Exchange Rate Trends Research Articles

Stop-Loss Orders and Price Cascades in Currency Markets

In this paper, I provide evidence that currency stop-loss orders contribute to rapid, self-reinforcing price movements, or price cascades. Stop-loss orders, which instruct a dealer to buy (sell) a certain amount of currency at the market rate once the rate has risen (fallen) to a prespecified level, generate positive-feedback trading. Theoretical research on the 1987 stock market crash suggests that such trading can cause price discontinuities, which would manifest themselves as price cascades. My analysis of high-frequency exchange rates offers three main results that provide empirical support for the hypothesis that stop-loss orders contribute to price cascades: (1) Exchange rate trends are unusually rapid when rates reach exchange rate levels at which stop-loss order have been documented to cluster. (2) The response to stop-loss orders is larger than the response to take-profit orders, which generate negative-feedback trading and are therefore unlikely to contribute to price cascades. (3) The response to stop-loss orders lasts longer than the response to take-profit orders. Most results are statistically significant for hours, although not for days. Together, these results indicate that stop-loss orders propagate trends and are sometimes triggered in waves, contributing to price cascades. Stop-loss propagated price cascades may help explain the well-known fat tails of the distribution of exchange rate returns, or equivalently the high frequency of large exchange rate moves. The paper also provides evidence that exchange rates respond to noninformative order flow.

Real Exchange Rate in China: A Long‐run Perspective

AbstractThis paper investigates the RMB exchange rate from a long‐run viewpoint. Whether China's rapid economic growth brought about real exchange rate appreciation between 1975 and 2002 is empirically examined, based on a supply‐side model, the Balassa—Semuelson Hypothesis (BSH). The same test is conducted on Japan, Hong Kong, Korea, Malaysia, Singapore, Thailand, the Philippines, Indonesia and India. Our result indicates that the BSH only exists where the industrial structure has been upgraded and the economy has been successfully transformed from an agricultural economy to a manufacturing economy. Interestingly, China, among those where the BSH does not present, appears to be upgrading its industrial and trade structure. We then try to answer the question of why past rapid growth has no significant relationship with the RMB real exchange rate and what factors are underlying the trend of the RMB real exchange rate. We expect an appreciating trend of RMB real exchange rate in the foreseeable future, presuming that China's industrial upgrading process continues and the factors pertaining to the BSH's prediction, such as rise of wage rates in both tradables and nontradables, become more significant.(Edited by Xiaoming Feng)

Are our FEERs justified?

The Fundamental Equilibrium Exchange Rate (FEER) method of calculating an equilibrium real exchange rate is the most widely used alternative to PPP. This paper presents the first comprehensive historical test of FEER calculations for six major economies, using estimates for the last 20 years. We focus on unit root and cointegration techniques both at the individual country level and jointly using panel based estimation. Specifically, we test whether real exchange rates cointegrate with time series for the FEER. Even at an individual country level, the results provide support for the FEER, particularly in Canada, the UK and Germany. Panel unit root tests suggest that the real exchange rate and FEER cointegrate. Overall the results suggest that the FEER approach represents an improvement over PPP in explaining medium- to long-term trends in the real exchange rates of the major industrialised countries.

Interventions in the Yen–dollar spot market: A story of price, volatility and volume

We test the effectiveness of Bank of Japan (BOJ)’s foreign exchange interventions on conditional first and second moments of exchange rate returns and traded volumes, using a bivariate EGARCH model of the Yen/USD market from 5-13-1991 to 3-16-2004. We also estimate a friction model of BOJ’s intervention reaction function based on reducing short-term market disorderliness and supplementing domestic monetary policy. Important finding of this study are that: (i) we find ineffectiveness of BOJ interventions in influencing exchange rate trends pre-1995, in general, but effectiveness post-1995; (ii) FED intervention amplified the effectiveness of the BOJ transactions; (iii) interventions amplified market volatility and volumes through a ‘learning by trading’ process; (iv) BOJ’s interventions were based on ‘leaning against the wind’ motivations on the exchange rate trend and volumes; and (v) BOJ interventions were vigorously used in support of domestic monetary policy objectives post-1995. Though some of our findings confirm recent studies, our analysis goes deeper to provide new findings with important implications for central banks and foreign exchange market participants.

The interaction between technical currency trading and exchange rate fluctuations

This paper examines the mutually reinforcing interactions between exchange rate dynamics and technical trading strategies. I first show that technical trading systems have been quite profitable during the floating rate period. This profitability stems from the successful exploitation of exchange-rate trends and not from taking winning positions relatively frequently. I then show that technical models exert an excess demand pressure on currency markets. When these models produce trading signals, almost all signals are on the same side of the market, either buying or selling. When technical models maintain open positions they are either long or short. Initial exchange rate movements triggered by news or by stop–loss orders are strengthened by technical trading and are often transformed into a trend. This “multiplier effect” is reflected by the close relationship between technical trading signals and order flows. Hence, order flows are not only driven by (fundamental) news but also by technical trading, which reinforces exchange rate trends to which it responds.

Intraday evidence of efficacy of 1991–2004 Yen intervention by the Bank of Japan

This paper investigates the intraday efficacy of Yen intervention conducted by the Bank of Japan. Segmenting a 24 h calendar day into three business hours – onshore and two offshore hours – I examine both contemporaneous and ex post intervention effects on the Yen/USD exchange rate. Prior to June 1995, intervention moved the exchange rate in the wrong direction and the level of volatility is significantly raised during Tokyo business hours. This is due to the well-known simultaneity bias. However, during the first overnight hours (London business hours) the simultaneity bias is significantly reduced and by the second overnight hours (New York afternoon hours) intervention successfully reversed the exchange rate trends and reduced the volatility. Post-June 1995, intervention had an immediate effect of reversing the exchange rate trend and it remained effective, although at reduced magnitude, throughout overnight horizons. A volatility reducing effect is significant from the first overnight horizon and its effectiveness rises in the second overnight horizon.

Strategies of exchange rate policy in G3 economies

The paper argues that communication has become the primary policy tool for G3 monetary authorities to influence exchange rates. It analyses the strategies policy-makers pursue through communication and actual interventions with regard to exchange rate trends, monetary policy and coordinated interventions.

The common-trend and transitory dynamics in real exchange rate fluctuations

This study examines the behaviour of both Common Trend (CT) and transitory components of Real Exchange Rate (RER) fluctuations under the current float. The CT component is in most cases found to be sizeable, albeit its relative importance can vary considerably across major currencies and its estimate can be sensitive to whether or not long-run Purchasing Power Parity (PPP) is imposed on the data. Further analysis suggests that both CT and transitory innovations are linked much more to interest rate changes than to productivity changes. Accordingly, it is interest rate, not productivity, disturbances that drive the highly persistent RER.

Forecasting real exchange rate trends using age structure data – the case of Sweden

Theory predicts that life cycle saving and consumption behaviour could cause real exchange rate variations as the age structure varies. Time series regressions show that the Swedish demographic structure has significant explanatory power on the real exchange rate during 1960 to 2002. A model using age shares as regressors is used for medium-term out-of-sample forecasts, which perform well both compared to naïve forecasts and forecasts based on an autoregressive model.

Incomes, Exchange Rates and the US Trade Deficit, Once Again*

AbstractThe chronic and expanding US trade deficit has refocused attention upon the responsiveness of trade flows to exchange rate and income changes. I estimate import and export equations over a period spanning the 1990s New Economy boom and the subsequent recession and dollar depreciation. The results indicate (1) a low responsiveness of imports to exchange rate changes, and (2) a diminution (but not disappearance) of the income elasticity asymmetry first noted by Houthakker and Magee. The combination of low price elasticity of imports with the present size of the trade deficit means that any reduction of the trade deficit will necessarily be accompanied by large exchange rate and income trend adjustments.

Anchoring and Psychological Barriers in Foreign Exchange Markets

This paper develops a simple behavioral exchange rate model in which investor perception of the fundamental value is anchored to the nearest round number. Traders adjust their anchors in two ways. Some believe that exchange rates move toward (perceived) fundamentals, while others bet on a continuation of the current exchange rate trend. The behavior of the traders causes complex dynamics. Since the exchange rate tends to circle around its perceived fundamental value, the foreign exchange market is persistently misaligned. Central authorities have the opportunity to reduce such distortions by pushing the exchange rate to less biased anchors, but to achieve this, they have to break psychological barriers between anchors.

A Tale of Two Currencies: the Asian Crisis and the Exchange Rate Regimes of Hong Kong and Singapore

Hong Kong has maintained a pegged exchange rate since 1983, while Singapore has been on a floating regime since the early 1970s. This paper provides an interpretation of the different performance of the Hong Kong and Singapore economy that could be attributable to the differences in their exchange rate regime. We develop a model that can help to interpret the differences in both the longer run trends in inflation and real exchange rates in Hong Kong and Singapore as well as the short differences in macroeconomic and real exchange rate volatility. The difference in the response of the two economies to the Asian crisis is also consistent with our model.

The Recent Trend of Real Effective Exchange Rate in Selected East Asian Countries

The Recent Trend of Real Effective Exchange Rate in Selected East Asian Countries

Neural network pruning applied to real exchange rate analysis

AbstractNeural networks are fitted to real exchange rates of several industrialized countries. The size and topology of the networks is found through the use of multiple correlation coefficients, principal component analysis of residuals and graphical analysis of network output per hidden layer cell and input layer cell. These pruned neural networks are good approximations to varying non‐linear trends in real exchange rates. Non‐linear dynamic analysis shows that the long‐term equilibrium values of several European currencies correspond to the actual values within the European Monetary System. Based on its long‐term equilibrium value, the Euro appears to be undervalued vis‐à‐vis the US dollar at the introduction of the Euro on 1 January 1999. Copyright © 2002 John Wiley & Sons, Ltd.

The determinants of foreign exchange intervention by central banks: evidence from Australia

Intervention by the Reserve Bank of Australia on foreign exchange markets from 1983 to 1997 is conjectured to have been determined by exchange rate trend correction, exchange rate volatility smoothing, the US and Australian overnight interest rate differentials, profitability and foreign currency reserve inventory considerations. Using Probit and friction models, we show that these factors were significant influences on intervention behavior. Consistent with the constraint of intervening only when a clear trend is apparent, we find that above average measures of deviations from trend and of volatility muted the response of the Reserve Bank.

Capital Flows to Transition Economies: Master or Servant?

This paper discusses the forces driving capital flows in the transition countries of Central and Eastern Europe (CEE). It argues that various influences – specifically, the real exchange rate history and trend and the factor intensity of production – can combine to motivate very large capital inflows. These inflows can either undermine attempts at monetary restraint or force excessive appreciations. They can also render the economy highly vulnerable to shifts in market sentiment. The policy implications of the analysis are awkward: exposure to global capital markets sets up difficult dilemmas for policy and leads to vulnerabilities that can be reduced but not eliminated.

Capital Flows to Transition Economies: Master or Servant

This paper discusses the forces driving capital flows in the transition countries of Central and Eastern Europe (CEE). It argues that various influences—specifically, the real exchange rate history and trend and the factor intensity of production—can combine to motivate very large capital inflows. These inflows can either undermine attempts at monetary restraint or force excessive appreciations. They can also render the economy highly vulnerable to shifts in market sentiment. The policy implications of the analysis are awkward: exposure to global capital markets sets up difficult dilemmas for policy and leads to vulnerabilities that can be reduced but not eliminated.

The Determinants of Foreign Exchange Intervention by Central Banks: Evidence from Australia

Intervention by the Reserve Bank of Australia on foreign exchange markets from 1983 to 1997 is conjectured to have been determined by exchange rate trend correction, exchange rate volatility smoothing, the U.S. and Australian overnight interest rate differentials, profitability and foreign currency reserve inventory considerations. Using Probit and friction models, we show that these factors were significant influences on intervention behaviour. Consistent with the constraint of intervening only when a clear trend is apparent, we find that above average measures of deviations from trend and of volatility muted the response of the Reserve Bank.

The temporal pattern of trading rule returns and exchange rate intervention: intervention does not generate technical trading profits

This paper characterizes the temporal pattern of trading rule returns and official intervention for Australian, German, Swiss and U.S. data to investigate whether intervention generates technical trading rule profits. The data reject the hypothesis that intervention generates inefficiencies from which technical rules profit. In particular, high frequency data show that abnormally high trading rule returns precede German, Swiss and U.S. intervention. Australian intervention precedes high trading rule returns, but trading/intervention patterns make it implausible that intervention actually generates those returns. Rather, intervention responds to exchange rate trends from which trading rules have recently profited.

The Temporal Pattern of Trading Rule Returns and Central Bank Intervention: Intervention Does Not Generate Technical Trading Rule Profits

This paper characterizes the temporal pattern of trading rule returns and official intervention for Australian, German, Swiss and U.S. data to investigate whether intervention generates technical trading rule profits. High frequency data show that abnormally high trading rule returns precede German, Swiss and U.S. intervention, disproving the hypothesis that intervention generates inefficiencies from which technical rules profit. Australian intervention precedes high trading rule returns, but trading/intervention patterns make it implausible that intervention actually generates those returns. Rather, intervention responds to exchange rate trends from which trading rules have recently profited.