Exchange Rate Expectations Research Articles

Can RMB Exchange Rate Expectations Explain the Fluctuations of China’s Housing Prices?

Unlike existing literature that has focused on the relationship between exchange rate and housing price, this paper studies the housing price fluctuations from the perspective of RMB exchange rate expectation to resolve the dilemma “guarantee housing price or exchange rate” after the sub-prime mortgage crisis. This paper shows that housing prices responded negatively to RMB appreciation expectation from 1999 to 2008, and positively from 2009 to 2019. After 2009, exchange rate expectation is the Granger causality of housing prices. After introducing the U.S. Economic Policy Uncertainty (EPU) released by Baker et al.(2016), the explanatory power of exchange rate expectations to housing price fluctuations declines but it's still significant. When EPU increased, housing prices responded negatively after a brief positive response. Besides exchange rate expectation, several unobservable factors with rich economic implications can explain the fluctuations of housing prices in China in the interval of 2006M01–2018M12. The empirical results show that the degree of Chinese government reversal intervention, interest rate spread between China and the U.S., and EPU can explain the exchange rate expectation. The government can control the degree of reversal intervention to affect the exchange rate expectation and realize the housing price control indirectly.

Measuring Exchange Rate Risks During Periods of Uncertainty

In this paper, we empirically look at the effects of uncertainty on risk measures for exchange rates, by focusing on two recent specific periods: the Brexit and the outbreak of the Covid-19. Based on a Fama regression extended with uncertainty measures, we forecast exchange rate in the short run through a quantile regression approach. By fitting a Skewed-Student distribution to the quantile forecasts, we put forward measures of risks for appreciation and depreciation of the expected exchange rates. We point out two interesting results. First, we show that the increase in Brexit-related uncertainty is strongly associated to higher future depreciation risks of the British Pound vs the Euro, as a mistrust towards the British economy. Second, we get that the Covid-related uncertainty is perceived as a global risk, leading to a flight-to-safety move towards the US Dollar and associated high depreciation risks for emerging currencies.

Investigating the Determinants of Exchange Rate Stability: An Empirical Evidence

The major drivers of nominal and real effective exchange rates are investigated in a sample of 30 countries between 1977 and 2017. We used the multiple linear regression analysis by Fixed GLS AR1, and Pooled Mean Group (PMG). The main drivers of nominal exchange rate in the long run are found to be: broad money, interest rate, claims on central government, government final consumption expenditures, trade, inflation, GDP per capita, oil prices, school enrollment and the expected exchange rate, in the long run. While in the short run it is affected mainly by interest rate, general government final consumption expenditure, inflation, taxes, and the expected exchange rate. On the other hand, the main drivers of real effective exchange rate in the long run are found to be: current account balance, gross capital formation, trade, school enrollment, oil prices, total reserves, broad money, interest rate, claims on central government, government final consumption expenditures, GDP per capita, taxes, and the expected exchange rate. While in the short run it is only trade, unemployment rate, and the expected exchange rate.

The Present-Value Model of the Exchange Rate with a Persistently Time-Varying Risk Premium: Evidence from the Dollar-Yen Rate

In this study, I formulate a present value model of the exchange rate with a risk premium and introduce exchange rate risk exposure as a factor of the persistently time-varying risk premium. The present value model incorporates expectations for the distant future, and therefore, indicates that spot exchange rate variations reflect changes in long-run future interest rate differential and exchange rate expectations, in addition to a risk premium for long-run risk exposure. I also conduct empirical analyses using mainly the USD/JPY rate and other exchange rates against the USD. The Japanese current account balance provides a better estimation of the change in USD/JPY rate market risk exposure as USD invoiced trades are prevalent in Japan. Then, I demonstrate the possibility that a persistently time-varying risk premium offsets the effect of the interest rate differential on exchange rate variations, which can be a solution to the uncovered interest rate parity puzzle.

Information rigidities and exchange rate expectations

Sluggish adjustment of expectations to new information is rational in an environment characterized by information costs and signal-to-noise problems. This paper investigates the role of such information rigidities for exchange rate expectations using data from Consensus Economics for ten emerging and industrial economies from 1999 until 2015. Our results confirm the importance of rigidities and show that the inclusion of forecast updates largely accounts for otherwise detected biases in expectation errors. Moreover, we find little evidence for a systematic effect of fundamentals or uncertainty measures on exchange rate disagreement.

Foreign Exchange Rate Exposure of Companies under Dynamic Regret

This paper analyzes optimal hedge ratios for foreign exchange (FX) rate risk of companies. Our contribution to the literature is twofold: (i) We present a theoretical two-period regret model that allows us to analyze the determinants of the optimal hedge ratio given the outcome of past hedging decisions and future expectations. The model implies that the optimal hedge ratio depends on the past hedge ratio, the past exchange rate return, the expected exchange rate return and the skewness of its distribution, its covariance to the foreign market return, as well as the company's risk and regret aversion. (ii) We test the related model-derived hypotheses on a broad sample of US non-financial companies over the period 1995 to 2015 and find strong evidence for the model's predictions. By adding a dynamic regret approach to the hedging and FX literature we shed further light on the rationale behind selective hedging.

Macroeconomic Expectations and Credit Card Spending

How do macroeconomic expectations affect consumer decisions? We examine this question using a natural field experiment with 2,872 credit card customers from a large commercial bank. We conduct a survey to measure consumer expectations about future inflation and the nominal exchange rate and combine this with an information-provision experiment that generates exogenous variation in these expectations. We merge the survey and experimental data with detailed administrative data on the subjects' credit card transactions and balances. The experiment is designed to test three standard predictions from models of intertemporal consumption choice: inflation expectations should affect spending on durables; exchange rate expectations should affect spending on tradables; and, holding constant the nominal interest rate, inflation expectations should affect borrowing. We find that the information provided to participants strongly affects subjective expectations. However, we do not find any significant effects on actual consumer behavior (as measured in administrative data) or self-reported consumption plans (as measured in survey data). Our preferred interpretation is that consumers are not sophisticated enough to factor inflation and exchange rate expectations into their consumption decisions. The absence of a link between consumer expectations and behavior has potentially important implications for macroeconomic policies such as forward guidance.

Macroeconomic Expectations and Credit Card Spending

How do macroeconomic expectations affect consumer decisions? This paper reports results from a natural field experiment with 2,872 credit card customers from a large commercial bank to answer this question. Participants of the experiment first completed as survey that measured consumer expectations about future inflation and the nominal exchange rate. This survey was combined with an information-provision experiment that generated exogenous variation in respondents’ macroeconomic expectations. The survey and experimental data were then merged with detailed administrative data on participants’ credit card transactions and balances. The experiment was designed to test three standard predictions from models of intertemporal consumption choice: inflation expectations should affect spending on durables; exchange rate expectations should affect spending on tradables; and, holding constant the nominal interest rate, inflation expectations should affect borrowing. The analysis finds that the information provided to participants strongly affects subjective expectations. However, no significant effects are found on actual consumer behavior (as measured in administrative data) or self-reported consumption plans (as measured in survey data). The preferred interpretation is that consumers are not sophisticated enough to factor inflation and exchange rate expectations into their consumption decisions. The absence of a link between consumer expectations and behavior has potentially important implications for macroeconomic policies such as forward guidance.

The Impact of RMB Exchange Rate Expectation on China's Foreign Direct Investment

In 2005, after the change of exchange rate, the expectation of upward expectation was deepened because of the fluctuation of RMB exchange rate. For international companies, on a country's currency exchange rate volatility trend is expected to change its subjective leading on the investment strategy of the country, is expected to exchange rate in the adjustment of China's FDI entry with a total layout of the industry leading role is allow all doubt. China is in a special phase of economic growth and transformation, and the policy of improving the allocation ratio of manufacturing industries and service industries needs the help of a large number of foreign capital. Therefore, it is a significant time to explore the adjustment principle of the exchange rate expectation change to the domestic FDI entry quantity at this time.

Political Announcements and Exchange Rate Expectations

Exchange rate fluctuations in a small open economy are closely related to political trust. Various political announcements exert significant influence on the exchange rate by affecting the expectations of economic actors. Due to information technology and social networks, these statements spread quicker and gain more publicity than ever before. In this paper, we present a dynamic model with adaptive expectations to describe the short and long-run effects of political announcements on the exchange rate. We found that relevant announcements cause significant fluctuations in the short-run but do not affect the long-term equilibrium exchange rate. Our results are also supported by case-studies from Hungary.

On the link between the exchange rates and interest rate differentials in China: evidence from an asymmetric wavelet analysis

This paper adopts wavelet analysis to explore the time–frequency comovement and causality between the exchange rates and the interest rate differentials in China (compared to the USA) over the period from February 1999 to March 2018. While the existing literature in general treats the relationship between the two variables as being symmetric, this paper attempts to detect possible asymmetric patterns by extending the standard wavelet analysis to an asymmetric analysis. In addition, given that the relationship might be affected by exchange rate expectations and foreign exchange interventions, we further employ the partial wavelet tools to filter out the effects of the two controlled variables. The results show that the general pattern of the comovement and causality does not change. The comovement is intensified at the low frequency after the exchange rate reform in 2005. Moreover, exchange rates are found to positively comove with interest rate differentials, and the former leads the latter. More importantly, we provide robust evidence of meaningful asymmetry and substantial time and frequency variations in the comovement and causality between the two variables. These findings provide important implications for improving the transmission of monetary policy in China.

Factors of Cross-border Capital Flow: An Empirical Study of Coastal Regions

Jiang, J.; Chen, H., and Wang, L., 2019. Factors of cross-border capital flow: the empirical study of coastal regions. In: Gong, D.; Zhu, H., and Liu, R. (eds.), Selected Topics in Coastal Research: Engineering, Industry, Economy, and Sustainable Development. Journal of Coastal Research, Special Issue No. 94, pp. 966–970. Coconut Creek (Florida), ISSN 0749-0208.This paper selects eight coastal areas as the research objects, constructs a multiple regression model to study the scale of cross-border capital flow in coastal regions and its influencing factors. The speculative capital in coastal areas is more sensitive to the changes of economic and political situations, and the capital inflow or outflow in coastal regions often plays a leading role of other regions. The government should pay more attention to the impact of interest rate spread between China and the United States, exchange rate expectation, the change of real estate price and securities market value on the cross-border capital flows in these eight coastal areas, timely identify risks and intervene, which is of positive significance to prevent systemic financial risks.

Taylor Rule, International Capital Flows and the Dynamic Determinant of RMB Exchange Rate

The report of the Nineteenth National Congress of the CPC and the 2018 Central Economic Work Conference clearly pointed out that maintaining the basic stability of RMB exchange rate at a reasonable and balanced level”. Therefore, while enhancing exchange rate flexibility, maintaining the orderly fluctuation of RMB exchange rate at the level of agreed equilibrium will be an important issue to the monetary authorities.This paper takes the monetary policy of open Taylor Rule as the framework, and endogenously implants international capital flows to examine the dynamic determinant mechanism of RMB exchange rate. In particular, we choose the sample period from July 2005 to October 2018, and adopt the TVP-SV-BVAR model to take an empirical analysis from different perspectives and periods.The following results are obtained: (1) Both the inflow of international capital and the expansion of interest margin will boost the appreciation of RMB exchange rate in the short and long term, and the impact will increase significantly after the exchange rate reform” in 2015. (2) The rise of inflation will also cause the appreciation of RMB exchange rate in the short and long term. However, this impact is relatively small in most periods. (3) Output increasing will lead to RMB devaluation in the short term, but it will promote RMB appreciation in the long term. Compared with other variables, the output gap has the greatest impact on the exchange rate, and is relatively stable in most sample periods. (4) The impact of exchange rate expectations on RMB spot exchange rate will be positive in the short term, but negative in the long term due to foreign exchange intervention.The results of this paper have important implications for preventing the abnormal flow of international capital and stabilizing the fluctuation of RMB exchange rate. In particular, the decision-making authorities should implement integrated supervision of international capital flows to avoid risks or even crises arising from large-scale capital flows. Taylor Rule, which includes international capital flows, plays an important role in promoting the marketization of the exchange rate and the interest rate.This paper expands the existing research from two aspects: Firstly, it endogenously implants international capital flows into the open Taylor Rule model and analyzes the dynamic determinant mechanism of RMB exchange rate from the theoretical level. Secondly, we utilize the TVP-SV-BVAR model to empirically analyze the nonlinear effect of Taylor Rule including international capital flows on RMB exchange rate from different points and periods. In addition, with the increasing complexity of domestic and foreign economic environment, the causes of regional heterogeneity involved in the study can be further identified.

Forecaster Rationality and Expectation Formation in Foreign Exchange Markets: Do Emerging Countries Differ from Industrialized Economies?

ABSTRACTThis paper uses the Consensus Economic Forecast poll to investigate how forecasters in the foreign exchange market form expectations and whether the expectation formation process differs between industrialized and emerging countries. In order to explain the expectation formation of forecasters in countries and country groups, we analyze around 50,000 forecasts for 22 OECD member currencies. We find that differences between the way forecasters in industrialized countries and emerging countries form exchange rate expectations. However, we show that one important difference is due to a difference in forecasting behavior of emerging countries. Controlling for this feature lets the forecasting behavior in emerging countries resemble more the ones found for industrialized countries, but not for all forecast horizons.

Contractionary Devaluation Risk: Evidence from the Free Silver Movement, 1878–1900

I identify significant effects of devaluation risk on interest rates and output using US silver coinage policy news between 1878 and 1900 as clean shocks to exchange rate expectations. The Free Silver movement heightened fears the United States would abandon the gold standard and depreciate the dollar. Because Congress, rather than a central bank, set silver coinage policy, silver policy news was likely uncorrelated with economic shocks. Corporate bonds exposed to dollar devaluation returned an additional 1 percent relative to safer bonds when silver risk decreased. Additionally, increased silver coinage risk is associated with an economically significant fall in industrial production.

A simple explanation of biased movements of renminbi exchange rate

The central parity of the renminbi is determined by the closing rate on the previous day according to the central parity formation mechanism following the August 2015 reform. This paper develops a simple model to study how this mechanism affects the currency’s exchange rate dynamics. The central parity is shown to be under monotonic decay or growth conditional on its rate relative to the expected exchange rate determined by a generic stochastic process. Such dynamics requires the central bank to engage in vigorous intra-marginal intervention to halt currency depreciation (or appreciation). Such upward (or downward) bias will disappear if a randomizing factor subject to market conditions is incorporated into the mechanism. The analysis is consistent with the observations in the renminbi foreign exchange market, and the theories and results in the previous studies on target zones.

Informal one‐sided target zone model and the Swiss franc

AbstractThis paper develops a new theoretical model with an asymmetric informal one‐sided exchange rate target zone, with an application to the Swiss franc following the removal of the minimum exchange rate of CHF 1.20 per euro in January 2015. We extend and generalize a standard target zone model by introducing perceived uncertainty about the lower edge of the band. We find that informal soft edge target zone bands lead to weaker honeymoon effects, wider target zone ranges, and higher exchange rate volatility than formal target zone bands. These results suggest that it would be beneficial for exchange rate policy intentions to be stated clearly in order to anchor exchange rate expectations and reduce exchange rate volatility. We also study how exchange rate dynamics can be characterized in models in which financial markets are aware of occasional changes in the policy regime. We show that expected changes in the central bank's exchange rate policy may lead to exchange rate oscillations, providing an additional source of exchange rate volatility, and to capture this it is important to take into account the possibility of regime changes in exchange rate policy.

How Efficient is the Foreign Exchange Market?

In this paper, we try to measure the degree of efficiency in the foreign exchange market by using four exchange rates ($/€, $/£, C$/$, and ¥/$). Different theoretical models are applied, like the random walk hypothesis, the unbiased forward rate hypothesis, the composite efficiency hypothesis, the semi-strong market efficiency, and the exchange rate expectations based on anticipated and unanticipated events (News). If exchange rate efficiency does not hold, a risk premium must exist and can be measured. Also, the determination of this exchange risk premium is taking place by using a GARCH (p, q) model. The empirical results for these four major exchange rates (five currencies) show that relative efficiency exists, but there are significant risk premia for some exchange rates used, here

Banking on foreign currency accounts: evidence from Malaysia

PurposeThe purpose of this paper is to study how the foreign currency account (FCA) is affected by the domestic fixed deposit (FD) rate, the FCA rate, the expected exchange rate and exchange rate risk.Design/methodology/approachThis paper analyses the causal relationship between the domestic FD rate, the FCA rate, the expected exchange rate on a set of foreign currency deposits and exchange rate volatility, based on the theory of portfolio choice. Based on the theory, the panel vector autoregressive regression of fully modified ordinary least squares and dynamic ordinary least squares are modelled.FindingsThere is no cointegrating relationship for the three-month FCA deposits, the domestic FD rate, the FCA rate and the expected exchange rate. Only the six-month FCA business deposits are affected by the domestic FD rate, the FCA rate and the expected exchange rate. The FCA depositors are not affected by exchange rate volatility.Research limitations/implicationsThis study is conducted based on the FCA rate quoted by the leading commercial banks in Malaysia, Maybank. Thus, the FCA rate is used as a proxy for the FCA rate of commercial banks in Malaysia.Originality/valueIndividual depositors have to save in more than the three-month FCA to realise their expected return. For individuals, the FCA deposit is not an alternative choice to domestic FD. Exporters may use the FCA deposit to finance their foreign purchases to save the cost of foreign exchange conversion but it is still not an appropriate hedging tool against foreign exchange fluctuations as compared to the existing forward foreign exchange facility.

The Swiss franc safety premium

This paper applies a recent method proposed by Maggiori (The U.S. Dollar Safety Premium, 2013) to estimate the Swiss franc safety premium. The results show that the three-step instrumental variable approach as used by Maggiori does not work for the Swiss franc exchange rates. The price of risk estimates take unrealistic, negative values. One possible explanation is that the approach as it is used by Maggiori suffers from a measurement error for the expected exchange rate which represents a potential source of imprecision. By using the prediction of an augmented Fama regression to measure the expected exchange rate change, this measurement error can be avoided and the safety premium estimates become more realistic and closer to those obtained with a maximum likelihood-estimated GARCH approach. Overall, however, the GARCH approach still seems to be preferable to the instrumental variable approach.