covered interest rate arbitrage in the interwar period and the keynes einzig conjecture keynes 1923 conjectured that deviations from covered interest rate parity would not be arbitraged unless a profit of at least a half of one percent on an annualized basis was available and that larger deviations would still be moderately persistent because of less than perfect elasticity of supply of arbitrage funds this two part conjecture was given further emphasis by other writers on this period notably einzig 1937 we apply nonlinear econometric techniques to a previously unexploited weekly data base for the 1920s london and new york markets and find strong support for the conjecture

tests of three parity conditions distinguishing risk premia and systematic forecast errors abstract this study provides evidence that uncovered interest differentials between currencies cannot be attributed to either risk premia or systematic forecast errors alone the evidence is based on developing joint tests of three parity conditions uncovered interest parity purchasing power parity and real interest parity the study tests parameter restrictions based on knowing that risk premiums only affect nominal and real interest differentials but not inflation differentials while systematic errors in forecasting exchange rates only affect nominal interest differentials and inflation differentials but not real interest differentials the study finds a variety of cases where deviations from some or all of the parity conditions can be systematically related to variables currently known to investors and borrowers the most intriguing evidence is that for some currencies these deviations from parity are perfectly correlated as if they were driven by a common factor

purchasing power parity modeling and testing mean reversion abstract a model of mean reversion of exchange rates to purchasing power parity is developed and tested where exchange rates are assumed to follow a mean reverting elastic random walk toward a stochastic ppp rate the model recognizes the possibility that mean reversion towards ppp may be nonlinear which allows greater flexibility in the adjustment process regression equations consistent with the theoretical model are derived the model is tested using long and short term data for six countries while the results are generally consistent with the findings of previous studies evidence is presented which demonstrates that the mean reversion process is not linear for some countries

deviations from purchasing power parity in the long run this paper demonstrates that deviations from purchasing power parity reveal a remarkable and possibly startling consistency with martingale behavior during both fixed and flexible rate periods for a wide variety of countries and in both monthly and annual data since this pattern appears to be much more general than one would expect on the basis of models founded on international commodity arbitrage the paper proposes an alternative explanation which instead relies on financial arbitrage in bonds as the underlying mechanism this paper will demonstrate that deviations from purchasing power parity ppp reveal a remarkable and possibly startling consistency with martingale behavior during both fixed and flexible exchange rate periods for a wide variety of countries and in both monthly and annual data this pattern appears to be much more general than one would expect on the basis of models founded on international commodity arbitrage the paper therefore proposes an alternative explanation which does not presuppose free trade in goods but which instead relies on financial arbitrage in bonds as the underlying mechanism the major implication of the theory and the results is that ppp is as likely to be violated in the long as in the short run as an empirical matter deviations from ppp can be observed for most currencies at any instant see kravis et al 21 stockman 37 and genberg 15 among others these deviations are typically both cumulative and persistent the real exchange rate can remain on either side of parity for lengthy but variable time intervals of a year or more as a consequence the current consensus shared

national price levels purchasing power parity and cointegration a test of four high inflation economies abstract the time series properties of exchange rates and wholesale prices from four high inflation countries show some evidence in support of purchasing power parity tests for stationarity of real exchange rates and cointegration among price and exchange rate variables are presented for argentina brazil chile and israel during the 1970s and 1980s error correction models describe the mechanism of adjustment to long run equilibrium

purchasing power parity in the long run a cointegration approach this paper utilizes cointegration analysis to examine purchasing power parity relationships over a long time horizon the results indicate that the exchange rate is cointegrated strongly with the wholesale price index ratio and somewhat weakly with the consumer price index ratio the cointegrating coefficient between the exchange rate and the price ratio is close to one when cointegration is confirmed the hypothesis that the real exchange rate follows a random walk is rejected in most cases finally a new test for common trends finds no such common trends in exchange rates or price ratios copyright 1990 by ohio state university press

real exchange rates between the wars abstract bilateral real exchange rates are analyzed for fifteen countries over the period 1925 1937 using a benchmark invariant principal components technique for the period 1925 1931 half of real exchange rate variation originates from countries on floating exchange rates and half from price level differences between countries on the gold standard for the period 1931 1937 real exchange rate movements between the sterling bloc the european gold bloc and the us and canada appear dominant within bloc variation is secondary and mostly due to competitive devaluations our results support earlier evidence that the nominal exchange rate regime to a large extent determines real exchange rate variation

nonlinear purchasing power parity under the gold standard 1 introductionrecent theoretical analysis of purchasing power deviations see e g dumas 1992 sercu uppal and van hull 1995 and o connell and wei 1997 demonstrates how transactions costs or the sunk costs of international arbitrage induce nonlinear adjustment of the real exchange rate to purchasing power parity ppp globally mean reverting this nonlinear process has the important property of exhibiting near unit root behavior for small deviations from ppp since small deviations from ppp are left uncorrected if they are not large enough to cover the transactions costs or the sunk costs of international arbitrage a parametric nonlinear model suggested by the theoretical literature that captures the nonlinear adjustment process in aggregate data is the exponential smooth transition autoregression model estar of ozaki 1985 a smooth rather than discrete adjustment mechanism is motivated by the theoretical analysis of dumas 1992 also as postulated by terasvirta 1994 and demonstrated theoretically by berka 2002 in aggregate data regime changes may be smooth rather than discrete given that heterogeneous agents do not act simultaneously even if they make dichotomous decisions 1 recent empirical work e g michael nobay and peel 1997 taylor peel and sarno 2001 peel and venetis 2002 has reported empirical results that suggest that the estar model provides a parsimonious fit into a variety of data sets particular for monthly data for the interwar and postwar floating period as well as for annual data spanning 200 years as reported in lothian and taylor 1996 in addition nonlinear impulse response functions derived from the estar models show that although the speed of adjustment for small shocks around equilibrium will be highly persistent larger shocks mean revert much faster than the glacial rates previously reported for linear models rogoff 1996 in this respect the estar models provide some solution to the ppp puzzle outlined in rogoff 1996 2the estar model can also provide an explanation of why ppp deviations analyzed from a linear perspective appear to be described by either a nonstationary integrated i 1 process or alternatively described by fractional processes see e g diebold husted and rush 1991 taylor peel and sarno 2001 and pippenger and goering 1993 show that the dickey fuller tests have low power against data simulated from an estar model michael nobay and peel 1997 and byers and peel 2003 show that data that is generated from an estar process can appear to exhibit the fractional property that this would be the case was an early conjecture by acosta and granger 1995 given that the estar model has a theoretical rationale whereas the fractional process is a relatively nonintuitive one the fractional property might reasonably be interpreted as a misleading linear property of ppp deviations granger and terasvirta 1999 whereas the empirical work employing estar models provides some explanation of the glacially slow adjustment speeds obtained in linear models there is one aspect of the empirical work that is worthy of further attention a second way of explaining the rogoff puzzle raised by rogoff himself 3 is to relax the assumption that the equilibrium real exchange rate is a constant see e g canzoneri cumby and diba 1996 and chinn and johnston 1996 theoretical models such as that of balassa 1964 and samuelson 1964 imply a nonconstant equilibrium in the real exchange rate if real productivity growth rates differ between countries 4 nonlinear models that incorporate proxies for these effects are found to parsimoniously fit post bretton woods data for the main real exchange rates see venetis paya and peel 2002 and paya venetis and peel 2003 naturally models that ignore this effect may generate misleading speeds of ppp adjustment to shocks in this regard the empirical results of hegwood and papell 2002 for the gold standard period are particularly interesting

interest rate pass through and monetary transmission evidence from individual financial institutions retail rates official interest rate changes should influence short rates on money market instruments and retail products such as deposit accounts and mortgages but complete pass through is often taken for granted this paper provides a theoretical and econometric framework for assessing the evidence for this assumption using seventeen years of monthly data for rates on thirteen deposit and mortgage products offered by individual uk financial institutions the methodology allows for asymmetries and non linearities in adjustment and the results show that the speed of adjustment in retail rates depends on whether the perceived gap between retail and base rates is widening or narrowing

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

the response of exchange rates to permanent and transitory shocks under floating exchange rates abstract using the joint behavior of inflation and real exchange rates we develop an empirical model to uncover the sources of the fluctuations in the real dollar exchange rates of four major industrial countries under the current float this model allows us to construct two time series for each country pair one representing the permanent component of each real exchange rate and the other the purely transitory component over the period as a whole transitory shocks played a relatively small but statistically significant role real dollar exchange rates therefore did not simply evolve in response to permanent shocks instead there are instances in which temporary shocks made a substantial contribution we conclude that the random walk model though an approximate statistical description of real exchange rate behavior is a poor guide to model structure jel f31

what is the major determinant of cross border banking flows abstract this study examines the major determinant of cross border credit flows through global banks across 70 countries employing a bayesian dynamic latent factor model we decompose volatilities of banking flows into the contribution of a global common factor regional common factor and country specific factor the results indicate that the global and regional common factor explains about 40 50 percent of volatility in overall cross border banking flows in particular the contribution of the global common factor increased in the 2000s simultaneously main determinants are largely heterogeneous across countries this implies that the desirable policy response to credit inflows may differ for each host country

potential pitfalls for the purchasing power parity puzzle sampling and specification biases in mean reversion tests of the law of one price the ppp puzzle is based on empirical evidence that international price differences for individual goods loop or baskets of goods ppp appear highly persistent or even nonstationary the present consensus is these price differences have a half life that is of the order of five years at best and infinity at worst this seems unreasonable in a world where transportation and transaction costs appear so low as to encourage arbitrage and the convergence of price gaps over much shorter horizons typically days or weeks however current empirics rely on a particular choice of methodology involving i relatively low frequency monthly quarterly or annual data and ii a linear model specification in fact these methodological choices are not innocent and they can be shown to bias analysis towards findings of slow convergence and a random walk intuitively if we suspect that the actual adjustment horizon is of the order of days then monthly and annual data cannot be expected to reveal it if we suspect arbitrage costs are high enough to produce a substantial band of inaction then a linear model will fail to support convergence if the process spends considerable time random walking in that band thus when testing for ppp or loop model specification and data sampling should not proceed without consideration of the actual institutional context and logistical framework of markets

monetary fundamentals and exchange rate dynamics under different nominal regimes we investigate the dynamic relationship between the us dollar exchange rate and its fundamentals across different exchange rate regimes using data going back to the late 1800s or early 1900s for six industrialized countries for these countries there is evidence of a long run relation between the nominal exchange rate and monetary fundamentals consistent with conventional theories of exchange rate determination we employ a markov switching vector equilibrium correction model that allows for regime shifts in the entire set of parameters and the variance covariance matrix our results suggest that the relative importance of exchange rates and fundamentals in restoring the long run equilibrium level implied by the exchange rate monetary fundamentals model varies significantly over time and is affected by the nominal exchange rate regime in operation

purchasing power parity and unit root tests using panel data abstract this paper reports the results of unit root tests for real exchange rates using a panel framework this panel approach provides greatly improved power compared to conventional univariate time series unit root tests we obtain evidence supporting ppp over the recent flexible exchange rate period for g 6 and oecd countries we show explicitly that failure to find such evidence in previous research was due to the low power of the tests

taming the global financial cycle what role for the global financial safety net abstract an ongoing active debate considers the role of the global financial cycle gfc in driving international capital flows especially in emerging economies as well as the policy options available to absorb their impact we make two contributions to the debate first we rely on a structural measure of the gfc developed in a companion paper to identify episodes of large capital flows and currency crises driven by global conditions second using both ols and instrumental variables we evaluate whether the availability and actual use of elements of the global financial safety net gfsn can help emerging markets cushion the impact of these episodes we find some evidence that potential access to imf support can help countries we also find that the use of imf support and reserves cushions the impact of global shocks on gdp growth this effect is quite heterogeneous across types of crises and across time as it is mostly present during currency crises and the benefits only occur with a delay

testing the monetary model of exchange rate determination new evidence from a century of data abstract we test the long run monetary model of exchange rate determination for a collection of 14 industrialized countries using data spanning the late nineteenth or early twentieth century to the late twentieth century interestingly we find support for a simple form of the long run monetary model in over half of the countries we consider for these countries we estimate vector error correction models to investigate the adjustment process to the long run monetary equilibrium in the spirit of meese and rogoff journal of international economics 14 1983 3 24 we also compare nominal exchange rate forecasts based on monetary fundamentals to those based on a naive random walk model

real exchange rate behavior abstract using random simulations with artificial data with identical sample characteristics to the long sample exchange rate data employed by lothian and taylor lothian j r and taylor m p 1996 the recent float from the perspective of the past two centuries journal of political economy 104 488 509 we show that standard unit root tests have extremely low power over sample sizes corresponding to the recent float the probability of rejecting the null hypothesis when it is false is extremely low with 20 years or even 50 years of data and only reaches an acceptable level over much longer spans

understanding global liquidity abstract we explore the concept of global liquidity based on a factor model estimated using a large set of financial and macroeconomic variables from 24 advanced and emerging market economies we measure global liquidity conditions based on the common global factors in the dynamics of liquidity indicators by imposing theoretically motivated sign restrictions on factor loadings we achieve a structural identification of the factors the results suggest that global liquidity conditions are largely driven by three common factors and can therefore not be summarised by a single indicator these three factors can be identified as global monetary policy global credit supply and global credit demand

financial innovations and arbitrage pricing in economies with frictions revisited abstract existing literature points to the role of market frictions in providing motivations for financial innovations in this paper we study the effectiveness of the arbitrage pricing approach and the design and pricing of innovated securities in economies with restrictions on short sales in the process we also define the no arbitrage conditions that is appropriate for such economies the differences between our results and chen s 3 are pointed out when appropriate journal of economic literature classification numbers c61 g10 g12 g20

do currency unions deliver more economic integration than fixed exchange rates evidence from the franc zone and the eccu in this article we develop a model to identify determinants of macroeconomic integration in the african franc zone and in dollar pegging caribbean countries including members of the east caribbean currency union these two groups of countries each comprise states using several different local currencies on the one hand the uemoa cfa franc and the cemac cfa franc both pegged to the euro on the other the eccu dollar and other national dollar pegged currencies the purpose of the analysis is to distinguish the effect of monetary union on macroeconomic integration from the effect of pegging to a common oecd currency

regime linkages in the us uk real exchange rate real interest differential relation abstract using a multivariate regime switching framework and focusing on the period 1921 2002 which is characterized by different nominal exchange rate regimes and monetary regimes we find supportive evidence of the us uk real exchange rate real interest differential relation in terms of volatility regime dependence the two variables are jointly characterized by high volatility during periods of floating exchange rates and by low volatility during periods of fixed exchange rates thereby suggesting that the nominal exchange rate regime is the driving force behind the volatility regime switching thus allowing for regime switching in the real exchange rate real interest differential relation bridges the gap between popular theories of real exchange rate determination which predict such a relation and previous empirical studies which failed to uncover such a relation for the us uk real exchange rate

bank integration and co movements across housing markets this paper investigates whether bank integration measured by cross border bank flows can capture the co movements across housing markets in developed countries by using a spatial dynamic panel model the transmission can occur through a global banking channel in which global banks intermediate wholesale funding to local banks changes in financial conditions are passed across borders through the banks balance sheet exposure to credit currency maturity and funding risks resulting in house price spillovers while controlling for country level and global factors we find significant co movement across housing markets of countries with proportionally high bank integration bank integration can better capture house price co movements than other measures of economic integration once we account for bank exposure other spatial linkages traditionally used to account for return co movements across region such as trade foreign direct investment portfolio investment geographic proximity etc become insignificant moreover we find that the co movement across housing markets decreases for countries with less developed mortgage markets characterized by fixed mortgage rate contracts low limits of loan to value ratios and no mortgage equity withdrawal

real and nominal exchange rates in the long run an empirical investigation abstract this paper reports on econometric tests of the hypothesis that purchasing power parity holds as a long run relationship using data on eight industrialized countries during the flexible exchange rate period the empirical work proceeds by i testing whether nominal exchange rates and relative price levels are co integrated and ii conducting impulse response analysis of long run exchange rate and relative price level changes to explain the data keynesian models suggest that shocks during the estimation period were due principally to exogenous shifts in aggregate demand while equilibrium models suggest that monetary factors have been relatively more important

potential pitfalls in determining multiple structural changes with an application to purchasing power parity we investigate the empirical performance of the bai and perron multiple structural change tests and show that the use of their critical values may cause severe size distortions in persistent series to correct these size distortions while maintaining a good power we implement the bai structural change test and extend it in two directions developing a new procedure to choose the number of breaks and a restricted version that specifically models breaks that imply mean or trend reversion using our new methodologies we reconcile the results of unit root tests with those of tests for structural change when testing for long run purchasing power parity

foreign exchange markets overview of the special issue introduction by way of abstract two decades ago exchange rate economics seemed to be in total shambles that however did not last long science proceeds by successive approximations and in the intervening years the foreign exchange market became one of the most heavily researched areas in economics the first wave of findings to come out of this new research concerned the centuries old theoretical construct of purchasing power parity and relatedly the behavior of real exchange rates here the consensus gradually shifted from the widespread view that ppp had collapsed to the view that it was in fact a useful empirical first empirical approximation in the long run as lothian and taylor 1996 put it in an introduction to the jimf conference issue on exchange rate modeling published in 1998 one of us wrote koedijk 1998 1 ten years of data and estimation techniques later the outlook is less bleak at least in the medium run a predictable relationship between exchange rates and economic fundamentals has re emerged and reintroduced tempered optimism in exchange rate economics

financial innovation and arbitrage pricing in frictional economies abstract frictional economies are fundamentally different from their frictionless counterparts for example in frictional economies the price function is sublinear and thus there will be incentives to innovate when decomposing existing securities and opening new markets innovators serve important economic functions such as allowing investors to obtain consumption at lower costs enabling investors to achieve better risk sharing and making the fundamental value of more payoffs observable in particular innovators serve these functions even when they introduce redundant securities that are not yet issued furthermore in frictional economies the replication based arbitrage valuation approach tends to overprice certain securities while underpricing others journal of economic literature classification numbers c61 g10 g12 g20

the purchasing power parity persistence paradigm abstract rogoff journal of economic literature 1996 34 647 668 describes the remarkable consensus of 3 5 year half lives of purchasing power parity deviations among studies using long horizon data these studies however focus on rejections of unit roots in real exchange rates and do not use appropriate techniques to measure persistence our half life estimates explicitly account for serial correlation sampling uncertainty and most importantly small sample bias calculating confidence intervals as well as point estimates for long horizon and post 1973 data we find that even though most of the point estimates lie within the 3 5 year range univariate methods provide virtually no information regarding the size of the half lives

purchasing power parity over two centuries abstract this paper re examines the purchasing power parity hypothesis for the dollar sterling exchange rate using the two centuries of data from lothian and taylor lt 1996 real exchange rate behavior the recent float from the perspective of the past two centuries journal of political economy 104 3 488 509 unlike lt we conclude that the dollar sterling rer is nonstationary implying a rejection of the long run ppp hypothesis the differences in our conclusions are explained by 1 sensitivity of adf unit root tests to the choice of lag length and or 2 the presence of significant time trends in the adf or phillips perron unit root test equations

real exchange rate adjustment in european transition countries abstract in single equation tests real exchange rates show mean reversion for nine of 10 central and eastern european transition countries for the period january 1993 to december 2005 because of the shift from controlled to market economies and accompanying crises failed policy regimes and changes in exchange rate regimes unit root tests for transition countries often require allowance for structural changes accounting for structural breaks gives substantially faster mean reversion speeds than those found for major industrialized countries these fast adjustment speeds are plausible transition countries had perhaps 10 years to make unprecedented adjustments required for accession to the european union a number of papers have applied non linear models to the central and eastern european countries this paper investigates four non linear models and compares them with piece wise linear break models the break models appear superior in detecting mean reversion for the central and eastern european transition countries

how puzzling is the ppp puzzle an alternative half life measure of convergence to ppp summary evidence of lengthy half lives for real exchange rates in the presence of a high degree of exchange rate volatility has been considered as one of the most puzzling empirical regularities in international macroeconomics this paper suggests that the measure of half life used in the literature might be problematic and proposes alternative measures with desirable properties their focus on the cumulative effects of the shocks distinguishes them from the measures used in the literature an empirical analysis of bilateral us dollar real exchange rates employing the alternative half life measure produces results consistent with theory and indicates that the ppp puzzle is less pronounced than initially thought copyright 2012 john wiley sons ltd

ppp strikes back aggregation and the real exchange rate we show the importance of a dynamic aggregation bias in accounting for the ppp puzzle we prove that the aggregate real exchange rate is persistent because its components have heterogeneous dynamics established time series and panel methods fail to control for this using eurostat data we find that when heterogeneity is taken into account the estimated persistence of real exchange rates falls dramatically its half life for instance may fall to as low as eleven months significantly below the consensus view of three to five years

sectoral adjustment costs and real exchange rate dynamics in a two sector dependent economy abstract this paper develops a two sector model in which intersectoral capital movements involve adjustment costs expressed as capital lost in the transformation process these costs have important consequences for the dynamics of capital accumulation and particularly for real exchange rate dynamics persistent deviations of the real exchange rate from its equilibrium are derived and for plausible values of the adjustment cost parameters are consistent with the observed degree of real exchange rate persistence for low adjustment costs the dynamics are qualitatively similar to those of the standard heckscher ohlin technology for high adjustment costs the model converges to the specific factors model thus our framework includes these two standard models as polar extremes

lessons from the evolution of foreign exchange trading strategies abstract the adaptive markets hypothesis posits that trading strategies evolve as traders adapt their behavior to changing circumstances this paper studies the evolution of trading strategies for a hypothetical trader who chooses portfolios from foreign exchange forex technical rules in major and emerging markets the carry trade and us equities the results show that a backtesting procedure to choose optimal portfolios improves upon the performance of nonadaptive rules we also find that forex trading alone dramatically outperforms the s p 500 with much larger sharpe ratios over the whole sample but there is little gain to coordinating forex and equity strategies which explains why practitioners consider these tools separately forex trading returns dip significantly in the 1990s but recover by the end of the decade and have been markedly superior to an equity position since 1998 overall trading rule returns still exist in forex markets with substantial stability in the types of rules though they have migrated to emerging markets to a considerable degree

across time and regimes 212 years of the us uk real exchange rate i introduction this paper examines the behavior of the real exchange rate under different nominal exchange rate regimes using monthly data on the us uk exchange rate over the period 1794 2005 the 212 yr series encompasses five floating and four fixed exchange rate periods and includes a new monthly exchange rate series for the periods that precede the classical gold standard figures 1 and 2 show the behavior of the real and nominal exchange over the entire sample three key stylized facts emerge from the analysis a real exchange rate volatility is higher when the nominal exchange rate is floating b the contribution of price level changes to real exchange rate movements has decreased over time and c the persistence of real exchange rate has been considerably higher in the postwar period the real exchange rate is the price of output in one country relative to another that is the real exchange rate is given by q e p sup p where p and p sup are home and foreign price indexes and e is the nominal exchange rate that is the home price of foreign currency a key question that can be examined with a series that includes multiple regimes is whether real exchange rate behavior is invariant to the nominal exchange rate regime that is whether the properties of q depend on whether e is fixed or floating mussa 1986 demonstrates that short term volatility of the real exchange rate is lower when the nominal exchange rate is fixed mussa s study relies on postwar data from oecd countries most of which had fixed exchange rates until bretton woods collapsed in the early 1970s and floated thereafter as grilli and kaminsky 1991 hereafter gk note relying on such limited evidence is not sufficient to establish general validity of the proposition that real exchange rate volatility is higher under floating regimes to remedy this gk examined the us uk real exchange rate using monthly data beginning in 1885 their study encompassed three fixed rate periods the classical gold standard the interwar gold exchange standard and bretton woods and three floating periods two interwar intervals and the post bretton woods float they conclude that the nominal exchange rate regime is not as crucial to the behavior of the real exchange rate as previous analyses have suggested the behavior of the real exchange rate varies substantially across historical periods but not nominal exchange rate arrangements 192 in their analysis the bretton woods period was characterized by a unique degree of stability they argue that the commonly held belief that floating exchange rates lead to higher real exchange rate volatility is an artifact of the unusual stability of the 1950s and 1960s figure 1 omitted figure 2 omitted the additional data used in this study encompass two additional floating rate periods and one additional fixed rate period gk are surely correct that real exchange rate behavior varies across different time periods due to the evolution of institutions for example decreasing transaction costs development of the financial system and increasing nominal rigidity comparing historically adjacent fixed and floating regimes provides a rough way to control for long run historical changes in order to see whether the nominal regime matters for the real exchange rate of all the periods examined bretton woods clearly has the lowest real exchange rate volatility however mussa s conclusion that real exchange rate volatility is higher in floating periods does not appear to be an artifact of this stability examining the entire 212 yr period a consistent pattern emerges every nominal regime switch from fixed to floating is associated with an increase in real exchange rate volatility and every switch from floating to fixed is associated with a decrease although there is a consistent relationship between the real exchange rate volatility and the nominal exchange rate regime the source and persistence of real exchange rate movements have evolved considerably over time

on the sources of business cycles in the g 7 abstract this paper examines sources of cyclical movements in output inflation and the term structure of interest rates in the g 7 it employs a novel identification approach which uses the sign of the theoretical cross correlation function in response to shocks to catalog orthogonal disturbances we find that demand shocks are the dominant source of output and inflation fluctuations in several of the g 7 countries the proportion of term structure variability explained by different structural sources does not depend on the horizon apart from the us and canada structural shocks are nearly uncorrelated across countries

real exchange rate behavior the recent float from the perspective of the past two centuries using annual data spanning two centuries for dollar sterling and franc sterling real exchange rates we find strong evidence of mean reverting real exchange rate behavior using simple stationary autoregressive models estimated on prefloat data we easily outperform nonstationary real exchange rate models in dynamic forecasting exercises over the recent float such stationary univariate equations explain 60 80 percent of the in sample variation in real exchange rates although the degree of short run persistence may be high the econometric estimates imply a half life of shocks to the real exchange rate of about 6 years for dollar sterling and a little under 3 years for franc sterling

international business cycles the authors estimate a dynamic two country model in which economic fluctuations are driven by a worldwide supply shock country specific supply shocks and relative fiscal money and preference shocks identification is achieved using only long run restrictions based on a theoretical model the main results are 1 supply shocks particularly country specific ones are very important in generating international business cycles and 2 although the post 1973 flexible exchange rate period has been inherently more volatile there are no differences in transmission properties of economic disturbances across exchange rate regimes for the endogenous variables they focus on copyright 1993 by american economic association

the links between international parity conditions and granger causality a study of exchange rates and prices this article investigates granger causality between exchange rates and prices for the us and four of its trading partners canada germany japan and the uk we emphasize the distinction between direct and indirect granger causality exchange rates directly cause prices if movements in exchange rates lead movement in prices and exchange rates indirectly cause prices if deviations from the purchasing power parity ppp condition can help forecast movement in prices but only by including the interest rate differential in our error correction model do we obtain results that align with economic theory the economic theory of ppp suggests that exchange rates and prices are cointegrated with exchange rates moving proportionally to prices in the long run in general we find either direct or indirect feedback mechanisms between exchange rates and prices

international business cycles world region and country specific factors the paper investigates the common dynamic properties of business cycle fluctuations across countries regions and the world we employ a bayesian dynamic latent factor model to estimate common components in macroeconomic aggregates output consumption and investment in a 60 country sample covering seven regions of the world the results indicate that a common world factor is an important source of volatility for aggregates in most countries providing evidence for a world business cycle we find that region specific factors play only a minor role in explaining fluctuations in economic activity we also document similarities and differences across regions countries and aggregates jel f41 e32 c11 c32

policy convergence the exchange rate mechanism and the misalignment of exchange rates some tests of purchasing power parity and generalized purchasing power parity the paper focuses on the convergence issues and the long run credibility of the european monetary system ems and more specifically on the evaluation of the effectiveness of the exchange rate mechanism erm in generating a stabilizing effect on real exchange rates across member countries for this purpose we execute some tests of long run purchasing power parity ppp for an erm group and a non erm group of countries using both the engle and granger procedure and the more powerful johansen cointegration technique we also execute a test of generalized ppp exploiting an idea developed by enders and hurn testing for ppp in a multicountry setting may be a useful methodology to identify the optimal currency area suggested by the data generation process on the basis of the reported homogeneity of real exchange rate behaviour of the countries considered

on exchange rates nominal and real abstract the paper first develops an australian commodity currency exchange rate model which is extended to deal with real exchange rates as well the nominal and real exchange rate versions are then tested on swiss data for the post bretton woods period while the model tracks the swiss franc nominal exchange rate vis a vis the dollar and the major european currencies very well swiss ppp real exchange rates are found to be heavily contaminated with measurement error as that error explains the large co movements in nominal and ppp real exchange rates those co movements are largely irrelevant to the ppp debate

cointegration how short is the long run abstract when testing for cointegration and faced with short sample periods it is common for researchers to turn to more frequently sampled observations that is to move from annual to quarterly or monthly data in order to increase the number of observations we argue that such a gain in the degrees of freedom is more apparent than real essentially cointegration is a long run concept and hence requires long spans of data to give tests for cointegration much power rather than merely large numbers of observations using monte carlo simulations we demonstrate this for four popular tests for cointegration

long run purchasing power parity in the 1920s abstract this paper presents an empirical analysis of long run purchasing power parity ppp during the 1920s float using recently developed methodology on the cointegration of economic time series our results are generally supportive of ppp as a long run equilibrium condition on which exchange rates tended to converge over the period for dollar sterling however there is some evidence of a non stationary drift away from fundamentals during the last year or so before britain s return to the gold standard perhaps due to speculation our results also appear to reconcile some apparently conflicting evidence in the literature

stationarity of the european real exchange rates evidence from panel data this paper employs a panel unit root test for the real exchange rates of 13 eu member countries the estimation period covers the ems period from 1980 1 to 1992 2 in contrast with the earlier panel unit root studies concerning purchasing power parity ppp effective real exchange rates are used as a result the non stationarity of the real exchange rate was rejected however the half life of the real exchange rate adjustment turned out to be long potential reasons for this might be the relatively short estimation period and the nature of the data

distance language religion and the law of one price evidence from canada and nigeria we examine the impact of physical distance language and religion on law of one price lop deviations across interwar canadian and modern nigerian cities the data comprise monthly average retail prices for narrowly defined goods collected by national statistical agencies we find that differences in the fraction of the city population sharing a common language and religion have a significant impact on lop deviations the impact of language differences is consistent with a recently developed theory in which both trade costs and differences in signal noise ratios contribute to lop deviations

the exchange rate and purchasing power parity extending the theory and tests abstract this paper analyzes the exchange rate in a no arbitrage or real business cycle equilibrium model and provides empirical evidence for this model vis a vis ppp our contribution is to show based on a generalization of the equilibrium model of exchange rates that i the test equation linking the exchange rate to fundamentals should allow for international heterogeneity in time preferences and risk attitudes as well as noise that is the model should not be tested as an exact relation ii empirical work should use levels of variables rather than first differences and iii tests on the existence of long run relations should be complemented by test on the signs of the coefficients our empirical work shows that as a long run relation the generalized model outperforms ppp moreover under the generalized model quarterly deviations from the estimated long term relation have a half life of only four to five quarters

efficiency and the bear short sales and markets around the world we analyze cross sectional and time series information from 46 equity markets around the world to consider whether short sales restrictions affect the efficiency of the market and the distributional characteristics of returns to individual stocks and market indices we find some evidence that prices incorporate negative information faster in countries where short sales are allowed and practiced a common conjecture by regulators is that short sales restrictions can reduce the relative severity of a market panic we find strong evidence that in markets where short selling is either prohibited or not practiced market returns display significantly less negative skewness

real exchange rates under the gold standard purchasing power parity is one of the most important equilibrium conditions in international macroeconomics empirically it is also one of the most hotly contested numerous recent studies for example have sought to determine the validity of purchasing power parity using data from the post bretton woods float and have reached different conclusions we assert that most such studies are flawed for two reasons first the post 1973 data contain by definition only a very limited amount of the low frequency information relevant for examination of long run parity second the dynamic econometric techniques used to model deviations from parity are typically quite crude with respect to admissible low frequency dynamics both deficiencies are rectified in the present paper with dramatic results we construct a new data set of 16 real exchange rates covering more than a century of the classic gold standard period and we study deviations from parity using long memory models that allow for subtle forms of mean

mind the gap a monetarist view of the open economy phillips curve abstract in many countries inflation has become less responsive to domestic factors and more responsive to global factors over the past decades we introduce money and credit into the workhorse open economy new keynesian model with this framework we show that i an efficient forecast of domestic inflation is based solely on domestic and foreign slack and ii global liquidity global money as well as global credit is tied to global slack in equilibrium then motivated by the theory we evaluate empirically the performance of open economy phillips curve based forecasts constructed using global liquidity measures such as g7 credit growth and g7 money supply growth instead of global slack as predictive regressors using 50 years of quarterly u s data we document that these global liquidity variables perform significantly better than their domestic counterparts and outperform in practice the poorly measured indicators of global slack that global liquidity proxies for

business cycles and the exchange rate system some international evidence this paper investigates the differences in time series behavior of key economic aggregates under alternative exchange rate systems we use a postwar sample of 49 countries to compare the behavior of output consumption trade flows government consumption spending and real exchange rates under alternative exchange rate systems pegged floating and cooperative systems such as the ems we then examine evidence from two particular episodes involving canada and ireland of changes in the exchange rate system aside from greater variability of real exchange rates under flexible than under pegged nominal exchange rate systems we find little evidence of systematic differences in the behavior of macroeconomic aggregates or international trade flows under alternative exchange rate systems these results are of interest because a large class of theoretical models implies that the nominal exchange rate system has important effects on a number of macroeconomic quantities

loan supply shocks during the financial crisis evidence for the euro area this paper employs a panel vector autoregressive model for the member countries of the euro area to explore the role of banks during the slump of the real economy that followed the financial crisis in particular we seek to quantify the macroeconomic effects of adverse loan supply shocks which are identified using sign restrictions we find that loan supply shocks significantly contributed to the evolution of the loan volume and real gdp growth in all member countries during the financial crisis however concerning both the timing and the magnitude of the shocks our results also indicate that the euro area was characterized by a considerable degree of cross country heterogeneity

nominal exchange rate regimes and the real exchange rate abstract two assumptions about the real exchange rate are common in the literature on international finance 1 the real exchange rate is a random walk 2 the time series properties of the real exchange rate depend on the nominal exchange rate regime this paper presents evidence that indicates that the random walk behavior of the real exchange rate is only a characteristic of the post world war ii period moreover our findings also suggest that what is crucial to the real exchange rate behavior is the particular historical period rather than the nominal exchange rate arrangement

fixed versus flexible lessons from ems order flow abstract we extend the literature on regime dependent volatility in two ways first our microstructural model provides a qualitatively new explanation second we test implications of our model using europe s recent shift to rigidly fixed rates ems to emu in the model shocks to order flow induce more volatility under flexible rates because the elasticity of speculative demand is endogenously low leading to pronounced portfolio balance effects new data on ff dm transactions show that order flow had persistent effects on the exchange rate before emu parities were announced after announcement the ff dm rate was decoupled from order flow as the model predicts

does exchange rate risk affect exports asymmetrically asian evidence abstract this paper tests the hypothesis of asymmetric effects of exchange rate risk with a dynamic conditional correlation bivariate garch 1 1 m model the asymmetry means that exchange rate risk volatility affects exports differently during appreciations and depreciations which may reflect exporter s asymmetric risk perception and hedging behavior using bilateral exports from eight asian countries to the us the real exchange rate risk significantly affects exports for all countries negative or positive in periods of depreciation or appreciation thus policy makers can consider the stability of the exchange rate in addition to its depreciation as a method of controlling export growth

volatility and persistence of simulated dsge real exchange rates abstract we investigate the time series properties of both filtered and unfiltered real exchange rate series produced by dsge models that feature local currency pricing home bias nontraded goods and incomplete markets detrended series produced by several specifications approach the empirically observed volatility although none of the models generates enough persistence conversely several models produce unfiltered series that possess the same degree of persistence as the data but none can match its volatility

does global liquidity help to forecast u s inflation we construct a measure of global liquidity using the growth rates of broad money for the g7 economies global liquidity produces forecasts of us inflation that are significantly more accurate than the forecasts based on us money growth phillips curve autoregressive and moving average models the marginal predictive power of global liquidity is strong at three years horizons results are robust to alternative measures of inflation

the synchronization of credit cycles abstract this paper proposes a simple econometric procedure to test for the synchronization of credit cycles using a century of data for 14 advanced economies we find that credit cycle synchronization dropped in the early 1920s from initially relatively high levels between the 1920s and the 1970s synchronization was overall low and concentrated within five predominantly regional clusters however synchronization has significantly increased in the post bretton woods era and has become less associated with geographic proximity australia denmark france italy japan norway spain switzerland the uk and the us form a single major credit cycle cluster since the 1970s a smaller cluster is formed by canada the netherlands and sweden while the german credit cycle follows a distinct path using logistic regressions we find that the synchronization of credit and business cycles go hand in hand our findings are especially relevant for the international coordination of macroprudential policy as well as to spur and inform further analysis on credit cycle dynamics

the purchasing power parity debate originally propounded by the 16th century scholars of the university of salamanca the concept of purchasing power parity ppp was revived in the interwar period in the context of the debate concerning the appropriate level at which to re establish international exchange rate parities broadly accepted as a long run equilibrium condition in the post war period it first was advocated as a short run equilibrium by many international economists in the first few years following the breakdown of the bretton woods system in the early 1970s and then increasingly came under attack on both theoretical and empirical grounds from the late 1970s to the mid 1990s accordingly over the last three decades a large literature has built up that examines how much the data deviated from theory and the fruits of this research have provided a deeper understanding of how well ppp applies in both the short run and the long run since the mid 1990s larger datasets and nonlinear econometric methods in particular have improved estimation as deviations narrowed between real exchange rates and ppp so did the gap narrow between theory and data and some degree of confidence in long run ppp began to emerge again in this respect the idea of long run ppp now enjoys perhaps its strongest support in more than 30 years a distinct reversion in economic thought

efficient trading strategies in the presence of market frictions we provide a price characterization of efficient contingent claims that is chosen by at least a rational agent in multiperiod economies with market frictions frictions include market incompleteness transaction costs short selling and borrowing costs we characterize the inefficiency cost of a trading strategy its required investment minus the largest amount necessary to obtain the same utility level and we propose a measure of portfolio performance we show that arbitrage bounds cannot be tightened based on efficiency without restricting preferences or endowments we observe common investment strategies becoming inefficient with market frictions and others rationalized by them in this article we characterize efficient contingent claims to future consumption consumption bundles in multiperiod economies with uncertainty taking a wide range of market frictions into account 1 such as dynamic market

noisy information distance and law of one price dynamics across us cities abstract us micro price data at the city level suggests that both the volatility and the persistence of law of one price deviations are rising in the distance between us cities a standard two city equilibrium model with trade costs can predict the relationship between volatility and distance but not between persistence and distance we show that if there is imperfect information about the state of nominal aggregate demand with noisy signals that are asymmetric across cities then distance and persistence will be positively correlated our main results are shown to be robust to the introduction of sticky prices and multiple cities

exchange rate expectations and the pricing of chinese cross listed stocks abstract i show that the price discounts of chinese cross listed stocks american depositary receipts adrs and h shares to their underlying a shares indicate the expected yuan us dollar exchange rate the forecasting models reveal that adr and h share discounts predict exchange rate changes more accurately than the random walk and forward exchange rates particularly at long forecast horizons using panel estimations i find that adr and h share investors form their exchange rate expectations according to standard exchange rate theories such as the harrod balassa samuelson effect the risk of competitive devaluations relative purchasing power parity uncovered interest rate parity and the risk of currency crisis

how sure are we about purchasing power parity panel evidence with the null of stationary real exchange rates this article presents evidence on mean reversion in industrial countries real exchange rates in a setup that accounts naturally for cross sectional dependence is invariant to the benchmark currency and actually tests for the null of interest i e purchasing power parity our results are based on the kwiatkowski et al 1992 test for the stationarity null generalized in a multivariate random walk plus noise model by nyblom and harvey 2000

competition in financial innovation this paper examines the incentives to innovate securities provided by frictionless competitive markets with short sales to entrepreneurs in economies with symmetric investor utilities we provide the conditions under which a rm s market value is maximized by a complete nancial structure that is when the mechanism that gives rise to market incompleteness is the one illustrated in the classical example of allen and gale 1991 the foundation for incompleteness in that case is derived from innovation costs and free riding among entrepreneurs for the class of preferences where an incomplete nancial structure maximizes the rms market values markets are incomplete with a probability of one even when innovation is cost free in this sense we provide an alternative to allen and gale s foundation for market incompleteness

searching for stationarity purchasing power parity under the current float abstract using panel data methods we investigate long run purchasing power parity by testing for unit roots in real exchange rates of industrial countries under the current float the evidence against the unit root hypothesis is stronger for larger than for smaller panels for monthly than for quarterly data and when the german mark rather than the united states dollar is used as the base currency while we find that accounting for serial correlation considerably weakens the evidence against the unit root null the results as a whole are consistent with long run purchasing power parity

understanding the empirical literature on purchasing power parity the post bretton woods era abstract this paper argues that the empirical failure of statistical tests of ppp in post bretton woods data is largely due to the low power of the tests employed this result is demonstrated using monte carlo experiments on the size and power of different testing procedures a new procedure based on horvath and watson econometric theory 11 pp 984 1014 1995 has greater power than previous approaches using the horvath watson procedure we find moderate evidence in favor of ppp in the post bretton woods era

additional evidence of long run purchasing power parity with restricted structural change we investigate two alternative versions of purchasing power parity ppp reversion to a constant mean in the spirit of cassel and reversion to a constant trend in the spirit of balassa and samuelson using long span real exchange rate data for industrialized countries we develop unit root tests that both account for structural change and maintain a long run mean or trend with conventional tests previous research finds evidence of some variant of ppp for 9 of the 16 countries with the unit root tests in the presence of restricted structural change we find evidence of ppp for five additional countries

effective securities in arbitrage free markets with bid ask spreads at liquidation a linear programming characterization abstract we consider a securities market with bid ask spreads at any period including liquidation although the minimum cost super replication problem is non linear we introduce an auxiliary problem that allows us to characterize no arbitrage via linear programming techniques we introduce the notion of effective new security and show that effectiveness restricts the no arbitrage bid and ask prices of a new security to the interval defined by the minimum cost problem we discuss in detail the cases in which the boundaries of this interval can be reached without violating no arbitrage

an empirical examination of long run purchasing power parity using cointegration techniques this paper presents an empirical analysis of long run purchasing power parity ppp for five major exchange rates using recently developed econometric techniques on the cointegration of economic time series our empirical results are extremely unfavourable to the ppp hypothesis as a long run equilibrium condition even with an allowance made for measurement error and or tranportation costs in particular we are unable to reject the hypothesis of non cointegration of the exchange rate and relative prices for any of the countries concerned far from finding a stable long run proportionality between exchange rates and relative prices our results therefore suggest that they tend to drift apart without bound

macroeconomic forecasting using diffusion indexes this article studies forecasting a macroeconomic time series variable using a large number of predictors the predictors are summarized using a small number of indexes constructed by principal component analysis an approximate dynamic factor model serves as the statistical framework for the estimation of the indexes and construction of the forecasts the method is used to construct 6 12 and 24 monthahead forecasts for eight monthly u s macroeconomic time series using 215 predictors in simulated real time from 1970 through 1998 during this sample period these new forecasts outperformed univariate autoregressions small vector autoregressions and leading indicator models

evidence on the purchasing power parity in a panel of cities evidence is provided on the ppp hypothesis using a sample of 50 spanish cities for a long time period through the application of panel data unit root tests although results suggest non rejection of the ppp short run deviations as measured by half lives indicate that real factors might be causing a slow rate of convergence to a common price index even in highly integrated economies