Exchange-Rate Dynamics (Princeton Series in International Economics) - Hardcover

Evans, Martin D. D.

Hardcover

ISBN 10: 0691150893 ISBN 13: 9780691150895

Verlag: Princeton University Press, 2011

Inhaltsangabe

Variations in the foreign exchange market influence all aspects of the world economy, and understanding these dynamics is one of the great challenges of international economics. This book provides a new, comprehensive, and in-depth examination of the standard theories and latest research in exchange-rate economics. Covering a vast swath of theoretical and empirical work, the book explores established theories of exchange-rate determination using macroeconomic fundamentals, and presents unique microbased approaches that combine the insights of microstructure models with the macroeconomic forces driving currency trading. Macroeconomic models have long assumed that agents--households, firms, financial institutions, and central banks--all have the same information about the structure of the economy and therefore hold the same expectations and uncertainties regarding foreign currency returns. Microbased models, however, look at how heterogeneous information influences the trading decisions of agents and becomes embedded in exchange rates. Replicating key features of actual currency markets, these microbased models generate a rich array of empirical predictions concerning trading patterns and exchange-rate dynamics that are strongly supported by data. The models also show how changing macroeconomic conditions exert an influence on short-term exchange-rate dynamics via their impact on currency trading. Designed for graduate courses in international macroeconomics, international finance, and finance, and as a go-to reference for researchers in international economics, Exchange-Rate Dynamics guides readers through a range of literature on exchange-rate determination, offering fresh insights for further reading and research. * Comprehensive and in-depth examination of the latest research in exchange-rate economics * Outlines theoretical and empirical research across the spectrum of modeling approaches * Presents new results on the importance of currency trading in exchange-rate determination * Provides new perspectives on long-standing puzzles in exchange-rate economics * End-of-chapter questions cement key ideas

Über diesen Titel

Über die Autorin bzw. den Autor

Martin D. D. Evans is professor of economics in the Department of Economics and professor of finance in the McDonough School of Business at Georgetown University.

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"This ambitious and impressive book covers the international macroeconomics and finance literature on nominal exchange-rate determination. It will be a useful reference for those who want to understand standard theoretical models and empirical techniques, and for those who want to specialize in the microstructure of the foreign exchange markets."--Pierre-Olivier Gourinchas, University of California, Berkeley

"There is no other book of this kind. Sound and interesting, it provides a rigorous treatment of exchange-rate economics. The new concepts and interpretation of exchange-rate behavior will spur more research in this area. The book will interest a broad community in international finance, practitioners in the foreign exchange market, and policymakers."--Lucio Sarno, Cass Business School, City University London

Aus dem Klappentext

"This ambitious and impressive book covers the international macroeconomics and finance literature on nominal exchange-rate determination. It will be a useful reference for those who want to understand standard theoretical models and empirical techniques, and for those who want to specialize in the microstructure of the foreign exchange markets."--Pierre-Olivier Gourinchas, University of California, Berkeley

"There is no other book of this kind. Sound and interesting, it provides a rigorous treatment of exchange-rate economics. The new concepts and interpretation of exchange-rate behavior will spur more research in this area. The book will interest a broad community in international finance, practitioners in the foreign exchange market, and policymakers."--Lucio Sarno, Cass Business School, City University London

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EXCHANGE-RATE DYNAMICS

By Martin D. D. Evans

PRINCETON UNIVERSITY PRESS

Copyright © 2011 Princeton University Press
All right reserved.
ISBN: 978-0-691-15089-5

Contents

Preface.............................................................................ixChapter 1 Macro Models without Frictions............................................3Chapter 2 Macro Models with Frictions...............................................63Chapter 3 Empirical Macro Models....................................................130Chapter 4 Rational Expectations Models..............................................183Chapter 5 Sequential Trade Models...................................................227Chapter 6 Currency-Trading Models...................................................261Chapter 7 Currency-Trading Models: Empirical Evidence...............................302Chapter 8 Identifying Order Flow....................................................342Chapter 9 Order Flows and the Macroeconomy..........................................377Chapter 10 Exchange Rates, Order Flows, and Macro Data Releases.....................422Chapter 11 Exchange-Rate Risk.......................................................464References..........................................................................523Index...............................................................................535

Chapter One

Macro Models without Frictions

This is the first of two chapters that examine the exchange-rate implications of macroeconomic models. My aim is not to survey all the macro models of exchange-rate determination, but rather to provide a theoretical overview of how exchange rates are linked to macro variables in environments that are familiar to students of macroeconomics. This overview serves two purposes. First, it highlights the degree to which the exchange-rate implications of widely used macro models accord with the empirical characteristics of exchange-rate behavior. Second, it establishes a theoretical benchmark for judging the success of the new micro-based exchange-rate models presented in subsequent chapters.

The macro models we study have standard features. There are two countries, each populated by a large number of identical utility-maximizing households. In this chapter we study models where households have access to a rich array of financial assets. More specifically, we assume that they all have access to markets for a complete set of contingent claims. As a result, households are able to share risk completely. This feature has important implications for the behavior of exchange rates in both endowment economies (where output is exogenous) and in production economies (where output is determined optimally by firms). Another standard feature of the models we study concerns the role of money. Here we assume that households derive utility from holding real balances and that central banks have complete control of their national money supplies. This framework has a long tradition in the international macro literature. When combined with the implications of complete risk-sharing, it allows us to characterize the differences between the behavior of real and nominal exchange rates in a straightforward manner.

The final noteworthy feature of the models presented herein concerns the behavior of prices. Although "price-stickiness" plays an important role in many international macro models, in this chapter we focus on models in which all prices are fully flexible. In so doing, our analysis abstracts from the complications caused by the presence of frictions in both financial and product markets. The exchange-rate implications of these frictions are examined in Chapter 2.

1.1 Preliminaries

1.1.1 Definitions

The focus of our analysis is on the behavior of the nominal spot exchange rate, which we refer to as the spot rate. The spot rate, denoted by S, is defined as the home price of foreign currency. Throughout, we take the United States as the home country, so S identifies the price of foreign currency in U.S. dollars. According to this definition, an appreciation in the value of the dollar is represented by a fall in S because it corresponds to a fall in the dollar price of foreign currency. Conversely, a rise in S represents a depreciation in the value of the dollar. Defining spot rates in this way can be a source of confusion at first, but it turns out to be very convenient when considering the determination of spot rates from an asset-pricing perspective. For this reason it is the standard definition used in the international finance literature.

The spot exchange rate identifies the price at which currencies can be traded immediately. Forward rates, by contrast, identify the price at which currencies can be traded at some future date. The k-period forward rate at time t, F^k_t, denotes the dollar price of foreign currency in a contract between two agents at time t for the exchange of dollars and foreign currency at time t + k. Foreign currency is said to be selling forward at a discount (premium) relative to the current spot rate when S_t - F^k_t is positive (negative). Obviously, spot and forward rates are equal when the maturity of the forward contract, k, equals zero.

Two relative prices play prominent roles in international macro models. The first is the terms of trade. In international finance the convention is to define the terms of trade, T, as the relative price of imports in terms of exports:

T = P^M/SP^x,

where P^M is the price U.S. consumers pay for imports and P^X is the price foreign consumers pay for U.S. exports. (Hereafter, we use a hat, i.e., "^", to denote foreign variables.) Since S is defined as the price of foreign currency in dollars, SP^x identifies the dollar price foreign consumers pay for U.S. exports. Note that a rise (fall) in the relative price of U.S. exports, representing an improvement (deterioration) in the U.S. terms of trade, implies a fall (rise) in T. Once again, this may seem unnecessarily confusing, but the international finance literature adopts this definition to simplify the relationship between the real exchange rate and the terms of trade.

The second important relative price is the real exchange rate. This is defined as the relative price of the basket of all the goods consumed by foreign households in terms of the price of the basket of all the goods consumed by U.S. households:

ε = SP/P,

where P is the foreign currency price of the foreign basket and P is the dollar price of the U.S. basket. Hence, P and P are the U.S. and foreign consumer price indices in local currency terms, and SP identifies the foreign price index in terms of dollars. According to this definition, a depreciation (appreciation) in the real value of the U.S. dollar corresponds to a rise (fall) in ε and represents an increase (decrease) in the price of foreign goods relative to U.S. goods.

1.1.2 Price Indices

The behavior of the real exchange rate plays a central role in macro models, so it is important to relate the behavior of the price indices, P and P, to the prices of individual goods. For this purpose, macro models identify price indices relative to a particular form for the consumption basket based on either the Constant Elasticity of Substitution (CES) or Cobb-Douglas functions.

To illustrate, suppose there are only two goods available to U.S. consumers. Under the CES formulation, the consumption basket defined over the consumption of goods a and b is given by

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (1.1)

where λ [member of] (0, 1) and θ > 0. This function aggregates the consumption of the two goods into a single index, ITLITL, from which households derive instantaneous utility, U(C), for some concave utility function U(.). The consumption-based price index, P, is identified as the minimum expenditure that buys one unit of the consumption index, ITLITL. In other words, P minimizes the expenditure Z = aP^a + bP^b, such that C(a, b) = 1, given the prices of goods a and b, P^a and P^b.

The mechanics of solving this problem illustrate several properties of the consumption basket and price index, so they are worth reviewing. Choosing a and b to minimize Z such that C(a, b) = 1 gives

b/a = 1 - λ/λ (P^b/P^a)^-θ. (1.2)

Thus, the relative demand for good b depends on its relative price, P^b/P^a, and the ratio of shares in the basket, 1-λ/λ. Note, also, that θ identifies the elasticity of substitution between goods a and b.

Combining equation (1.2) with the definition of total expenditure, Z = aP^a + bP^b, gives us the total demand for each good:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (1.3)

and

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]

Substituting these expressions into (1.1) and setting the result equal to one gives us the minimum necessary expenditure:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]

Simplifying this equation and solving for Z produces the equation for the price index:

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (1.4)

By definition, an expenditure of Z purchases Z/P units of the consumption index ITLITL, so we can use (1.4) to rewrite the expressions in (1.3) as

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (1.5)

These equations identify the demand for the individual goods as a function of the share parameter, λ, relative prices, and the consumption index.

The specification of the consumption basket in (1.1), its implications for the price index in (1.4), and individual demand functions in (1.5) prove very useful in the analyses below. In essence, if instantaneous utility over individual goods, U(a, b), can be written in terms of the consumption basket, that is, U(C) with C = C(a, b), household consumption decisions can be separated into two parts. The first is an intertemporal decision concerning the size of the current basket, ITLITL. The second is an intratemporal decision about the consumption of individual goods that make up the current basket. As we shall see, understanding how exchange rates affect both intertemporal and intratemporal consumption decisions lies at the heart of macro exchange-rate models.

Finally, it is worth noting that in the limit as the elasticity parameter θ approaches 1, the CES function in (1.1) becomes

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (1.6)

with the associated price index of

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (1.7)

1.1.3 Purchasing Power Parity and the Law of One Price

We can now use the price indices to link the real exchange rate to the behavior of individual prices. This allows us to consider three related concepts: the Law of One Price, Absolute Purchasing Power Parity, and Relative Purchasing Power Parity.

The Law of One Price (LOOP) states that identical goods sell in two locations for the same price. This means that when the local currency price of the good for sale abroad is converted into dollars with the spot exchange rate, it will match the price of the same good available in the United States. Thus, if the LOOP applies to good a, P^a = SP^a, where P^a is the local currency price of good a in the foreign country.

The LOOP has implications for the behavior of the real exchange rate. Suppose there are two goods, a and b, that make up the U.S. consumption basket with share parameters λ and 1 - λ, and the foreign basket with shares λ and 1 - λ. The real exchange rate will then be given by

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]

If the LOOP applies to both goods, we can rewrite this expression as

[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (1.8)

Clearly, ε will equal one when λ = λ. Thus, if the consumption baskets have the same composition in each country and the LOOP applies to each good, then the price of the consumption basket will be the same across countries: P = SP. This condition is known as Absolute Purchasing Power Parity (PPP).

Now suppose that λ [not equal to] [??] so that good a has a different weight in the U.S. consumption basket than in the foreign consumption basket. In this case, (1.8) implies that ε is a function of Pb/Pa. If this relative price is constant, so too is the real exchange rate, but its value can differ from one. This condition, known as Relative Purchasing Power Parity, implies that the depreciation in the spot rate is equal to the difference between the foreign and domestic rates of inflation,

Δs = Δp - Δp, where Δ denotes the first-difference and lowercase letters denote natural logs, for example, p = ln P.

If λ [not equal to] λ and P^b/P^a varies, both forms of PPP break down. This case is most easily illustrated by taking a log linear approximation of equation (1.8) around the point where P^b = P^a. This form of approximation will prove very useful throughout the book and is fully described in Appendix 1.A.2. Here it produces

ln ε = ε = (λ - [??])(p^b - p^a).

(Continues...)

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Details zur Ausgabe

• Verlag: Princeton University Press
• Erscheinungsdatum: 2011
• Sprache: Englisch
• ISBN 10: 0691150893
• ISBN 13: 9780691150895
• Einband: Tapa dura
• Anzahl der Seiten: 600
• Kontakt zum Hersteller: Nicht verfügbar
• Verantwortliche Person: Nicht verfügbar