A Bootstrap Neural Network Based Heterogeneous Panel Unit Root Test: Application to Exchange Rates

This paper proposes a bootstrap artificial neural network based panel unit root test in a dynamic heterogeneous panel context. An application to a panel of bilateral real exchange rate series with the US Dollar from the 20 major OECD countries is provided to investigate the Purchase Power Parity (PPP). The combination of neural network and bootstrapping significantly changes the findings of the economic study in favour of PPP.

Co-movements in Real Effective Exchange Rates: Evidence from the Dynamic Hierarchical Factor Model

We analyze and quantify co-movements in real effective exchange rates while considering the regional location of countries. More specifically, using the dynamic hierarchical factor model (Moench et al. (2011)), we decompose exchange rate movements into several latent components; worldwide and two regional factors as well as country-specific elements. Then, we provide evidence that the worldwide common factor is closely related to monetary policies in large advanced countries while regional common factors tend to be captured by those in the rest of the countries in a region. However, a substantial proportion of the variation in the real exchange rates is reported to be country-specific; even in Europe country-specific movements exceed worldwide and regional common factors.

Price Transmission and Effects of Exchange Rates on Domestic Commodity Prices via Offshore and Currency Hedging

The framework presents how trading in the foreign commodity futures market and the forward exchange market can affect the optimal spot positions of domestic commodity producers and traders. It generalizes the models of Kawai and Zilcha (1986) and Kofman and Viaene (1991) to allow both intermediate and final commodities to be traded in the international and futures markets, and the exporters/importers to face production shock, domestic factor costs and a random price. Applying mean-variance expected utility, we find that a rise in the expected exchange rate can raise both supply and demand for commodities and reduce domestic prices if the exchange rate elasticity of supply is greater than that of demand. Whether higher volatilities of exchange rate and foreign futures price can reduce the optimal spot position of domestic traders depends on the correlation between the exchange rate and the foreign futures price. Even though the forward exchange market is unbiased, and there is no correlation between commodity prices and exchange rates, the exchange rate can still affect domestic trading and prices through offshore hedging and international trade if the traders are interested in their profit in domestic currency. It illustrates how the world prices and foreign futures prices of commodities and their volatility can be transmitted to the domestic market as well as the dynamic relationship between intermediate and final goods prices. The equilibrium prices depends on trader behaviour i.e. who trades or does not trade in the foreign commodity futures and domestic forward currency markets. The empirical result applying a two-stage-least-squares approach to Thai rice and rubber prices supports the theoretical result.

3-Regime symmetric STAR modeling and exchange rate reversion

The breakdown of the Bretton Woods system and the adoption of generalized oating exchange rates ushered in a new era of exchange rate volatility and uncer- tainty. This increased volatility lead economists to search for economic models able to describe observed exchange rate behavior. In the present paper we propose more general STAR transition functions which encompass both threshold nonlinearity and asymmetric e¤ects. Our framework allows for a gradual adjustment from one regime to another, and considers threshold e¤ects by encompassing other existing models, such as TAR models. We apply our methodology to three di¤erent exchange rate data-sets, one for developing countries, and o¢ cial nominal exchange rates, the sec- ond emerging market economies using black market exchange rates and the third for OECD economies.

Technical Appendix-3-Regime asymmetric STAR modeling and exchange rate reversion

The breakdown of the Bretton Woods system and the adoption of generalized oating exchange rates ushered in a new era of exchange rate volatility and uncer- tainty. This increased volatility lead economists to search for economic models able to describe observed exchange rate behavior. The present is a technical Appendix to Cerrato et al. (2009) and presents detailed simulations of the proposed methodology and additional empirical results.

An investigation of customer order flow in the foreign exchange market

This paper examines the effect that heterogeneous customer orders flows have on exchange rates by using a new, and the largest, proprietary dataset of weekly net order flow segmented by customer type across nine of the most liquid currency pairs. We make several contributions. Firstly, we investigate the extent to which customer order flow can help to explain exchange rate movements over and above the influence of macroeconomic variables. Secondly, we address the issue of whether order flows contain (private) information which explain exchange rates changes. Thirdly, we look at the usefulness of order flow in forecasting exchange rate movements at longer horizons than those generally considered in the microstructure literature. Finally we address the question of whether the out-of-sample exchange rate forecasts generated by order flows can be employed profitably in the foreign exchange markets

Local Currency Pricing, Foreign Monetary Shocks and Exchange Rate Policy

The implications of local currency pricing (LCP) for monetary regime choice are analysed for a country facing foreign monetary shocks. In this analysis expenditure switching is potentially welfare reducing. This contrasts with the existing LCP literature, which focuses on productivity shocks and thus analyses a world where expenditure switching is welfare enhancing. This paper shows that, when home and foreign producers follow LCP, expenditure switching is absent and a floating rate is preferred by the home country. But when only home producers follow LCP, expenditure switching is present and a fixed rate can be welfare enhancing for the home country.

Equilibrium Exchange Rate Determination and Multiple Structural Changes

The large appreciation and depreciation of the US dollar in the 1980s stimulated an important debate on the usefulness of unit root tests in the presence of structural breaks. In this paper, we propose a simple model to describe the evolution of the real exchange rate. We then propose a more general smooth transition (STR) function than has hitherto been employed, which is able to capture structural changes along the (long-run) equilibrium path, and show that this is consistent with our economic model. Our framework allows for a gradual adjustment between regimes and allows for under- and/or over-valued exchange rate adjustments. Using monthly and quarterly data for up to twenty OECD countries, we apply our methodology to investigate the univariate time series properties of CPI-based real exchange rates with both the U.S. dollar and German mark as the numeraire currencies. The empirical results show that, for more than half of the quarterly series, the evidence in favour of the stationarity of the real exchange rate was clearer in the sub-sample period post-1980.

Inflation Uncertainty, Exchange Rate Depreciation and Volatility: Evidence from Ghana, Mozambique and Tanzania

While flexible exchange rates facilitate stabilisation, exchange rate fluctuations can cause real volatility. This gives policy importance to the causal relationship between exchange rate depreciation and its volatility. An exchange rate may be expected to become more volatile when the underlying currency loses value. We conjecture that a reverse causation, which further weakens the currency, may be mitigated by price stability. Data from Ghana, Mozambique and Tanzania support this: depreciation makes exchange rate more volatile for all but volatility does not causes depreciation in Tanzania which has enjoyed a more stable inflation despite all countries adopting similar macro-policies since early 1990s.

Measuring the Economic Significance of Structural Exchange Rate Models

This paper examines both the in-sample and out-of-sample performance of three monetary fundamental models of exchange rates and compares their out-of-sample performance to that of a simple Random Walk model. Using a data-set consisting of five currencies at monthly frequency over the period January 1980 to December 2009 and a battery of newly developed performance measures, the paper shows that monetary models do better (in-sample and out-of-sample forecasting) than a simple Random Walk model.

The Signalling Channel of Central Bank Interventions: Modelling the Yen/US Dollar Exchange Rate

This paper presents a theoretical framework analysing the signalling channel of exchange rate interventions as an informational trigger. We develop an implicit target zone framework with learning in order to model the signalling channel. The theoretical premise of the model is that interventions convey signals that communicate information about the exchange rate objectives of central bank. The model is used to analyse the impact of Japanese FX interventions during the period 1999 -2011 on the yen/US dollar dynamics.

The Signalling Channel of Central Bank Interventions: Modelling the Yen/US Dollar Exchange Rate

This paper presents a theoretical framework analysing the signalling channel of exchange rate interventions as an informational trigger. We develop an implicit target zone framework with learning in order to model the signalling channel. The theoretical premise of the model is that interventions convey signals that communicate information about the exchange rate objectives of central bank. The model is used to analyse the impact of Japanese FX interventions during the period 1999 -2011 on the yen/US dollar dynamics.

Exchange Rate Predictability in a Changing World

An expanding literature articulates the view that Taylor rules are helpful in predicting exchange rates. In a changing world however, Taylor rule parameters may be subject to structural instabilities, for example during the Global Financial Crisis. This paper forecasts exchange rates using such Taylor rules with Time Varying Parameters (TVP) estimated by Bayesian methods. In core out-of-sample results, we improve upon a random walk benchmark for at least half, and for as many as eight out of ten, of the currencies considered. This contrasts with a constant parameter Taylor rule model that yields a more limited improvement upon the benchmark. In further results, Purchasing Power Parity and Uncovered Interest Rate Parity TVP models beat a random walk benchmark, implying our methods have some generality in exchange rate prediction.

Measuring the Euro-Dollar Permanent Equilibrium Exchange Rate using the Unobserved Components Model

This paper employs an unobserved component model that incorporates a set of economic fundamentals to obtain the Euro-Dollar permanent equilibrium exchange rates (PEER) for the period 1975Q1 to 2008Q4. The results show that for most of the sample period, the Euro-Dollar exchange rate closely followed the values implied by the PEER. The only significant deviations from the PEER occurred in the years immediately before and after the introduction of the single European currency. The forecasting exercise shows that incorporating economic fundamentals provides a better long-run exchange rate forecasting performance than a random walk process.

Productivity, Preferences and UIP deviations in an Open Economy Business Cycle Model

We show that a flex-price two-sector open economy DSGE model can explain the poor degree of international risk sharing and exchange rate disconnect. We use a suite of model evaluation measures and examine the role of (i) traded and non-traded sectors; (ii) financial market incompleteness; (iii) preference shocks; (iv) deviations from UIP condition for the exchange rates; and (v) creditor status in net foreign assets. We find that there is a good case for both traded and non-traded productivity shocks as well as UIP deviations in explaining the puzzles.