Quantitative Comparisons on the Intrinsic Features of Foreign Exchange Rates Between the 1920s and the 2010s: Case of the USD-GBP Exchange Rate

Abstract

(ProQuest: ... denotes formulae omitted.)I. INTRODUCTIONAs pointed by Baillie and Bailey (1984), many economists have been fascinated for a long time with the floating exchange rates that occurred in the 1920s. In this context, the floating exchange rate in the 1920s appears to be very worthy of study because it provides a good opportunity to collaborate evidence from the current floating rate in the 2010s. In particular, the currency market in the early 1920s experienced one of the most turbulent periods in the history of foreign exchange markets as the markets adjusted to the post-WWI and non-gold standard conditions. The problems associated with the hyperinflation in Germany and the budget deficit in France spilled over to affect several neighboring currencies including the British Pound. Einzig (1937, 1962) has documented many of the main economic and political events of this period and their impacts on the currency markets. Thus, the period of the 1920s is a very interesting period of history since it is the earliest period of freely floating exchange rates that were remarkably turbulent because of the political and economic conditions in Europe, and it constitutes the other main source of information on the behavior of the floating exchange rates since it could be well documented from a data perspective (e.g. Matthews, 1986; Taylor and McMahon, 1988; Smith and Smith, 1990; Taylor, 1992; Baillie et al., 1993).The exchange markets in the 1920s seem to be very different from those in the 2010s in several aspects. Although relatively little precise information is known about the extent of capital movements in the 1920s markets, it seems that there was a very low level of capital movements and arbitrage. Hence, the total volume of foreign exchange market transactions would be only marginally more than the volume of trade. And, the exchange markets in the 1920s were clearly less well organized and developed, and they were in the less sophisticated telecommunications system compared with the 2010s, which have more innovative market structures with more advanced computer technology and better developed financial instruments like options and futures. These facts distinguish the 1920s from the 2010s.Despite the relatively primitive market conditions, the 1920s foreign exchange markets seem to be similar in character to the current markets in the 2010s in terms of the world economic situations. The world economy in the 1920s was recovering from the devastating effects of the post WWI with the turmoil of war reparations and hyperinflation in Germany (Baillie et al., 1993). This also led to concerted speculative attacks on various currencies. These situations in the 1920s are quite similar to those in the 2010s which were overcoming the global financial crisis with a worldwide credit crunch caused by the collapse of the US subprime mortgage industry in 2007 so that most of exchange rates changed very volatilely in foreign exchange markets with severe speculations on several currencies occurred (Melvin and Taylor, 2009).Hence, the main purpose of this paper is to quantitatively compare the intrinsic features of the exchange rates in the 2010s with those in the 1920s. For the comparison, this paper focuses on the two key features, the long memory volatility property and the structural breaks of the exchange rate returns in the periods of the 1920s and the 2010s. In particular, this paper uses the daily exchange rates of US Dollar (USD)-Great British Pound (GBP) which is globally traded in the both periods, in order to investigate the dynamics of the long memory volatility property and the structural breaks in the daily exchange returns. This analysis seems warranted for the reason that this issue has not been previously investigated and it is thus important to expand the range of empirical comparison studies.The quantitative comparison in this paper finds that the daily USD-GBP exchange returns in the 1920s contain surprisingly similar intrinsic features to those in the 2010s in terms of the long memory volatility property and the structural breaks. …