POLICY RESEARCH WORKING PAPER 1396

# Summary findings

In this analytical sequel to _A Typology of Foreign Exchange Auction Markets in Sub-Saharan Africa,_ Aron and Elbadawi compare the micromanagement of different foreign exclhange auctions in Sub-Saharan Africa.

Multi-unit auctions for foreign exchange were introduced in a number of countries in tde 1980s and 199Os, in a transitional step toward a credible, sustainable, unified regime, such as an efficient interbank ma'cet. But there is little understanding of how auction markets function in Sub-Saharan Africa, and there has been virtually no research on the causes of frequent policy reversals or of auction failure.

- One possible cause of failure apart from thin markets, macroeconomic laxity, and vulnerability to terms-of-trade shocks and fluctuations in the - disbursement of foreign aid is the inappropriate design and management of auctions.

Aron and Elbadawi estimate models for the microdetermiinants of the auction rate, using weekly data on foreign exchange auctions for Ghana, Nigeria, Uganda, and Zambia. Among the poliqc lessons: N Nigeria and Zambia failed to unify and stabilize the exchange rate pardy because there was no reserve price rule. When bidders learn such a rule, speculative bidding diminishes.

* The management of a credible, sustainable reserve price policy requires an efficient secondnry market.

A simple underlying model, synthesized from the theoretical literature on auctions, specifies the auction rate as a function of fundamental variables and struccural shift dummies. The repeated, sequential narure of these multi-unit auctions and the nonstationary nature of most of the auction variables are captured empirically by a cointegrated (error correction) framework.

In addition to consistendy estimating long-run and short-run parameters of auction fundamentals, the error correction model allows asymptotically efficient testing of three policy hypothcses deriving from auction theory: the competitiveness hypothesis, the effect of uncermtinty on the auction-determined rate, and the revenueequivalence hypothesis.

In other words, they used these models to test the impact on the level of the auction rate of increased competiton among bidders, of the effect of uncertainty (proxied by a volatile supply of foreign exchange), and of different pricing mechanisms (Dutch and marginal pricing).

This paper-a product of the Macroeconomics and Growih Division, Policy Research Department-is part of the departmental project "Forcign Exchange Auction Markets and Exchange Rare Unification in Sub-Saharan Africa. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Raquel Luz, room _Ni 1-053,_ extension 39059(38 pages). December 1994.

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