Assessment on estimations of currency basket weights—With coefficient correction for common factor dominance

Ping Wang,Peijie Wang

doi:10.1002/ijfe.2222

Abstract

AbstractThis paper proposes an approach to correcting parameter misrepresentation under the dominance of a common factor, a customarily overlooked phenomenon. Meanwhile, it provides a general solution to a specific regression bias, namely coefficient correction for common factor dominance in econometrics, which is commonly encountered in the research on currency interactions and co‐movements and beyond. The RMB basket weights are then scrutinized exhaustively, going through all stages of the evolving RMB regime and reforms. Correct and sensible currency basket weights are derived accordingly. It has been found that only the introduction of the central parity regime in 2015 has changed the RMB exchange rate patterns notably. The RMB market behavior and patterns virtually did not change during the prior reforms that had widened the band of daily fluctuation in the RMB exchange rate against the US dollar from 0.3% through to 2%, given the band's unique link to the US dollar.

Highlights

The distribution of currency weights in a currency basket indicates the degree of flexibility of the currency on the foreign exchange market
That the “weight” of the US dollar is still as high as 90% and the other freely floating currencies have usually accounted for less than 1% each even in the second sub-period of the central parity regime should not come as a surprise
The RMB currency basket weights are assessed sensibly and weight estimates are achieved objectively, applying an approach developed in this paper to correcting parameter misrepresentation under the dominance of a common factor

Summary

Introduction

The distribution of currency weights in a currency basket indicates the degree of flexibility of the currency on the foreign exchange market. The de jure arrangements as described by the countries and the de facto arrangements can differ, as documented by International Monetary Fund (IMF) in various issues of the Annual Report on Exchange Arrangements and Exchange Restrictions (IMF, 2018a). This is reinforced by Reinhart (2000) who observes that countries say they allow their exchange rate to float mostly do not. That the lack of exchange rate depreciation in the fixed exchange rate regime is accompanied by a stronger fall in exports than non-fixed exchange rate regimes is one of the three adverse findings for fixed exchange rate arrangements in Zeev (2019) It is documented in Reinhart (2000) that the low relative exchange rate variability leads to very

Objectives

Findings

Conclusion