant of real exchange rates, with a permanent increase of the skilled–unskilled labor ratio leading to a long-run appreciation of the real exchange rate. This finding is robust to the inclusion of several control variables, like those used in traditional analyses of real exchange rates.     

Cointegration and forward and spot exchange rate regressions

We investigate the relationship between cointegration models of the current spot exchange rate, s_t, and the current forward rate, f_t, and cointegration models of the future spot rate, s_t+1, and f_t and the implications of this relationship for tests of the forward rate unbiasedness hypothesis (FRUH). We show that simple models of cointegration between s_t and f_t imply complicated models of cointegration between s_t+1 and f_t. Consequently, standard methods are often inappropriate for modeling the cointegrated behavior of (s_t+1, f_t)′ and we show that the use of such methods can lead to erroneous inferences regarding the FRUH.     

On the correlation of exchange rates and interest rates

This note shows that a negative correlation between the price of foreign currency and nominal interest rates in not necessarily an indication of movements in the real rate of interests. Such a correlation could be consistent with a monetarist model in which the real rate is constant.     

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.     

Productivity shocks and real exchange rates

Previous studies have concluded that productivity shocks have negligible effects on real exchange rate fluctuations. This paper shows that when long-run equilibrium relationships between real exchange rate levels and fundamental variables are taken into account, relative productivity shocks account for most of the long-run movements in the real exchange rates. This can be interpreted as empirical support for the Balassa (1964. Journal of Political Economy 72, 584-596) and Samuelson (1964. Review of Economics and Statistics 46, 145-154) model where differences in relative productivity is the main source of long-run deviations for purchasing power parity.     

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.     

Flexible exchange rates and stabilizing speculation

This paper re-establishes the superiority of flexible exchange rates in small open economy models characterized by an efficient foreign exchange market and short-run imperfections in the product (labor) market.     

International asset returns and exchange rates

We present a consumption-based international asset-pricing model to study global equity premiums, the US riskfree rate and the cross section of international asset returns. The model entails idiosyncratic, country-specific consumption risk, which helps explain the magnitude of global equity premiums. It also features country-specific habit formation, which helps explain the level of the interest rate on the US short-term Treasury bills traded by domestic and international investors. We find that the model explains approximately 40–50% of the cross section of currency and equity premiums as well as expected returns from value and growth portfolios of at least a dozen countries. Changes in real exchange rates are responsible for explaining approximately half of the cross section of international asset returns.     

Fractional cointegration and real exchange rates

This paper uses fractional integration and cointegration to model the DM-US dollar and the yen-US dollar real exchange rates in terms of both monetary and real factors, more specifically real interest rate and labour productivity differentials. We find that whilst the individual series may be integrated of order 1, their long-run relationship might have a fractionally cointegrated structure. This means that mean reversion occurs, consistently with the findings of other studies. However, it also indicates, in contrast to such studies, that the cointegrating relationship possesses long memory. In other words, the error correction term responds slowly to shocks, implying that deviations from equilibrium are long-lived. It appears that only a combination of real and monetary variables can accurately track down the movements of real exchange rates.     

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.