Abstract
We document stylized facts about China's recent exchange rate for its currency, the renminbi (RMB). Our empirical findings suggest that a policy is in place, aiming to balance RMB index stability and exchange rate flexibility. We then develop a tractable no-arbitrage model of the RMB under the two-pillar policy. Using derivatives data on the RMB and the U.S. dollar index, we estimate the model to assess financial markets' views about the fundamental exchange rate and sustainability of the policy. Our model is able to predict the modification of the two-pillar in May 2017, when a discretion-based countercyclical factor was introduced for the first time. We also examine the model's ability to forecast RMB movements.
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