Exchange Rate Behavior Research Articles

The behavior of exchange rate and stock returns in high and low interest rate environments

In this paper, we contribute to the literature in the following ways. First, we test whether stock returns respond differently to exchange rates in high and low interest rate environments. Second, we further probe into possible asymmetric effects of appreciation and depreciation on stock returns. Third, we examine the role of extreme (negative) low interest rate in the nexus among the low interest rate economies. Using panel data procedures that account for the salient features of the relevant variables, the following are discernible from the analyses. First, we establish contrasting evidence between low and high interest rate environments in relation to short run & long run results. Second, we find that the low interest rate group exhibits long run positive nexus while the high interest rate counterpart predominantly reveals short run negative nexus. Third, we show that all these outcomes remain true whether or not we account for the roles of macroeconomic factors including interest rate, inflation, and global oil price and alternative data frequency. Some insightful implications of our findings are highlighted and we do hope that investors and policy makers will find the results useful for decision making purpose.

Monetary policy surprises and exchange rate behavior

Central banks unexpectedly tightening policy rates often observe the exchange value of their currency depreciate, rather than appreciate as predicted by standard models. We document this for Fed and ECB policy days using event studies and ask whether an information effect, where the public attributes the policy surprise to an unobserved state of the economy, may explain the abnormality. It turns out that many informational assumptions make a standard two-country New Keynesian model match this behavior. To identify the particular mechanism, we condition on multiple asset prices in the event study and model implications for these. We find that there is heterogeneity in this dimension in the event study and no model with a single regime can match the evidence. Further, even after conditioning on possible information effects driving longer term interest rates, there appear to be other drivers of exchange rates. Our results show that existing models have a long way to go in reconciling event study analysis with model-based mechanisms of asset pricing.

Emerging market exchange rates during quantitative tapering: The effect of US and domestic news

We analyze the impact of domestic and US-based news announcements of a large set of economic and policy-related fundamentals on the US dollar versus the Turkish lira exchange rate from 2013 to 2016. Since exchange rate behavior is closely related to political trust, we also incorporate the effect of domestic and global political uncertainty, using country indices based on Google search results. Contrary to previous findings, our results reveal that surprises related to the domestic economy have a greater effect on the exchange rate compared to surprises related to the US economy. Most important are the surprises related to domestic inflation and monetary policy, as well as foreign employment, while political uncertainty plays a minor role. There is also an asymmetry in the market response. Bad news about the US economy has more impact than good news, and good news about the domestic economy has more impact than bad news.

Exchange Rate in Ethiopia: A Graphical Analysis of Trends and Determinates

The question of exchange rate determination has been just in the core of academic debates. Even though many exchange rate determination models and their amendments have been developed, scholars/writers still cannot agree on which model best describes behavior of exchange rate. Exchange rate is an essential element of the macro- economic variables that needs to be address in Ethiopia since the Ethiopian birr consistently losing its value and it is necessary to know the factors affecting, in order to analysis the determinate factors, to see which of those possible factors need to be care to control the exchange rate. The objective of this paper was to analysis the relationship among the level of exchange rate in Ethiopia and selected main determinant factors argued in both flow and stock theory of exchange rate determination. The analysis was carried out by detail reviewing the prior researchers work on the area and using correlation and trend analysis for the 18 (2000-2017 G.C) year data obtained from National bank of Ethiopia Quarterly Bulletin. The result shows that nominal exchange rate of Ethiopia relates positively with government spending, broad money supply, inflation level, economic growth, interest rate and negatively with term of trade balance and current account balance. Moreover, it revealed that, government spending; broad money supply and nominal interest rate are the major determinants than inflation, economic growth term of trade balance, and current account balance. Keywords: Exchange rate, balance of payment theory, Monetary theory, Ethiopia DOI: 10.7176/JESD/12-3-05 Publication date: February 28 th 2021

In Search of Exchange Rate Undershooting in Pakistan

Exchange rate behaviour does not follow very obvious and predicted pattern. Many attempts have been made to predict its behaviour as much as possible. This research re-examines the Dornbusch’s model of exchange rate overshooting caused by price rigidities. Dornbusch’s assumption of full employment in economy has been violated in this research which creates the possibility of exchange rate undershooting. In response to positive monetary shock, interest rate decreases and exchange rate undershoots its long run equilibrium. This research explains the dynamics of anti-intuitive exchange rate undershooting. Apart from theoretical formations of exchange rate undershooting, this research also analyses Pakistani data for exchange rate undershooting or overshooting in response to increase in money supply. Quarterly data of twenty three years for exchange rate, nominal interest rate, price, real output and money have been taken and vector autoregressive technique has been used. Evidence of exchange rate undershooting in response to positive money supply shock was found. It also gives an important insight into policy making by identifying some probable behaviour of exchange rate.

Behavior of Exchange Rate and its Impact on Other Macroeconomic Variables: Perspective of the Sri Lankan Economy

Behavior of Exchange Rate and its Impact on Other Macroeconomic Variables: Perspective of the Sri Lankan Economy

The MPC meetings, macroeconomic announcements and exchange rate behaviour in Nigeria

Literature recognise that announcement impinge shocks which could shift the mean behaviour of the exchange rate. This study apply event driven models to analyse how the expectation of daily log-exc...

Dynamics of Relationship Between Macroeconomic Fundamentals and Exchange Rate: A Comparison of Advanced and Least Developed Countries

The exploration of relationship between macroeconomic fundamentals and exchange rate is needed in the perspective of economic structure of the economies. The focus of current study is to inquire the dynamics of exchange rate behavior in response to macroeconomic fundamentals for advanced and least developed countries. The Pooled Mean Group regression based on panel ARDL and Panel Granger Causality Test are employed on annual panel data sets for the time period 1995-2015. The results evidence a strong relationship between macroeconomic fundamentals and exchange rate volatility in advanced countries and a moderate relationship in least developed countries. The exchange rate level has been observed entirely governed by the selected set of macroeconomic fundamentals in both group of countries. The results validate the fundamental macroeconomic models of exchange rate determination as the macroeconomic fundamental indicators play an important role in the determination of exchange rate volatility as well as exchange rate level. It may be concluded that the relationship between fundamental macroeconomic indicators and exchange rate behavior is sensitive to the economic structure of the countries.

Nonlinearities and Asymmetric Adjustment to PPP in an Exchange Rate Model with Inflation Expectations

This paper estimates a model of the real exchange rate including standard fundamentals as well as two alternative measures of inflation expectations for five inflation targeting countries (UK, Canada, Australia, New Zealand, Sweden) over the period January 1993-July 2019. Both a benchmark linear ARDL model and a nonlinear ARDL (NARDL) specification are considered. The results suggest that the nonlinear framework is more appropriate to capture the behaviour of real exchange rates given the presence of asymmetries both in the long- and short-run. In particular, the speed of adjustment towards the PPP-implied long-run equilibrium is three times faster in a nonlinear framework, which provides much stronger evidence in support of PPP. Moreover, inflation expectations play an important role, with survey-based ones having a more sizable effect than market-based ones. Monetary authorities should aim to achieve a high degree of credibility to manage them and thus currency fluctuations effectively. The inflation targeting framework might be especially appropriate for this purpose.

Oil Price and Exchange Rate Behaviour of the BRICS

ABSTRACT We attempt to predict the exchange rate returns of the BRICS (Brazil, Russia, India, China, and South Africa) countries with the global oil price using monthly datasets covering the period of 1973 to 2020. We formulate a predictive model that accounts for the salient features of the predictor and the predicted series in line with the recent literature. We establish that oil price is a good predictor of exchange rate returns for both net oil exporters (Brazil and Russia) and net oil-importers (South Africa and China). The consideration of asymmetries improves the predictability of an oil-based model for exchange rate movements and ignoring the same may lead to wrong conclusions. Finally, all the variants of the oil-based model outperform the benchmark model albeit with higher out-of-sample forecast gains with a nonlinear (asymmetric) model.

The news effects on exchange rate returns and volatility: Evidence from Pakistan

AbstractThis article explores the effects of macroeconomic news on Pak rupee's exchange rates. For this purpose, it employs GARCH models by using real‐time data on macroeconomic news and exchange rates. The results exhibit that daily Pak rupee exchange rates dynamics are linked to macroeconomic fundamentals. Both foreign and domestic macroeconomic news announcements significantly affect Pak rupee exchange rates. The exchange rate returns and volatility of Pak rupee immediately adjust to most of the foreign and domestic macroeconomic news. Most of the US and PAK domestic macroeconomic news immediately affect PKR/USD exchange rates as compared to the effect of other foreign and domestic macroeconomic news on other Pak rupee exchange rates. Finally, the article shows that Pak rupee exchange rate returns and their volatilities are responsive to foreign and domestic macroeconomic news announcements with different magnitudes for all the currency pairs. These findings suggest that the behaviour of PAK rupee exchange rate appears to be consistent with the models of exchange rate determination and the monetary authority's reaction function.

The relationship between currency crises and capital flow reversals: An empirical examination

Large capital flow reversals and currency crises are an important feature of the global economy. They are often treated as being closely related and as typically occurring together. We investigate the relationship between them for a large set of emerging market economies using both event analysis and logit estimation. We find that more often than not the two types of events do not occur together. We find that this conclusion holds irrespective of the way in which currency crises and capital flow reversals are measured. We examine the circumstances under which we might expect them to occur together or separately and compare the behavior of a number of economic and financial variables prior to each type of event. While some conditions, such as rapid credit growth and economic overheating precede both currency crises and capital reversals, we also find important differences. Exchange rate behavior tends to be more important for currency crises than for capital flow reversals, while capital flow surges and financial conditions in the global economy are more important for capital flow reversals.

Nonlinear Relationship based on Range Quadratic Loss Function

Abstract This paper uses the interval quadratic preference loss function to establish the threshold model of exchange rate volatility by Taylor series expansion, and GMM method to study the intervention behavior of exchange rate. It found that the central bank has asymmetric intervention preference for exchange rate, discontinuous and nonlinear intervention for exchange rate, and there is an intervention threshold, and the central bank has a certain degree of “fear of appreciation” trend. To some extent, asymmetric interval intervention preference has resulted in the rapid growth of China's foreign exchange reserves.

Determinants of Exchange Rate in Ethiopia: A Graphical Approach

The question of exchange rate determination has been just in the core of academic debates. Even though many exchange rate determination models and their amendments have been developed, scholars/writers still cannot agree on which model best describes behavior of exchange rate. Exchange rate is an essential element of the macro- economic variables that needs to be address in Ethiopia since the Ethiopian birr consistently losing its value and it is necessary to know the factors affecting, in order to analysis the determinate factors, to see which of those possible factors need to be care to control the exchange rate. The objective of this paper was to analysis the relationship among the level of exchange rate in Ethiopia and selected main determinant factors argued in both flow and stock theory of exchange rate determination. The analysis was carried out by detail reviewing the prior researchers work on the area and using correlation and trend analysis for the 18 (2000-2017 G.C) year data obtained from National bank of Ethiopia Quarterly Bulletin. The result shows that nominal exchange rate of Ethiopia relates positively with government spending, broad money supply, inflation level, economic growth, interest rate and negatively with term of trade balance and current account balance. Moreover, it revealed that, government spending; broad money supply and nominal interest rate are the major determinants than inflation, economic growth term of trade balance, and current account balance. Indeed, it is concluded as there is some theoretical and empirical deviations on the result of this study, may be due to the effect of some other missed variables (gov’t intervention level, political risk, cultural sentiment. Keywords: Exchange rate, balance of payment theory, Monetary theory, Ethiopia DOI: 10.7176/IAGS/68-01 Publication date: July 31 st 2020

Un modelo no monetario de la inflación en México, 2007-2018

This article studies the inflation process in Mexico during the period 2007-2018 with a non-monetary analysis, where it is emphasized the magna gasoline price like a main cause of inflationary process. First, this research examines the Mexican economy evolution ‒the level of economic activity, economic growth rate and its perspectives‒; secondly, it follows with an analysis of the Mexican financial systems, where receives special attention the interest rates in Mexico and USA, and the exchange rate behavior like an inflationary factor. In the third part, it is discussed the trend of Mexican gasoline prices, taking the USA prices like a reference. Finally, data about Mexican inflation are shown disaggregated through its two main components. Also, an econometric model of inflation as a function of gasoline prices is carried out.

Exchange Rates and Fundamentals: A General Equilibrium Exploration

AbstractEngel and West (2005) show that the observed near random‐walk behavior of nominal exchange rates is an equilibrium outcome of a partial equilibrium asset approach when economic fundamentals follow exogenous first‐order integrated processes and the discount factor approaches one. In this paper, I argue that the unit market discount factor creates a theoretical trade‐off within a two‐country general equilibrium model. The unit discount factor generates near random‐walk nominal exchange rates, but it counterfactually implies perfect consumption risk sharing and flat money demand. Bayesian posterior simulation exercises, based on post‐Bretton Woods data from Canada and the United States, reveal difficulties in reconciling the equilibrium random‐walk proposition within the canonical model; in particular, the market discount factor is identified as being much smaller than one. A relative money demand shock is identified as the main driver of nominal exchange rates.

Asymmetric and Time-Varying Behavior of Exchange Rate and Interest Rate Differential in Emerging Markets

ABSTRACT This study assesses the nonlinearities in the nexus between exchange rate and interest rate differential in emerging economies of BRICS. We employ Panel Nonlinear Autoregressive Distributed Lag and Panel Threshold Regression (PTR) models. The study finds mixed result for asymmetry in the nexus. It also shows evidence for time-variation and the positive impact of interest rate differential on exchange rate gradually increases at higher economic activity and inflation regime. The implication is that interest rate differential has both asymmetric and time-varying effects on exchange rate which partly explains the continuous adjustment of monetary policy rates in many emerging markets. Finally, the role of economic productivity and domestic price level in the response of exchange rate to interest rate differentials across the BRICS should not be jettisoned to realize plausible outcomes.

REER Imbalances and Macroeconomic Adjustments: Evidence from the CEMAC Zone

The European Monetary Union (EMU) crisis holds special lessons for existing monetary unions. We assess the behaviour of real effective exchange rates (REERs) of members of the Central African Economic and Monetary Community zone with respect to their long-term equilibrium paths. A reduced form of the fundamental equilibrium exchange rate model is estimated for associated misalignments. Our findings suggest that for majority of countries, macroeconomic fundamentals have the expected associations with the exchange rate fluctuations. The analysis also reveals that only the REER adjustments of Cameroon and Gabon are significant in restoring the long-term equilibrium in the event of a shock. The Cameroonian economic fundamentals of terms of trade, government expenditure and openness have different long-term relations with the REER in comparison to those of other member states. There is no need for an adjustment in the level of the peg based on the present quantitative analysis of REER paths. JEL: F31, F33, F42, F61, O55

Nominal exchange rate determination and dynamics in an OLG framework

The empirical evidence on nominal exchange rate dynamics shows a long-run relationship of this variable with the fundamentals of the economy, although such relationship disappears at shorter horizons. This apparently contrasting behaviour of the nominal exchange rate can be explained in an overlapping generations model where the currencies are not perfect substitutes. In this framework, we show that the nominal exchange rate is pinned down by the fundamentals at the monetary steady state. We study the local dynamics and show that when the monetary steady state is locally indeterminate, then fluctuations of the nominal exchange rate around its long-run value can emerge. In particular, we prove the existence of stationary sunspot equilibria, where random fluctuations of the nominal exchange rate arise as a result of self-fulfilling beliefs.

Real Exchange Rate Dynamics Beyond Business Cycles

We examine how medium-term movements in real exchange rates and GDP vary with international financial conditions. For this purpose, we study the international transmission of productivity shocks across a variety of IRBC models that incorporate different assumptions about the persistence of productivity shocks, the degree of international risk sharing and access to international asset markets. Using a new global solution method, we demonstrate that the transmission of productivity shocks depends critically on the proximity of a national economy to its international borrowing limit. We then show that this implication of the IRBC model is consistent with the behavior of the US-UK real exchange rate and GDP over the past 200 years. The model also produces a negative correlation between relative consumption growth and real depreciation rate consistent with more recent data, and hence offers a resolution of the Backus-Smith puzzle.