Abstract
This study tests whether gold can effectively hedge exchange rate risks. We take into account the asymmetric characteristic of exchange rate fluctuations and use the dynamic panel threshold model in order to select gold prices in major gold-related currencies in the world: the Australian dollar, the Canadian dollar, the euro, the Indian rupee, the Japanese yen, the South African rand, and the British pound. Using monthly data from January 1999 to January 2010, with lagged one-period exchange rate returns (US dollar depreciation rate) as the threshold variable, the estimation results suggest that there are two thresholds at –7.5% and –3.7%. These can be divided into regime 1 (exchange rate returns ≤ –7.5%), regime 2 (–7.5% < exchange rate returns ≤ –3.7%), and regime 3 (exchange rate returns > –3.7%). Regarding the effectiveness of gold hedging, regime 2 is higher than is regime 3. The risk hedging effect of regime 1 is not significant because it might be caused by the excessive devaluation of the US dollar in the short-term and the overshooting of the exchange rate adjustment, making gold unable to hedge the devaluation risks of the US dollar.
Highlights
Since 2009, fuelled by the capital market, gold price quotes have frequently surprised by traders
Following Wang and Lee (2011), we develop a simple model for the global gold market in which the purchasing power parity (PPP) theory holds for gold prices but not for the prices of general commodities
Previous studies of whether gold can effectively avoid exchange rate risks have usually analysed the relationship between a single currency and gold prices by individual country using time series data
Summary
Since 2009, fuelled by the capital market, gold price quotes have frequently surprised by traders. If the relationship between gold prices and the exchange rate can be estimated by nonlinear models, more information about using gold to effectively hedge exchange rate fluctuations can be provided to investors. The main purpose of this study is to test whether gold can effectively hedge exchange rate risks, namely whether gold can offset changes in the domestic purchasing power of a currency in the case of depreciation. This study takes into account the asymmetric characteristics of exchange rate changes and uses the DPTM in order to select gold prices in major gold-related currencies in the world: the Australian dollar, the Canadian dollar, the euro, the Indian rupee, the Japanese yen, the South African rand, and the pound. The main implication of the use of nonlinear models and multinational panel data in this study is to further expand the concept of exchange rate fluctuations. Coupled with the DPTM, the validation approach has never before been attempted and this is the major innovation of this study
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