Non-deliverable Forward Market Research Articles

Does offshore NDF market influence onshore forex market? Evidence from India

AbstractThe paper uses a vector error correction model–multivariate generalized autoregressive conditional heteroskedasticity approach to examine the interrelationship between onshore and offshore nondeliverable forward (NDF) markets for the Indian Rupee. The empirical results suggest a stable and bidirectional long‐run relationship between onshore and offshore markets. The subperiod analysis implies that there are unidirectional mean spillovers from NDF markets to onshore spot, forward, and futures markets during the post‐taper tantrum period. Regarding “volatility spillover,” the analysis indicates a unidirectional volatility spillover from spot and forward segments to NDF market in normal circumstances, which turns bidirectional during times of depreciation pressure on the rupee.

Dynamic Linkages between US Dollar-Ringgit spot, forward and NDF during QE and Post-QE Exit

This study investigates the information flow between U.S. Dollar-Ringgit spot, forward and Nondeliverable Forward (NDF) exchange rates during the pre and post-U. S. Quantitative Easing (QE) exit. Our results show: First, there is a robust unidirectional causality from NDF to spot and NDF to forward in the post-QE period; Second, Malaysian Government Securities (MGS) has a vital role during the QE period while international reserve precedes the spot, forward and NDF exchange rates in the post-US QE exit. Our results reaffirm the policy measures taken by the Central Bank in regulating the NDF market. Our finding suggests that: First: MGS and Reserve are essential variables that can be used to counter speculation from the offshore NDF market; and Second, right policy stance must be communicated by the Central Bank to the market participants to avoid excessive volatility to the domestic currency which will affect the real economy

Indian Financial Integration: Evidence from the NDF Market

This study seeks to investigate the extent and causes of financial integration of India with the rest of the world during the sample period of January 2000 to October 2017. The study compares the interest rate which ought to prevail, with respect to the Non-Deliverable Forward (NDF) rate, in case of Covered Interest Parity and what actually does prevail. The difference between the Covered Interest Parity implied domestic interest rate and the actual domestic interest rate is our measure of financial integration. The study tries to find out different macroeconomic variables which affect the financial integration of India. The study used ordinary least squares, Johansen’s Cointegration technique along with VECM and Granger causality to unearth the long run and short run relationship of financial integration with plausible macroeconomic variables. We found India to be significantly non-integrated. Inflation volatility, changes in NEER and GDP along with Bank Rate and CRR were found to unequivocally influence financial integration of India. We also found structural break present in variables under study at June 2008.

Public information arrival, price discovery and dynamic correlations in the Chinese renminbi markets

The Chinese renminbi (RMB) currency system has undergone several major developments in the past two decades, including the adoption of a managed floating system since July 2005, the expansion of an offshore RMB non-deliverable forward (NDF) market, and the relaxation of certain regulatory controls to promote the increased use of the RMB in the region. These developments have sparked intense debate on the potential of RMB internationalization and its pros and cons. In view of these developments, this paper provides a comprehensive analysis of the dynamics of the RMB in both the spot and NDF markets since 2005 by examining the role and significance of the RMB NDF in the price discovery process and in predicting the volatility dynamics of the RMB markets. The results indicate that asymmetric volatility effects are significant for several NDF contract maturities and the spot-NDF correlations are significantly time-varying. Moreover, shocks to the volatility levels are highly persistent. Causality tests on the spot and NDF volatilities further suggest that the NDF markets impact the future fluctuations of the spot market, but the spot market does not have predictive power for the volatility of the NDF markets. Public information flows are found to have a significantly positive impact on the spot-forward conditional correlations. These findings have important implications for market linkages and effective hedging strategies.

Dynamic information spillovers in intraregionally-focused spot and forward currency markets

This paper proposes an intraregionally-focused tri-currency modeling framework to investigate dynamic information spillovers across spot and forward exchange rate markets in frontier and emerging country currencies, for both price levels and volatilities. Empirical estimates of structural parameters were obtained using an MGARCH–MSKST model that incorporated the term structure of non-deliverable forward (NDF) and deliverable forward (DF) markets, the dominance of regional currencies, and the influence of differing forward contract maturities (1-, 3-, 6- and 12-months). The currencies for nine countries were grouped into three regions: Northeast Asia (China, Korea and Taiwan); South/Southeast Asia (India, Indonesia and Philippines); and Latin America (Brazil, Chile and Columbia). The currency for each selected country was evaluated within the regionally determined tri-currency system. We found that NDF markets play a dominant role over DF markets with regard to price discovery during periods of tranquility. During periods of crisis, both NDF and DF markets exhibit a more balanced impact on currency market price discovery mechanisms. In addition, distinct differences were observed across regions: currencies in Northeast Asia were shown to be affected by the Chinese renminbi during periods of crisis and the Indian rupee could be regarded as the dominant currency in South/Southeast Asia. No robust results were obtained with regard to the dominance of currencies in Latin America. Finally, our results also suggest important distinctions between the effect of various instrument maturities on NDF and DF market returns – with DF returns being more responsive to longer maturities (6-months and 12-months). During tranquil periods NDF returns are more responsive to shorter maturities, but during crisis periods this effect is diminished.

Expected Exchange Rate Movement and Forward-Looking Importers

This paper presents theory and empirical evidence on that a forward-looking potential importer facing sunk costs will respond to expectation of future exchange rate fluctuations. This finding indicates the importance of sunk costs in firms' decisions to import goods. Building upon a heterogeneous-firm framework, the model makes a variety of predictions about the effect of anticipated fluctuations in the domestic currency exchange rate. First, changes in the expectation of future exchange rates lead to the entry/exit of marginally productive firms, reshaping the extensive margin of imports, and inducing significant changes in aggregate import values. Second, the firm level marginal benefit/loss of importing diminishes as expected appreciation/depreciation persists, due to the impact of continued entry/exit on markups. This changing marginal benefit/loss consequently weakens the adjustment of the extensive margin in the long run. Third, firms present heterogeneous responses to forward exchange rate fluctuations in the presence of sunk costs; these responses are related to their access to credit and other firm-level characteristics. Using disaggregated transaction level data of Chinese imports from the United States combined with data on the US dollar-RMB future rates on the non-deliverable forward market, this paper confirms that the extensive margin of import significantly responds to forward exchange rate premiums. This paper also finds evidence on firms' heterogeneous responses to anticipated exchange rate changes that support the model predictions by merging import data with firm-level balance sheet data.

Interlinkages in Asia-Pacific Non-Deliverable Forward (NDF) Markets (A Comparison between Pre and Post Currency Futures Era)

This paper examines the inter-linkages in Asia Pacific, currency market before and after the introduction of currency futures in India using simple correlation and Granger causality tests. It is found that inter-linkages among Asia- pacific markets have increased after the emergence of currency future, and Asia-Pacific NDF markets are closely linked with one another. Further, Indonesian market does not seem to have any influence on the other Asia-Pacific markets except India and similarly is not much affected by any market other than the China, India and Philippines. Vietnam market seems to be isolated from the region. Indonesia market appears to dominate other markets in the region and its effect on them is even greater than that of China. All eight Asia-Pacific markets affect one another and their effects are transmitted within three days in most of the cases.

Effectiveness of Capital Controls in India: Evidence from the Offshore NDF Market

This paper examines the effectiveness of international capital controls in India over time by analyzing daily return differentials in the nondeliverable forward (NDF) markets using the self-exciting threshold autoregressive (SETAR) methodology. The paper presents a narrative on the evolution of capital controls in India and calculates a new index of capital account liberalization using cumulative monthly changes in restrictions on inflows and outflows. It employs the de jure indices of changes in restrictions on capital inflows and outflows to identify particular policy episodes, and tests the de facto effects of restrictions by calculating deviations from covered interest parity (CIP) utilizing data from the three-month offshore nondeliverable rupee forward market. The paper estimates no-arbitrage bands for each episode using SETAR where boundaries are determined by transactions costs and by the effectiveness of capital controls. It finds that Indian capital controls are asymmetric over inflows and outflows, have changed at one stage from primarily restricting outflows to effectively restricting inflows; and that arbitrage activity closes deviations from CIP when the threshold boundaries are exceeded in all subperiods. Moreover, the results indicate a significant reduction in the barriers to arbitrage since 2009, suggesting that gradual liberalization of India's capital account has played an important role in integrating onshore and offshore markets. The paper also applies the methodology to the Chinese RMB NDF market and find that capital controls are strictly limiting capital inflows with the exception of two periods of regional and international financial turbulence. The intensity of Chinese controls varies over time, indicating discretion in the application of capital control policy but, unlike India, shows no sign of gradual relaxation or liberalization.

Do external political pressures affect the Renminbi exchange rate?

This paper investigates whether external political pressure for faster Renminbi appreciation affects both the daily returns and the conditional volatility of the Renminbi central parity rate. We construct several political pressure indicators pertaining to the Renminbi exchange rate, with a special emphasis on the US pressure, to test the hypothesis. After controlling for Chinese macroeconomic surprise news, we find that US and non-US political pressure does not have a significant influence on Renminbi's daily returns. However, evidence suggests that political pressures, and especially those from the US, have statistically significant impacts on the conditional volatility of the Renminbi. Furthermore, we conduct the same exercise on the 12-month Renminbi non-deliverable forward rate. We find that the non-deliverable forward market is highly responsive to macroeconomic surprise news and there is some evidence that Sino-US bilateral meetings affect the conditional volatility of the Renminbi non-deliverable forward rate.

Onshore and offshore market for Indian rupee: recent evidence on volatility and shock spillover

The article empirically examines the onshor-offshore linkages of the Indian rupee using recently developed multivariate GARCH technique. The empirical results show that the offshore non-deliverable forward market does not have mean spillover impact on onshore spot, forward and futures markets while shocks and volatilities in the non-deliverable forward market influence the onshore markets. A key finding of the study is that the magnitude of volatility spillover from non-deliverable forward to spot market has accentuated after the introduction of currency futures in India. This development could be attributable to large arbitrage between futures and non-deliverable forward market in the more recent period. The finding has critical implications for exchange rate policy and management in the Indian context. There is need for close monitoring of both the onshore and offshore markets.

Volatility transmissions between renminbi and Asia-Pacific on-shore and off-shore U.S. dollar futures.

This paper uses multivariate GARCH techniques to study volatility spillovers between the Chinese non-deliverable forward market and seven of its Asia-Pacific counterparts over the period January 1998 to March 2005. To account for the time-variability of conditional correlation, a dynamic correlation structure is included in the volatility model specification. The empirical results demonstrate that the renminbi non-deliverable forward (NDF) has been a driver of various Asian currency markets but that such co-movements exhibit a substantial degree of heterogeneity. As to the determinants of the magnitude of these co-movements, we test the relevance of potential factors and find that it is the degree of real and financial integration, in particular, that exerts the largest influence on volatility transmission.

Volatility Transmissions between Renminbi and Asia-Pacific On-Shore and Off-Shore U.S. Dollar Futures

This paper uses multivariate GARCH techniques to study volatility spillovers between the Chinese non-deliverable forward market and seven of its Asia-Pacific counterparts over the period January 1998 to March 2005. To account for the time-variability of conditional correlation, a dynamic correlation structure is included in the volatility model specification. The empirical results demonstrate that the renminbi non-deliverable forward (NDF) has been a driver of various Asian currency markets but that such co-movements exhibit a substantial degree of heterogeneity. As to the determinants of the magnitude of these co-movements, we test the relevance of potential factors and find that it is the degree of real and financial integration, in particular, that exerts the largest influence on volatility transmission.

Nondeliverable forward market for Chinese RMB: A first look

This study discusses the non-deliverable forward (NDF) markets in general and presents some analysis about the RMB NDF market in particular. The NDF is a cash settled forward contract. We discover that the foreign exchange forward premium (RMB/US$) becomes discount for various maturities of the NDF after November 13, 2002. The discount is likely a result of the increasingly large China-U.S. trade deficit and mounting foreign reserves. The use of RMB NDF will likely continue to rise as more foreign investors have a bigger stake in doing business in China.

Information flows between non-deliverable forward (NDF) and spot markets: Evidence from Korean currency

This paper investigates the interrelation and information flows between the Won–Dollar spot and offshore forward, i.e., NDF markets. In particular, this paper focuses on the impact of the reform in the Korean exchange rate systems, which occurred in December 1997 in response to the currency crisis, on the relation between the two markets. Using the augmented GARCH formulation, this paper finds that during the pre-reform period a mean spillover effect exists from the spot to the NDF market but not vice versa, and a volatility spillover effect exists in both directions. After the reform, however, the results are reversed and a mean spillover effect exists from the NDF to the spot market. Also, the volatility spillover effect exists only in the same direction. These findings suggest that there are information flows between the two markets, and the reform has changed the direction of the dynamic relation.