The Real Exchange Rate in Small Open Developed Economies: Evidence from Cointegration Analysis

We examine the effects of the terms of trade and the expected real interest rate differential on the real exchange rate in a sample of small open developed economies. We employ cointegration analysis to search for possible long-term linkages. We find that while both the terms of trade and the expected real interest rate differentials affect the real exchange rate in the long run, the role of the terms of trade generally proves more consistent across countries. The speed of adjustment for the expected real interest rate differential in the error-correction model, however, is quantitatively larger than it is for the terms of trade.

Increasing Derivatives Market Activity in Emerging Markets and Exchange Rate Exposure

Understanding the effects of off-balance sheet transactions on interest and exchange rate exposures has become more important for emerging market countries that are experiencing remarkable growth in derivatives markets. Using firm level data, we report a significant fall in exposure over the past 10 years and relate this to higher derivatives market participation. Our methodology is composed of a three stage approach: First, we measure foreign exchange exposures using the Adler-Dumas (1984) model. Next, we follow an indirect approach to infer derivatives market participation at the firm level. Finally, we study the relationship between exchange rate exposure and derivatives market participation. Our results show that foreign exchange exposure is negatively related to derivatives market participation, and support the hedging explanation of the exchange rate exposure puzzle. This decline is especially salient in the financial sector, for bigger firms, and over longer time periods. Results are robust to using different exchange rates, a GARCH-SVAR approach to measure exchange rate exposure, and different return horizons.

Exchange Rate Stabilization and IMF High Interest Rate Policy: A Critical Reconsideration Using a Dynamic Model

This paper examines whether the IMF high interest rate policy was suitable for crisis-ridden East Asian economies. Using an "overshoot" model similar to that of Dornbusch's (1976), it shows that this sort of policy might cause an unnecessary deflationary adjusting process and have no effect on containing the real depreciation of exchange rates in the long run. The study also demonstrates that Thai economic data coincides quite well with the model presented here. Finally, it points out that the high interest policy itself might provoke high risk-premium, the existence of which, in turn, justifies the policy. This means that the policy has a self-fulfilling property. In conclusion, a "one-size-fits-all" adaptation of high interest rate policy in a currency crisis is very dangerous in general, and was inappropriate for East Asia. The desirable policy would have been to let currencies depreciate and keep interest rates stable.

What Explains Real and Nominal Exchange Rate Fluctuations? Evidence from SVAR Analysis for India

This study empirically analyzes the sources of the exchange rate fluctuations in India by employing the structural VAR model. The VAR system consists of three variables, i.e., the nominal exchange rate, the real exchange rate, and the relative output of India and a foreign country. Consistent with most previous studies, the empirical evidence demonstrates that real shocks are the main drives of the fluctuations in real and nominal exchange rates, indicating that the central bank cannot maintain the real exchange rate at its desired level over time.

Transition from black to official markets for foreign exchange in Myanmar

We address the puzzle why the black market for foreign exchange thrives in Myanmar despite the successful unification of multiple exchange rates. A closer look at the black market reveals that its enduring competitiveness stems from its lower transaction costs. A question arising from this observation is how the official market, namely banks, can compete with and replace the black market. Our empirical analysis based on an original questionnaire survey of private export firms regarding their choices of currency trading modes suggests that banks can attract exporters by exploiting the economies of scope between currency trading and lending.

Fractionation factors and activation energies for exchange of the low barrier hydrogen bonding proton in peptidyl trifluoromethyl ketone complexes of chymotrypsin

NMR investigations have been carried out of complexes between bovine chymotrypsin Aα and a series of four peptidyl trifluoromethyl ketones, listed here in order of increasing affinity for chymotrypsin: N-Acetyl-l-Phe-CF3, N-Acetyl-Gly-l-Phe-CF3, N-Acetyl-l-Val-l-Phe-CF3, and N-Acetyl-l-Leu-l-Phe-CF3. The D/H fractionation factors (φ) for the hydrogen in the H-bond between His 57 and Asp 102 (His 57-Hδ1) in these four complexes at 5°C were in the range φ = 0.32–0.43, expected for a low-barrier hydrogen bond. For this series of complexes, measurements also were made of the chemical shifts of His 57-Hɛ1 (δ2,2-dimethylsilapentane-5-sulfonic acid 8.97–9.18), the exchange rate of the His 57-Hδ1 proton with bulk water protons (284–12.4 s−1), and the activation enthalpies for this hydrogen exchange (14.7–19.4 kcal⋅mol−1). It was found that the previously noted correlations between the inhibition constants (Ki 170–1.2 μM) and the chemical shifts of His 57-Hδ1 (δ2,2-dimethylsilapentane-5-sulfonic acid 18.61–18.95) for this series of peptidyl trifluoromethyl ketones with chymotrypsin [Lin, J., Cassidy, C. S. & Frey, P. A. (1998) Biochemistry 37, 11940–11948] could be extended to include the fractionation factors, hydrogen exchange rates, and hydrogen exchange activation enthalpies. The results support the proposal of low barrier hydrogen bond-facilitated general base catalysis in the addition of Ser 195 to the peptidyl carbonyl group of substrates in the mechanism of chymotrypsin-catalyzed peptide hydrolysis. Trends in the enthalpies for hydrogen exchange and the fractionation factors are consistent with a strong, double-minimum or single-well potential hydrogen bond in the strongest complexes. The lifetimes of His 57-Hδ1, which is solvent shielded in these complexes, track the strength of the hydrogen bond. Because these lifetimes are orders of magnitude shorter than those of the complexes themselves, the enzyme must have a pathway for hydrogen exchange at this site that is independent of dissociation of the complexes.

A general two-process model describes the hydrogen exchange behavior of RNase A in unfolding conditions.

When NMR hydrogen exchange was used previously to monitor the kinetics of RNase A unfolding, some peptide NH protons were found to show EX2 exchange (detected by base catalysis) in addition to the expected EX1 exchange, whose rate is limited by the kinetic unfolding process. In earlier work, two groups showed independently that a restricted two-process model successfully fits published hydrogen exchange rates of native RNase A in the range 0-0.7 M guanidinium chloride. We find that this model predicts properties that are very different from the observed properties of the EX2 exchange reactions of RNase A in conditions where guanidine-induced unfolding takes place. The model predicts that EX2 exchange should be too fast to measure by the technique used, whereas it is readily measurable. Possible explanations for the contradiction are considered here, and we show that removing the restriction from the earlier two-process model is sufficient to resolve the contradiction; instead of specifying that exchange caused by global unfolding occurs by the EX2 mechanism, we allow it to occur by the general mechanism, which includes both the EX1 and EX2 cases. It is logical to remove this restriction because global unfolding of RNase A is known to give rise to EX1 exchange in these unfolding conditions. Resolving the contradiction makes it possible to determine whether populated unfolding intermediates contribute to the EX2 exchange, and this question is considered elsewhere. The results and simulations indicate that moderate or high denaturant concentrations readily give rise to EX1 exchange in native proteins. Earlier studies showed that hydrogen exchange in native proteins typically occurs by the EX2 mechanism but that high temperatures or pH values above 7 may give rise to EX1 exchange. High denaturant concentrations should be added to the list of variables likely to cause EX1 exchange.

EU-Mercosur trade relations: impacts of exchange rate misalignments on tariffs. CEPS Working Document No. 372, February 2013

The issue of “trade and exchange rate misalignments” is being discussed at the G20, IMF and WTO, following an initiative by Brazil. The main purpose of this paper is to apply the methodology developed by the authors to exam the impacts of misalignment on tariffs in order to analyse the impacts of misalignments on the trade relations between two customs unions – the EU and Mercosur, as well as to explain how tariff barriers are affected. It is divided into several sections: the first summarises the debate on exchange rates at the WTO; the second explains the methodology used to determine exchange rate misalignments; the third and fourth summarises the methodology applied to calculate the impacts of exchange rate misalignments on the level of tariff protection through an exercise of ‘misalignment tariffication’; the fifth reviews the effects of exchange rate misalignments on tariffs and its consequences for the trade negotiations between the two areas; and the last concludes and suggests a way to move the debate forward in the context of regional arrangements.

System for foreign exchange trading using genetic algorithms and reinforcement learning

Foreign exchange trading has emerged recently as a significant activity in many countries. As with most forms of trading, the activity is influenced by many random parameters so that the creation of a system that effectively emulates the trading process will be very helpful. A major issue for traders in the deregulated Foreign Exchange Market is when to sell and when to buy a particular currency in order to maximize profit. This paper presents novel trading strategies based on the machine learning methods of genetic algorithms and reinforcement learning.

A machine learning approach to intraday trading on foreign exchange markets

Foreign Exchange trading has emerged in recent times as a significant activity in many countries. As with most forms of trading, the activity is influenced by many random parameters so that the creation of a system that effectively emulates the trading process will be very helpful. In this paper we try to create such a system using Machine learning approach to emulate trader behaviour on the Foreign Exchange market and to find the most profitable trading strategy.

Leading edge forecasting techniques for exchange rate prediction

This paper describes how modern machine learning techniques can be used in conjunction with statistical methods to forecast short term movements in exchange rates, producing models suitable for use in trading. It compares the results achieved by two different techniques, and shows how they can be used in a complementary fashion. The paper draws on experience of both inter- and intra-day forecasting taken from earlier studies conducted by Logica and Chemical Bank Quantitative Research and Trading (QRT) group's experience in developing trading models.

Exchange rate exposure : do size and foreign operations matter?

Purpose – The purpose of this paper is to examine the effect of firm size and foreign operations on the exchange rate exposure of UK non-financial companies from January 1981 to December 2001. Design/methodology/approach – The impact of the unexpected changes in exchange rates on firms’ stock returns is examined. In addition, the movements in bilateral, equally weighted (EQW) and trade-weighted and exchange rate indices are considered. The sample is classified according to firm size and the extent of firms’ foreign operations. In addition, structural changes on the relationship between exchange rate changes and individual firms’ stock returns are examined over three sub-periods: before joining the exchange rate mechanism (pre-ERM), during joining the ERM (in-ERM), and after departure from the ERM (post-ERM). Findings – The findings indicate that a higher percentage of UK firms are exposed to contemporaneous exchange rate changes than those reported in previous studies. UK firms’ stock returns are more affected by changes in the EQW, and US$ European currency unit exchange rate, and respond less significantly to the basket of 20 countries’ currencies relative to the UK pound exchange rate. It is found that exchange rate exposure has a more significant impact on stock returns of the large firms compared with the small and medium-sized companies. The evidence is consistent across all specifications using different exchange rate. The results provide evidence that the proportion of significant foreign exchange rate exposure is higher for firms which generate a higher percentage of revenues from abroad. The sensitivities of firms’ stock returns to exchange rate fluctuations are most evident in the pre-ERM and post-ERM periods. Practical implications – This study provides important implications for public policymakers, financial managers and investors on how common stock returns of various sectors react to exchange rate fluctuations. Originality/value – The empirical evidence supports the view that UK firms’ stock returns are affected by foreign exchange rate exposure.

The exchange rate exposure of UK non-financial companies

Purpose – The purpose of this paper is to investigate the exchange rate exposure of UK nonfinancial companies from January 1981 to December 2001. Design/methodology/approach – The study employs different exchange rate measures and adopts an equally weighted exchange rate. The analyses are conducted at the firm level. All analyses are conducted by regressing the firm’s exchange rate exposure coefficients on its size, foreign activity variables and financial hedging proxies over the whole sample period. Findings – The findings show that a higher percentage of UK non-financial companies are exposed to exchange rate changes than those reported in previous studies. Generally, the results provide a stronger support for the suggested equally weighted rate as an economic variable, which affects firms’ stock returns. The results also show a high proportion of positive exposure coefficients among firms with significant exchange rate exposure, indicating a higher proportion of firms benefiting from an appreciation of the pound. Finally, the results also indicate evidence that firms’ foreign operations and hedging variables affect their sensitivity to exchange rate exposure. Practical implications – This study provides important implications for public policymakers who wish to understand links between policies that affect exchange rates and relative wealth effects. Originality/value – The empirical results of this study should help investors to examine how common stock returns react to exchange rate fluctuations when making financial decisions, and prove useful for financial managers when measuring exposure to foreign exchange rate changes.

Post-Bretton Woods evidence on PPP under different exchange rate regimes

This article investigates the behaviour of exchange rates across different regimes for a post-Bretton Woods period. The exchange rate regime classification is based on the classification of Frankel et al. (2004) who condensed the 10 categories of exchange rate regimes reported by the International Monetary Fund (IMF) into three categories. Panel unitroot tests and panel cointegration are used to examine the Purchasing Power Parity (PPP) hypothesis. The latter test is used to check for both the weak and strong forms of PPP. The panel unit-root tests show no evidence of PPP and suggest there is no difference in the behaviour of exchange rates across different regimes. However, failure to detect PPP across any of the regimes could be due to structural breaks. This assumption is reinforced by the results of cointegration tests, which suggest that there exists at least a weak form of PPP for the different regimes. The evidence for strong PPP decreases as the exchange rate regime moves away from a flexible exchange rate regime.

Exchange rate economic exposure and hedging:the significance of currency options

This thesis focuses on the theoretical examination of the exchange rate economic (operating) exposure within the context of the theory of the firm, and proposes some hedging solutions using currency options. The examination of economic exposure is based on such parameters as firms' objectives, industry structure and production cost efficiency. In particular, it examines an hypothetical exporting firm with costs in domestic currency, which faces competition from foreign firms in overseas markets and has a market share expansion objective. Within this framework, the hypothesis is established that economic exposure, portrayed in a diagram connecting export prices and real exchange rates, is asymmetric (i.e. the negative effects depreciation are higher than the positive effects of a currency depreciation). In this case, export business can be seen as a real option, given by exporting firms to overseas customer. Different scenarios about the asymmetry hypothesis can be derived for different assumptions about the determinants of economic exposure. Having established the asymmetry hypothesis, the hedging against this exposure is analysed. The hypothesis is established, that a currency call option should be used in hedging against asymmetric economic exposure. Further, some advanced currency options stategies are discussed, and their use in hedging several scenarios of exposure is indicated, establishing the hypothesis that, the optimal options strategy is a function of the determinants of exposure. Some extensions on the theoretical analysis are examined. These include the hedging of multicurrency exposure using options, and the exposure of a purely domestic firm facing import competition. The empirical work addresses two issues: the empirical validity of the asymmetry hypothesis and the examination of the hedging effectiveness of currency options.