A multivariate generalized ARCH approach to modeling risk premia in forward foreign exchange rate markets

Assuming that daily spot exchange rates follow a martingale process, we derive the implied time series process for the vector of 30-day forward rate forecast errors from using weekly data. The conditional second moment matrix of this vector is modelled as a multivariate generalized ARCH process. The estimated model is used to test the hypothesis that the risk premium is a linear function of the conditional variances and covariances as suggested by the standard asset pricing theory literature. Little supportt is found for this theory; instead lagged changes in the forward rate appear to be correlated with the 'risk premium.'. © 1990.

Modeling foreign exchange rate pass-through using the exponential GARCH

In this chapter, the authors use an EGARCH-ECM to estimate the pass-through effects of Foreign Exchange (FX) rate changes and changes in producers' prices for 20 U.K. export sectors. The long-run adjustments of export prices to FX rate changes and changes in producers' prices are within the range of -1.02% (for the Textiles sector) and -17.22% (for the Meat sector). The contemporaneous Pricing-To-Market (PTM) coefficients are within the range of -72.84% (for the Fuels sector) and -8.05% (for the Textiles sector). Short-run FX rate pass-through is not complete even after several months. Rolling EGARCH-ECMs show that the short and long-run effects of changes in FX rate and producers' prices vary substantially, as do asymmetry and volatility estimates before equilibrium is achieved.

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.

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 impacts of FOREX fluctuations on construction business performance : an organisational capabilities perspective

Construction projects are a high risk business activity. When undertaking projects in an international context, it is further complicated by the risk of fluctuations in the foreign exchange rates (FOREX). Construction business performance is affected by these fluctuations. They affect progress and cause delays, which in turn create problems for subcontractors, namely cost overruns, disputes, arbitration, total abandonment and litigation. FOREX fluctuations also cause the price of raw materials to increase, leading the cost overruns. Managing FOREX risk is critical and past research have focused on the need for adequate insurance, careful planning and management, and foreign exchange futures hedging to overcome issues that have been caused by the FOREX risk. Analysis of FOREX risk in international construction business usually focused only on issues at the project level. There is currently lack of understanding of Organisational Capabilities (OC) to manage the impacts of FOREX risk, which when examined, are seen in isolation. This paper attempts to bridge the gap by discussing the impacts of FOREX fluctuations on the international construction business. The focus is on the OC perspective and the need to develop OC framework to mitigate the risk in sustaining construction business performance.

A DYNAMIC FRAMEWORK FOR THE RELATIONS BETWEEN FOREIGN EXCHANGE RATES, SAVINGS AND INVESTMENTS

The Meese-Rogoff forecasting puzzle states that foreign exchange (FX) rates are unpredictable. Since one country’s macroeconomic conditions could affect the price of its national currency, we study the dynamic relations between the FX rates and some macroeconomic accounts. Our research tests whether the predictability of the FX rates could be improved through the advanced econometrics. Improving the predictability of the FX rates has important implications for various groups including investors, business entities and the government. The present thesis examines the dynamic relations between the FX rates, savings and investments for a sample of 25 countries from the Organization for Economic Cooperation and Development. We apply quarterly data of FX rates, macroeconomic indices and accounts including the savings and the investments over three decades. Through preliminary Augmented Dickey-Fuller unit root tests and Johansen cointegration tests, we found that the savings rate and the investment rate are cointegrated with the vector (1,-1). This result is consistent with many previous studies on the savings-investment relations and therefore confirms the validity of the Feldstein-Horioka puzzle. Because of the special cointegrating relation between the savings rate and investment rate, we introduce the savings-investment rate differential (SID). Investigating each country through a vector autoregression (VAR) model, we observe extremely insignificant coefficient estimates of the historical SIDs upon the present FX rates. We also report similar findings through the panel VAR approach. We thus conclude that the historical SIDs are useless in forecasting the FX rate. Nonetheless, the coefficients of the past FX rates upon the current SIDs for both the country-specific and the panel VAR models are statistically significant. Therefore, we conclude that the historical FX rates can conversely predict the SID to some degree. Specifically, depreciation in the domestic currency would cause the increase in the SID.

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.

The management of foreign exchange exposure on business contracts overseas

This thesis is a piece of applied research. It is the result of a joint project between the University of Aston Interdisciplinary Higher Degrees Scheme and International Aeradio plc (IAL). It considers the structure and organisation of overseas business and the effects that exchange rate movements have on financial performance. It looks in detail at a series of overseas contracts and factors which affect the monitoring and performance of those contracts. From this initial research is developed a series of conceptual models which attempt to capture the effects of foreign exchange rate movements on contract costing, the monitoring of performance on overseas contracts and a measure of company wide exposure. These models are then considered in the context of real IAL generated data and circumstances. The work is finally considered in the context of a survey of other companies with a similar mode of undertaking overseas business with the aim of placing the work in a general context.

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.

Bid-ask spread dynamics in foreign exchange markets

The aim of this paper is to examine the short term dynamics of foreign exchange rate spreads. Using a vector autoregressive model (VAR) we show that most of the variation in the spread comes from the long run dependencies between past and future spreads rather than being caused by changes in inventory, adverse selection, cost of carry or order processing costs. We apply the Integrated Cumulative Sum of Squares (ICSS) algorithm of Inclan and Tiao (1994) to discover how often spread volatility changes. We find that spread volatility shifts are relatively uncommon and shifts in one currency spread tend not to spillover to other currency spreads. © 2013.

Macroeconomic News Effects and Foreign Exchange Jumps

This thesis investigates how macroeconomic news announcements affect jumps and cojumps in foreign exchange markets, especially under different business cycles. We use 5-min interval from high frequency data on Euro/Dollar, Pound/Dollar and Yen/Dollar from Nov. 1, 2004 to Feb. 28, 2015. The jump detection method was proposed by Andersen et al. (2007c), Lee & Mykland (2008) and then modified by Boudt et al. (2011a) for robustness. Then we apply the two-regime smooth transition regression model of Teräsvirta (1994) to explore news effects under different business cycles. We find that scheduled news related to employment, real activity, forward expectations, monetary policy, current account, price and consumption influences forex jumps, but only FOMC Rate Decisions has consistent effects on cojumps. Speeches given by major central bank officials near a crisis also significantly affect jumps and cojumps. However, the impacts of some macroeconomic news are not the same under different economic states.

Neutralizing the tendency to the overvaluation of the exchange rate or assuming a foreign constraint and asking for foreign savings

The objectives of these notes are two. The first objective is to analyze whether the strategy of growth with absorption of foreign savings leads to a trajectory of the economy that is sustainable in the long run. The second one is to evaluate the possibility of success of a policy of administered devaluation of the exchange rate in Brazil.

Impacts of foreign exchange auctions on the informal market rate in Myanmar

Since the abolition of the official peg and the introduction of a managed float in April 2012, the Central Bank of Myanmar has operated the daily two–way auctions of foreign exchange aimed at smoothing exchange rate fluctuations. Despite the reforms to the foreign exchange regime, however, informal trading of foreign exchange remains pervasive. Using the daily informal exchange rate and Central Bank auction data, this study examines the impacts of auctions on the informal market rate. First, a VAR analysis indicates that the official rate did not Granger cause the informal rate. Second, GARCH models indicate that the auctions did not reduce the conditional variance of the informal rate returns. Overall, the auctions have only a quite modest impact on the informal exchange rate.

Going Multinational under Exchange Rate Uncertainty

Published as an article in: Journal of International Money and Finance, 2010, vol. 29, issue 6, pages 1171-1191.

Bid-ask spreads and volatility in the foreign exchange market. An empirical analysis

Consistent with the implications from a simple asymmetric information model for the bid-ask spread, we present empirical evidence that the size of the bid-ask spread in the foreign exchange market is positively related to the underlying exchange rate uncertainty. The estimation results are based on an ordered probit analysis that captures the discreteness in the spread distribution, with the uncertainty of the spot exchange rate being quantified through a GARCH type model. The data sets consists of more than 300,000 continuously recorded Deutschemark/dollar quotes over the period from April 1989 to June 1989. © 1994.