We study inflation replication in European markets and find that investors can improve their inflation hedge by acquiring foreign inflation-linked derivatives on the international market. Although European inflation-linked bonds holdings have a substantial impact on the inflation hedging ability, their weight in the hedging portfolio is declining over the investment horizon. We show that UK and US inflation-linked bonds can be attractive as well by exploiting long run dynamics of inflation and currency movements. While under stable conditions the replication ability of these portfolios can be improved, uncertainty about long run dynamics may still influence its hedging performance. We confirm with a Bayesian methodology taking into account the uncertainty associated with long run dynamics that during the Financial crisis local nominal bond holdings increased while foreign inflation-linked bonds decreased. While we observe the flight to local securities for inflation hedging investors, European inflation-linked bond holdings remain steady, showing the importance of these bonds in the replication strategy of the investor.
{"title":"Basis Risk and Inflation Replication","authors":"A. de Roode","doi":"10.2139/ssrn.2383207","DOIUrl":"https://doi.org/10.2139/ssrn.2383207","url":null,"abstract":"We study inflation replication in European markets and find that investors can improve their inflation hedge by acquiring foreign inflation-linked derivatives on the international market. Although European inflation-linked bonds holdings have a substantial impact on the inflation hedging ability, their weight in the hedging portfolio is declining over the investment horizon. We show that UK and US inflation-linked bonds can be attractive as well by exploiting long run dynamics of inflation and currency movements. While under stable conditions the replication ability of these portfolios can be improved, uncertainty about long run dynamics may still influence its hedging performance. We confirm with a Bayesian methodology taking into account the uncertainty associated with long run dynamics that during the Financial crisis local nominal bond holdings increased while foreign inflation-linked bonds decreased. While we observe the flight to local securities for inflation hedging investors, European inflation-linked bond holdings remain steady, showing the importance of these bonds in the replication strategy of the investor.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"32 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-08-25","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114269026","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this paper, we report evidence that mean currency returns are positive for both a domestic investor in a foreign currency and a foreign investor in a domestic currency. A shared currency gain creates a positive volatility factor for both. Volatility dominates other return determinants that have opposite impacts on an exchange rate and its inverse to produce positive average returns that we find to be over one per-cent per annum. Positive mean returns impact the global asset allocation of investors to accumulate to a large fraction of wealth creation over time. Currency returns are also large given the common a-priori expectation of investors that they average zero.
{"title":"Positive Mean Currency Returns","authors":"Yufen Fu, G. Blazenko","doi":"10.2139/ssrn.2358048","DOIUrl":"https://doi.org/10.2139/ssrn.2358048","url":null,"abstract":"In this paper, we report evidence that mean currency returns are positive for both a domestic investor in a foreign currency and a foreign investor in a domestic currency. A shared currency gain creates a positive volatility factor for both. Volatility dominates other return determinants that have opposite impacts on an exchange rate and its inverse to produce positive average returns that we find to be over one per-cent per annum. Positive mean returns impact the global asset allocation of investors to accumulate to a large fraction of wealth creation over time. Currency returns are also large given the common a-priori expectation of investors that they average zero.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"5 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-07-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115740158","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper studies the cross-section of foreign exchange volatility returns. A zero cost trading strategy that is long (short) volatility swaps on G10 currencies that have high (low) historical volatility relative to the implied volatility swap rate produces statistically and economically significant returns. The strategy has a Sharpe Ratio in excess of 1.7 and results are robust to different market conditions and time periods remaining highly profitable after transaction costs; standard risk adjustments do not significantly diminish profitability because the strategy is only weakly correlated with the equity market, the carry trade, and the Fama-French risk factors. Moreover, the historical minus implied volatility (HMI) factor also predicts excess-returns of the underlying currencies. Currencies that have high historical volatility relative to their implied volatility have much higher returns. A market-neutral strategy of the underlying currency returns performs better than the carry trade during the sample period and the two factors are negatively correlated.
{"title":"The Cross-Section of Currency Volatility","authors":"K. Rasekhschaffe","doi":"10.2139/ssrn.2154784","DOIUrl":"https://doi.org/10.2139/ssrn.2154784","url":null,"abstract":"This paper studies the cross-section of foreign exchange volatility returns. A zero cost trading strategy that is long (short) volatility swaps on G10 currencies that have high (low) historical volatility relative to the implied volatility swap rate produces statistically and economically significant returns. The strategy has a Sharpe Ratio in excess of 1.7 and results are robust to different market conditions and time periods remaining highly profitable after transaction costs; standard risk adjustments do not significantly diminish profitability because the strategy is only weakly correlated with the equity market, the carry trade, and the Fama-French risk factors. Moreover, the historical minus implied volatility (HMI) factor also predicts excess-returns of the underlying currencies. Currencies that have high historical volatility relative to their implied volatility have much higher returns. A market-neutral strategy of the underlying currency returns performs better than the carry trade during the sample period and the two factors are negatively correlated.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"27 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-06-13","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"134423751","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Models of risk-sharing predict that relative consumption growth rates are positively related to changes in real exchange rates. We investigate this hypothesis using a new multicountry and multiregional data set. Within countries, we find evidence for risk-sharing: episodes of high relative regional consumption growth are associated with regional real exchange rate depreciation. Across countries, however, the association is reversed: relative consumption and real exchange rates are negatively correlated. We define this reversal as a “border” effect. We find the border effect and show that it accounts for over half of the deviations from full risk-sharing. Since cross–border real exchange rates involve different currencies, it is natural to ask how much of the border effect is accounted for by movements in exchange rates. Our measures indicate that a large part of the border effect comes from nominal exchange rate fluctuations. We develop a simple open economy model that is consistent with the importance of nominal exchange rate variability in accounting for deviations from cross–country risk-sharing.
{"title":"Borders and Nominal Exchange Rates in Risk-Sharing","authors":"M. Devereux, Viktoria V. Hnatkovska","doi":"10.2139/ssrn.2285263","DOIUrl":"https://doi.org/10.2139/ssrn.2285263","url":null,"abstract":"\u0000 Models of risk-sharing predict that relative consumption growth rates are positively related to changes in real exchange rates. We investigate this hypothesis using a new multicountry and multiregional data set. Within countries, we find evidence for risk-sharing: episodes of high relative regional consumption growth are associated with regional real exchange rate depreciation. Across countries, however, the association is reversed: relative consumption and real exchange rates are negatively correlated. We define this reversal as a “border” effect. We find the border effect and show that it accounts for over half of the deviations from full risk-sharing. Since cross–border real exchange rates involve different currencies, it is natural to ask how much of the border effect is accounted for by movements in exchange rates. Our measures indicate that a large part of the border effect comes from nominal exchange rate fluctuations. We develop a simple open economy model that is consistent with the importance of nominal exchange rate variability in accounting for deviations from cross–country risk-sharing.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"104 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-06-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127975579","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper investigates the relationship between real exchange rate changes and the German, French and UK automobile and mechanical engineering sector. In stylized models, exports decline whenever the domestic currency appreciates and vice versa. Strategic firm behavior, however, can obscure the unambiguousness of this relationship, rendering the impact of a strengthening Euro on exports and on overall order volume unclear. To quantify the impact of the EUR/USD real exchange rate on German and French key exporting industries, we estimate a trivariate VAR based on monthly data from 1995 to 2010, respectively. We proceed analogously with the GBP/USD rate and the UK automobile and mechanical engineering sector series. Our findings indicate that an appreciating Euro hampers exports in the German and French core sectors, but does not cause these industries “pain” in the sense of an aggravated business climate. The latter does not apply to the respective time series for the UK. Time varying parameter VAR estimates confirm this immunization for members in the period after installation of the currency union.
{"title":"The Exchange Rate Susceptibility of Some European Core Industries and the Currency Union","authors":"David Leuwer, Bernd Süssmuth","doi":"10.2139/ssrn.2274647","DOIUrl":"https://doi.org/10.2139/ssrn.2274647","url":null,"abstract":"This paper investigates the relationship between real exchange rate changes and the German, French and UK automobile and mechanical engineering sector. In stylized models, exports decline whenever the domestic currency appreciates and vice versa. Strategic firm behavior, however, can obscure the unambiguousness of this relationship, rendering the impact of a strengthening Euro on exports and on overall order volume unclear. To quantify the impact of the EUR/USD real exchange rate on German and French key exporting industries, we estimate a trivariate VAR based on monthly data from 1995 to 2010, respectively. We proceed analogously with the GBP/USD rate and the UK automobile and mechanical engineering sector series. Our findings indicate that an appreciating Euro hampers exports in the German and French core sectors, but does not cause these industries “pain” in the sense of an aggravated business climate. The latter does not apply to the respective time series for the UK. Time varying parameter VAR estimates confirm this immunization for members in the period after installation of the currency union.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"24 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-05-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132774035","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Collateral discounting recognises the value of funding for derivatives, which has gained prominence in recent years as basis spreads have widened in response to the financial crises. This article considers the impact of collateral volatility on discount factors and Libor and FX forwards, and re-examines the core assumptions of the approach. Convenient expressions are derived for convexity adjustments and collateral options, in a form that easily integrates into curve building and pricing. Analysis of the models with reasonable volatility assumptions suggests that these pricing adjustments are not negligible.
{"title":"Collateral Convexity of Libor and FX Forwards (Slides)","authors":"P. Mccloud","doi":"10.2139/ssrn.2432526","DOIUrl":"https://doi.org/10.2139/ssrn.2432526","url":null,"abstract":"Collateral discounting recognises the value of funding for derivatives, which has gained prominence in recent years as basis spreads have widened in response to the financial crises. This article considers the impact of collateral volatility on discount factors and Libor and FX forwards, and re-examines the core assumptions of the approach. Convenient expressions are derived for convexity adjustments and collateral options, in a form that easily integrates into curve building and pricing. Analysis of the models with reasonable volatility assumptions suggests that these pricing adjustments are not negligible.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"9 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-04-17","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130953898","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper examines the PPP hypothesis analysing the behaviour of the real exchange rates vis-a-vis the US dollar for four major currencies (namely, the Canadian dollar, the euro, the Japanese yen and the British pound). An innovative approach based on fractional integration in a multivariate context is applied to annual data from 1970 to 2011. Long memory is found to characterise the Canadian dollar, the British pound and the euro, but in all four cases the results are consistent with the relative version of PPP.
{"title":"The PPP Hypothesis Revisited: Evidence Using a Multivariate Long-Memory Model","authors":"G. Caporale, L. Gil‐Alana, Yuliya Lovcha","doi":"10.2139/ssrn.2248676","DOIUrl":"https://doi.org/10.2139/ssrn.2248676","url":null,"abstract":"This paper examines the PPP hypothesis analysing the behaviour of the real exchange rates vis-a-vis the US dollar for four major currencies (namely, the Canadian dollar, the euro, the Japanese yen and the British pound). An innovative approach based on fractional integration in a multivariate context is applied to annual data from 1970 to 2011. Long memory is found to characterise the Canadian dollar, the British pound and the euro, but in all four cases the results are consistent with the relative version of PPP.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"46 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-04-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122019011","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Pub Date : 2013-03-01DOI: 10.5089/9781475532814.001.A001
Matthew Malloy
Using panel data for 15 economies from 2001-12, I identify determinants of central bank foreign exchange intervention in emerging markets (“EMs”) with flexible to moderately managed exchange rates. Similar to other studies, I find that central banks tend to “lean against the wind,” buying/selling more foreign exchange in response to greater short-run and medium-run appreciation/depreciation pressures. The panel structure provides a framework to test whether other macroeconomic variables influence the different rates of reserve accumulation between economies. In testing other variables, I find evidence of both precautionary and external competitiveness motives for reserve accumulation.
{"title":"Factors Influencing Emerging Market Central Banks’ Decision to Intervene in Foreign Exchange Markets","authors":"Matthew Malloy","doi":"10.5089/9781475532814.001.A001","DOIUrl":"https://doi.org/10.5089/9781475532814.001.A001","url":null,"abstract":"Using panel data for 15 economies from 2001-12, I identify determinants of central bank foreign exchange intervention in emerging markets (“EMs”) with flexible to moderately managed exchange rates. Similar to other studies, I find that central banks tend to “lean against the wind,” buying/selling more foreign exchange in response to greater short-run and medium-run appreciation/depreciation pressures. The panel structure provides a framework to test whether other macroeconomic variables influence the different rates of reserve accumulation between economies. In testing other variables, I find evidence of both precautionary and external competitiveness motives for reserve accumulation.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-03-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130250030","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
D. Cain, Adrian Thaxter, Darron Anthony Thomas, K. Thomas, Apryl-Ann Walker
Developing country governments are often forced to issue debt in a foreign currency or commit the "original sin". The "original sin", regardless of exchange rate regime, exacerbates debt problems for these countries. Consequently, this paper investigates the relationship between US dollar denominated government debt and exchange rate movements using unbalanced panel data co-integration techniques on 87 low and middle income countries over the period 1960 to 2006. Our findings suggests that exchange rate Granger-causes the stock of foreign currency denominated debt, however, there is no bidirectional causality.
{"title":"The Original Sin and Exchange Rate Dynamics: Panel Cointegration Evidence","authors":"D. Cain, Adrian Thaxter, Darron Anthony Thomas, K. Thomas, Apryl-Ann Walker","doi":"10.2139/ssrn.2312425","DOIUrl":"https://doi.org/10.2139/ssrn.2312425","url":null,"abstract":"Developing country governments are often forced to issue debt in a foreign currency or commit the \"original sin\". The \"original sin\", regardless of exchange rate regime, exacerbates debt problems for these countries. Consequently, this paper investigates the relationship between US dollar denominated government debt and exchange rate movements using unbalanced panel data co-integration techniques on 87 low and middle income countries over the period 1960 to 2006. Our findings suggests that exchange rate Granger-causes the stock of foreign currency denominated debt, however, there is no bidirectional causality.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"2 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-12-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"131487337","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper investigates efficiency performance of the black market for foreign exchange in Sudan. The finding of the paper indicate the inefficiency hypothesis cannot be rejected. This result imply, authorities in the central bank need to be cautious about use of the black market depreciation rate as indicator to official exchange rate devaluation rate. The finding of the paper also shows there is no significant evidence of structural change in the behavior of the black market due to the loss of the country a significant portion of its oil revenue after the country split. This result can be interpreted as evidence of weak association of the black market with fundamentals of the economy.
{"title":"Black Market for Foreign Currencies: A Lesson from a Siege Economy","authors":"I. Onour","doi":"10.2139/ssrn.2175032","DOIUrl":"https://doi.org/10.2139/ssrn.2175032","url":null,"abstract":"This paper investigates efficiency performance of the black market for foreign exchange in Sudan. The finding of the paper indicate the inefficiency hypothesis cannot be rejected. This result imply, authorities in the central bank need to be cautious about use of the black market depreciation rate as indicator to official exchange rate devaluation rate. The finding of the paper also shows there is no significant evidence of structural change in the behavior of the black market due to the loss of the country a significant portion of its oil revenue after the country split. This result can be interpreted as evidence of weak association of the black market with fundamentals of the economy.","PeriodicalId":413816,"journal":{"name":"Econometric Modeling: International Financial Markets - Foreign Exchange eJournal","volume":"100 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-11-13","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127824828","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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