Emerging Market Currencies Research Articles

Global Liquidity and Exchange Market Pressure in Emerging Market Economies

We analyse the relationship between global liquidity and exchange market pressure in 32 emerging market economies. Exchange market pressure is a measure of excess currency demand that is applicable across different exchange rate regimes as it accounts for changes in exchange rates, foreign exchange reserves and, optionally, interest rates. Surges in monetary liquidity, credit provision, and short-term funding in advanced economies are shown to be robustly associated with appreciation pressure on emerging market currencies. The underlying transmission mechanism, however, only operates under regular financial market conditions: ample liquidity provision in advanced economies contributes to the build-up of financial stability risks in emerging market economies in tranquil times, but further liquidity injections do not avert the pronounced depreciation pressure on emerging market currencies in times of high market volatility.

Spoofing and Pinging in Foreign Exchange Markets

This paper investigates the susceptibility of FX spot markets to limit order submission strategies that are either intended to create a false impression of the state of the market (‘spoof orders’) or to extract hidden information in the market (‘ping orders’). Using a complete limit order book dataset from EBS, we study currency pairs that have mature algorithmic markets (EUR/USD and USD/JPY), as well as other G10 and emerging market currencies where EBS is used as a secondary electronic trading platform (EUR/SEK, USD/RUB and USD/TRY). Our results, indicating that EUR/USD and USD/JPY are highly sensitive to information-rich orders, suggests that spoofing tactics might be more dependent on the chosen electronic trading venue, rather than the overall market liquidity of the currency pairs. Furthermore, we find widespread adoption of pinging tactics in the EUR/SEK and USD/RUB markets.

Currency Risk Premia in Emerging Markets

Understanding the dynamics of time-varying currency risk premia is the central issue of current empirical FX research. Since most findings, however, are based on developed market (DM) currencies, this paper contributes in such a way that it explicitly analyzes the specific dynamics of emerging market (EM) currencies. We use the well-documented Harrod-Balassa-Samuelson effect to relax the assumption of long-run purchasing power parity, which cannot be assumed to hold for EM economies. We show that the interest rate differential is the best positive predictor of short-run currency returns, while the real exchange rate (RER) is a better negative predictor over longer horizons. Interestingly, the positive relation between the interest rate differential and future currency returns reverses at a 6-months time horizon for EM currencies. Besides that, we find that - in contrast to DM currencies - high-yield EM currencies do not tend to appreciate over the short-run, and that the predictive power of the RER is the strongest for the lowest 12-months ahead EM currency returns, while it becomes insignificant for the highest 12-months returns.

The Time-Varying Diversifiability of Corporate Foreign Exchange Exposure

Estimating co-movement measures for a large set of bilateral foreign exchange (FX) rates, I explore the relation between firm-level FX exposure and its time-varying diversifiability. For a sample of U.S. firms, the magnitude of FX exposure appears to increase during periods of low currency risk diversifiability. Additional results suggest that the introduction of the euro exacerbated the effect of diversifiability on developed market currency exposure. Moreover, the low diversifiability of emerging market currencies seems to have a stronger effect on FX exposure than the low diversifiability of developed market currencies.

Price leadership in the South African foreign-exchange market: an empirical analysis

PurposeThe purpose of this paper is to investigate the information-based microstructure theory’s effectiveness in explaining short-term disturbances in currency prices by determining whether the price discovery process in the US dollar (USD) and South African rand (ZAR)-USD/ZAR spot market is led by an individual market agent, around an exogenous news event.Design/methodology/approachThe influence of central bank intervention-related events on USD/ZAR volatility is investigated through the application of Brown-Forsythe variance equality tests on individual dealer and market quotes. Furthermore, the study applies bivariate Granger-causality tests to individual dealers’ USD/ZAR spot rate quotes, in an effort to determine whether certain dealers can be established as price leaders around an exogenous news event.FindingsThe study finds significant evidence to suggest the USD/ZAR market price leadership of Nomura forex (FX) prior to the public announcement of a South African Reserve Bank intervention-related news event. This finding supports microstructure theory’s assertions regarding the existence of foreign-exchange market characteristics such as trader heterogeneity and private information.Research limitations/implicationsThe paper is conducted on a sample of eight USD/ZAR market agents, of which six are offshore dealers, and only two are located locally. Although these proportions are somewhat relatable to the locations of rand turnover, it would still be interesting to investigate the existence of price leadership solely amongst South African authorised FX dealers.Practical implicationsThe results suggest the existence and price relevance of private information, as well as the heterogeneous nature of USD/ZAR market participants, based on informational asymmetries. The outcomes of the paper are useful to market participants, researchers, and central banks alike.Originality/valueThough the study does not impugn the body of work related to the orthodox macroeconomic approaches to exchange rate determination, it seems apparent that much more microstructure-related research still has to be conducted in the context of emerging market currencies. It is this void that the current study has attempted to provide for in contribution to literature.

Momentum in Traditional and Cryptocurrencies Made Simple

Momentum trading strategies are thoroughly described in the academic literature and used in many trading strategies by hedge funds, asset managers, and proprietary traders. Baz et al. (2015) describe a momentum strategy for different asset classes in great detail from a practitioner’s point of view. Using a geometric Brownian Motion for the dynamics of the returns of financial instruments, we extensively explain the motivation and background behind each step of a momentum trading strategy. Constants and parameters that are used for the practical implementation are derived in a theoretical setting and deviations from those used in Baz et al. (2015) are shown. The trading signal is computed as a mixture of exponential moving averages with different time horizons. We give a statistical justification for the optimal selection of time horizons. Furthermore, we test our approach on global currency markets, including G10 currencies, emerging market currencies, and cryptocurrencies. Both a time series portfolio and a cross-sectional portfolio are considered. We find that the strategy works best for traditional fiat currencies when considering a time series based momentum strategy. For cryptocurrencies, a cross-sectional approach is more suitable. The momentum strategy exhibits higher Sharpe ratios for more volatile currencies. Thus, emerging market currencies and cryptocurrencies have better performances than the G10 currencies. This is the first comprehensive study showing both the underlying statistical reasons of how such trading strategies are constructed in the industry as well as empirical results using a large universe of currencies, including cryptocurrencies.

An Alternative Post-Keynesian Framework for Understanding Capital Flows to Emerging Markets

:This article contributes to the establishment of a framework for the analysis of international capital flows, with a specific focus on emerging markets. It is based on a “monetary” analysis of the economy, as well as on the works of Hyman Minsky and Jan Toporowski in particular. The key aspects of such an approach are the following. First, in a monetary economy, capital flows need to be understood as “flows of funds” that pertain to the realm of financial choices, as opposed to the traditional understanding of capital flows as based on “real” variables, such as saving and investment. A consequence of this is the need to focus on gross flows rather than capital flows. Second, liquidity preference considerations also apply at the international level, particularly in relation to the liquidity of emerging-market currencies that, in turn, depends on context-specific “Keynesian fundamentals.” Third, the rise of institutional investors is the key historical development in the financial system, shaping the current reality of cross-border capital flows, including to emerging markets. I argue that institutional investors’ liabilities, in light of the theories of Minsky and Toporowski, are one of the most important variables in determining these investors’ portfolio choices. I synthesize these elements by defining capital flows to emerging markets as the demand for emerging-market assets by institutional investors. I propose a framework to categorize the various channels that guide this demand.

Policy Rules for Capital Controls

This paper attempts to borrow the tradition of estimating policy reaction functions in monetary policy literature and apply it to capital controls policy literature. Using a novel weekly dataset on capital controls policy actions in 21 emerging economies over the period 1 January 2001 to 31 December 2015, I examine the competitiveness and macroprudential motivations for capital control policies. I introduce a new proxy for competitiveness motivations: the weighted appreciation of an emerging-market currency against its top five trade competitors. The analysis shows that past emerging-market policy systematically responds to both competitiveness and macroprudential motivations. The choice of instruments is also systematic: policy-makers respond to competitiveness concerns by using both instruments - inflow tightening and outflow easing. They use only inflow tightening in response to macroprudential concerns. I also find evidence that that policy is acyclical to foreign debt but is countercyclical to domestic bank credit to the private non-financial sector. The adoption of explicit financial stability mandates by central banks or the creation of inter-agency financial stability councils increased the weight of macroprudential factors in the use of capital controls policies. Countries with higher exchange rate pass-through to export prices are more responsive to competitiveness concerns.

Settlement Risk in the Global FX Market: How Much Remains?

Settlement risk is a critical concern in all financial markets and especially so in foreign exchange markets where it poses the threat of complete loss. In this paper, we offer a historical look at how risk mitigation in FX settlement has developed over time. We rely on two surveys conducted by the BIS in 1997 and 2007 and a new survey conducted by CLS Bank in April 2013. Based on our review of the evidence, we find that the market has achieved significant progress in both developing and implementing techniques that have dramatically reduced exposure to FX settlement risk. The share of FX turnover settled by means of traditional correspondent bank arrangements has declined from 85% to 32% to 13% across the three surveys. CLS Bank which offers payment-versus-payment (PVP) settlement and virtually eliminates settlement risk now settles roughly half of all FX turnover. However, because of enormous growth in FX turnover, particularly in emerging market currencies where access to risk mitigation alternatives is less prevalent, the absolute value of FX turnover exposed to settlement risk remains large. Surprisingly, one-quarter of FX turnover in currencies eligible for PVP settlement using CLS Bank still relies on bilateral settlement with some exposure to settlement risk. These findings support the need for banks, industry groups and central banks to remain vigilant and continue their efforts to incentivize PVP settlement positively, making it widely available and utilized, or finding alternative risk mitigating solutions. We offer various approaches to deal with the remaining settlement risk.

Bitcoin as a Complement to Emerging Market Currencies

ABSTRACTBitcoin is a digital currency that has gained significant traction as an economic instrument. Despite its rise, it has received little attention from the scholarly community. This study is one of the first studies to examine Bitcoin’s use as a complement to emerging markets currencies; more specifically, I analyze the value and volatility of Bitcoin relative to emerging market currencies and explore ways in which Bitcoin can complement emerging market currencies. The results suggest that Bitcoin has characteristics that make it well-suited to work as a complement to emerging market currencies and that there are ways to minimize Bitcoin’s risks.

The effects of fair value reporting on corporate foreign exchange exposures

We analyze the effects of fair value reporting standards (FVR) SFAS 133 and IAS 39 on foreign exchange (FX) exposures of U.S. multinational firms. We observe reductions in FX exposures to developed market currencies that coincide with the implementation of FVR. Risk reductions mainly affect U.S. multinational firms and to a much lesser extent matched control groups of domestic firms. For firms with exposures to emerging market currencies, we observe no changes in positive FX exposures but substantial shifts in negative exposures resulting in a change of exposure direction. Additionally we report changes in FX exposure asymmetry affecting multinational and domestic firms. Observed results are robust to several alternative model specifications and are unlikely explained by the launch of the euro, changes in firm-level FX exposure determinants, the rise and decline of technology shocks, shifts in systematic risk factors, or the Asian Financial Crisis.

The information content of risk reversals in emerging market currencies

This paper analyzes the information content of risk reversals for ten emerging
 market currencies. In contrast to the findings for major developed currencies,
 it is found that in some cases risk reversals (RR) are helpful in predicting
 currency returns, but in general RR are predicted by but do not predict carry
 trade returns. Evidence based on country vector autoregressions (VARs) and a
 panel VAR (PVAR) indicate that RR react in a procyclicalway to carry returns, i.e.,
 it is cheaper (more expensive) to buy protection against currency weakness after
 positive (negative) total returns. All in all, it is found that crash risk accounts
 for a small share of carry trade returns variance, which seems to be more related
 to global risk aversion shocks. A sentiment indicator of crash risk in emerging
 market currencies is highly correlated with the VIX.

US Dollar Carry Trades in the Era of 'Cheap Money'

In this paper, we employ a unique dataset of actual US dollar (USD) forward positions against a number of currencies taken by so-called Commodity Trading Advisors (CTAs). We investigate to what extent these positions exhibit a pattern of USD carry trading or other patterns of currency trading over the recent period of the ultra-loose US monetary policy. Our analysis indeed shows that USD positions against emerging market currencies are characterised by a pattern of carry trading. That is, the USD, as the lower yielding currency, is associated with short positions. The payoff distributions of these positions, moreover, are found to have positive Sharpe ratios, negative skewness and high kurtosis. On the other hand, we find that USD positions against other advanced country currencies have a pattern completely opposite to carry trading which is in line with uncovered interest parity trading; that is, the lower (higher) yielding currency is associated with long (short) positions.

Technical trading: Is it still beating the foreign exchange market?

We carry out a large-scale investigation of technical trading rules in the foreign exchange market, using daily data over 45years for 30 developed and emerging market currencies. Employing a stepwise test to counter data-snooping bias and examining over 21,000 technical rules, we find evidence of substantial predictability and excess profitability in both developed and emerging currencies, measured against a variety of performance metrics. We cross-validate our results using out-of-sample analysis. We find time series and cross-sectional variation in subperiods and cultural and/or geographic groups, respectively, suggesting that temporarily not-fully-rational behavior and market immaturity generate technical predictability and potential excess profitability.

The Forecast Ability of Option-implied Densities from Emerging Markets Currencies

This paper empirically evaluates Risk-Neutral Densities (RND) and Real-World Densities (RWD) as predictors of emerging markets currencies. The dataset consists of volatility surfaces from 11 emerging market currencies, with approximately six years of daily data, using options with one-month expiration. Therefore, there is a strong overlapping in data, which is tackled with specific econometric techniques. Results of the out-of-sample assessment show that both RND and RWD underweight the tails of the actual distribution. This is probably due to the lack of options with extreme strikes. Although the RWDs perform better than RND in terms of Kolmogorov distance, they still have problems in fitting the tails of actual data. Thus, the risk-aversion adjustment may improve the forecast ability, but it does not solve the tails misfitting.

Tail Risks, Asymmetric Contagion and Domino Patterns in Emerging Currency Markets

We identify new structural channels for the transmission of shocks in emerging currencies, and develop a model in which shock propagations evolving from domestic emerging stock markets, liquidity (banks’ credit default swaps), credit risk (Volatility Index) and growth (commodity prices) channels disseminate to emerging market foreign exchanges. We quantify joint downside risks and document that these asset classes tend to experience concurrent extreme shocks. We measure the time-varying shock spillover intensities to ascertain a significant increase in cross-asset linkages during periods of high volatility which is over and above any expected economic fundamentals, providing strong evidence of asymmetric investor induced contagion, triggered by cross asset rebalancing. The critical role of the credit crisis is amplified, as the beginning of an important reassessment of emerging market currencies which lead to changes in the dependence structure, a revaluation and recalibration of their risk characteristics. By modelling tail risks we detect structural breaks and find patterns consistent with the domino effect. JEL Classification: C5, F31, F37, G01, G17.

Analysis of Non-Synchronous Trading Effects on the Pricing of Exchange Traded Products

Exchange Traded Products (ETPs) have become important members of the investment universe. They are praised by institutional and retail investors alike for their low cost, transparency and efficient pricing mechanisms. ETPs trade much like equity securities but with a unique creation and redemption mechanism which typically aligns quoted prices with the Net Asset Value (NAV) of the underlying securities. This dissertation examines a class of ETPs whose underlying reference basket consists of securities listed on stock exchanges operating in a time zone different to the time zone of the ETP instrument itself, and whose currencies of the underlying securities are different to the currency of the ETP instrument. The ETP instruments reviewed comprise of the iShares MSCI Country Series and are all listed on the New York Stock Exchange (NYSE).The ETPs are classified into three groups depending on the degree of overlap between the exchange operating times on which their underlying securities are traded and the exchange operating times of the NYSE. These groups are non-synchronous for no overlapping hours, partially synchronous for some overlapping hours and synchronous for overlapping hours.By assessing a measure of range-based volatility during 15-minute intraday intervals throughout the NYSE trading day, an understanding of the volatility profile of these ETPs is determined and analysed. It is found that non-synchronous ETPs do exhibit a higher relative level of volatility when compared to the partially synchronous group. Within the partially synchronous group, evidence of a regime-shift is observed during the period when the market of the underlying securities transitions from open to closed during the NYSE trading session. Another factor observed in the relative volatility profile is the impact of foreign exchange translation. ETPs with underlying securities priced in an emerging market currency show higher relative levels of range-based volatility. However, both emerging market and developed market denominated securities baskets exhibit relatively higher levels of volatility during the opening and closing periods of the US trading day.The results point to the need for caution and understanding of the underlying reference basket when transacting in these ETPs as investors may inadvertently transact at a price which does not reflect the fair-market value of the underlying securities basket due to price distortions as a result of volatility.

2016 External Sector Report

After narrowing in the aftermath of the global financial crisis and remaining broadly unchanged in recent years, global imbalances increased moderately in 2015, amid a reconfiguration of current accounts and exchange rates. Shifts in 2015 were driven primarily by the uneven strength of the recovery in advanced economies, the redistributive effects of the sharp fall in commodity prices, and tighter external financing conditions for emerging markets (EMs). A relatively stronger U.S. outlook led to a further appreciation of the USD and a depreciation of the yen and the euro. The sharp decline in commodity prices, reflecting both supply shocks and concerns about rebalancing and growth in China, brought about a significant redistribution of income from commodity exporters to importers, and a weakening of commodity exporters’ currencies. Meanwhile, heightened global risk aversion, contributed to softer capital inflows and depreciation pressures in many EMs. This moderate widening of current account imbalances was largely driven by systemic economies. Surpluses in Japan, the euro area and China grew, supported by improved terms of trade and currency depreciation, while the current account deficit in the U.S. widened amid the steep appreciation of the USD. These widening imbalances were only partially offset by narrowing surpluses in large oil exporters and smaller deficits in vulnerable EMs and some euro area debtor countries. Similarly, excess imbalances expanded in 2015. External positions in the U.S. and Japan moved from being broadly in line with fundamentals to being “moderately weaker” and “moderately stronger”, respectively. This was partly offset by a further narrowing of excess deficits in vulnerable EMs and euro area debtor countries. Meanwhile, excess surpluses persisted among the larger surplus countries, some of which remain “substantially stronger” than fundamentals (Germany, Korea). Currency movements since end-2015 helped to partially reverse the trends observed last year, although market volatility following the result of the U.K. referendum to leave the European Union have led to a strengthening of the USD and yen along with a weakening of the sterling, euro, and EM currencies. The implications for external assessments going forward, especially for the U.K. and the euro area, remains uncertain and will likely depend on how the transition is managed and on what new arrangements are adopted. With output below potential in most countries, and limited policy space in many, balancing internal and external objectives will require careful policy calibration. In general, a more balanced policy mix that avoids excessive reliance on policies with significant demanddiverting effects is necessary, with greater emphasis on demand-supportive measures and structural reforms. Surplus countries with fiscal space have a greater role to play in supporting global demand while reducing external imbalances. Global collective policy action, especially if downside risks materialize, would also help address global demand weakness while mitigating its effects on external imbalances.

Emerging Market Corporate Bond Yields and Monetary Policy

We examine the determinants of corporate bond yields in emerging markets with a focus on the spillover of US monetary policy on corporate bond yields. We find that emerging market corporate bond yields are positively associated with the federal funds rate. However, there is evidence that this positive relation is transmitted through the domestic policy rate. If domestic policy rates are held constant, the spillover of US monetary policy on corporate bond yields diminishes. This suggests that domestic policymakers face a tradeoff: if they choose to leave their policy rate unchanged when the Fed hikes, this may have benign consequences for corporate bond yields. However, a relatively higher US policy rate may lead to exchange rate depreciation for emerging market currencies and thus elevated debt burdens for their US dollar debtors. Alternatively, if the Fed hikes and policymakers follow suit, funding conditions for corporates worsen through higher yields.

Asian emerging-market currencies in the international debt market (1994–2014)

This paper investigates the increasing presence of Asian emerging-market currencies in the international debt market over the last two decades. I use the “original sin” index developed by Eichengreen et al. (The pain of original sin. 〈http://elsa.berkeley.edu/~;;eichengr/research/ospainaug21-03.pdf〉 (August, 2003) to measure the use of an economy's home currency in international debt relative to the total international debt of its residents. The relative reliance on home currency debt is seen to have increased markedly in a number of economies. Using a random effects Tobit model, I examine factors underlying recent changes for a sample of nine Asian emerging market economies. The results suggest the importance of economic size, strength of institutions, and financial market development.