Tian, Mo
(2013)
Essays on exchange rate volatility and current account adjustments.
PhD thesis, University of Nottingham.
Abstract
This thesis empirically assesses exchange rate volatility given the choice of exchange rate regimes and the responses of current account components (trade balance and net investment income flows) to exchange rate fluctuations across countries.
Chapter 1 presents the general motivations of this thesis, followed by the research aims and methodology. The structure of thesis is then outlined.
Chapter 2 investigates exchange rate volatility given the choice of exchange rate regimes. By assessing a large currency-pair sample over 1999M1-2006M12, bilateral exchange rate volatility increases with the degree of the flexibility of the exchange rate regime combinations. Currency network effects (i.e. pegs sharing the same anchor would benefit lower exchange rate volatility) are significant, with the structural variables also being controlled. Relative to the both-free-floating pairs, the marginal volatility-stabilising effects are identical across the anchors (networks) and hence the network effect increases with the network size. Managed floats are shown to track the US dollar, which consequently increases the effective size of the USD network relative to the others. Structural factors, such as larger cycle asymmetry, lower bilateral trade openness, larger economy size and per capita land resources, are associated with greater bilateral exchange rate volatility. Inflation conditions significantly undermine the network effects. Moreover, the volatility-stabilising effects increases with the peg network size under the arithmetic multilateral exchange rate volatility measure but not under the trade-weighted measure, indicating the competing rationales for the choice of anchors (networks).
Chapter 3 assesses the trade balance adjustments in response to exchange rate fluctuations across countries. By estimating fixed-effects regressions covering 96 countries from 1993 to 2006, trade balance exhibits significant responses for the contemporaneous and the subsequent one year, particularly for the Industrial and Emerging Market groups. The J-curve dynamics become more evident after exports and imports are examined separately. There are clear asymmetric patterns between the Industrial and developing economies. The latter group tends to have larger and more instant adjustments both on trade balance and between tradable and nontradable sectors than the former. Moreover, the Industrial economies on average show symmetric long-run and short-run responses to depreciations and appreciations. However, the Emerging Market economies’ trade balance tend to respond faster to depreciations than to appreciations. Relative to the moderate degree of fluctuations, large exchange rate changes for developing economies are associated with the inverse dynamics of the normal cases. Other factor variables, such as the terms of trade and domestic income variables exhibit explanatory power as expected in the literature.
By taking fixed-effects regressions over a similar sample to Chapter 3, Chapter 4 examines the changes of net investment incomes in response to exchange rate fluctuations across countries with different foreign currency lending positions. Given the initial net capital outflow, depreciations (appreciations) are associated with net investment income improvements (deteriorations) for the Industrial economies, most of which have positive positions of foreign currency exposure (FXE), i.e. foreign currency assets exceed liabilities. An inverse case applies for the developing economies of which most possess negative positions of FXE. Given the changes of exchange rate, the degree of this valuation effect increases with the imbalance position of FXE particularly among the Industrial and Emerging Market economies. Further investigations show that this is mainly driven by the adjustments of foreign currency components in the two groups’ external balance sheets. For the other developing economies, there are insignificant valuation effects conditioning on the FXE positions that are mainly driven by the overall net foreign borrowing positions. The initial captial outflow proxied by the lagged current account position tends to have insignificant effects on the net investment income flows across the countries.
Combing the trade balance dynamics and the valuation effects, the overall current account adjustments are mainly driven by the trade balance across the economies. Given similar long-run quantitative effects of exchange rate fluctuations between the Industrial and Emerging Market economies, the latter group exhibits faster and larger short-run trade balance and current account responses than the former. The valuation effects are insignificant in the overall current account adjustments. Nevertheless, the valuation effects tend to counteract the trade balance adjustments for the Emerging Market economies given an exchange rate change, while those two channels work in the same direction for the Industrial economies. These asymmetries further indicate the importance of country’s external portfolio dynamics.
Chapter 5 summarises the main findings, followed by the discussions about implications and possible future research.
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