Exchange Rates and International Finance Laurence Copeland Acclaimed for its clarity, Exchange Rates and International Finance provides an approachable guide to the causes and consequences of exchange rate fluctuations, enabling you to grasp the essentials of the theory and its relevance to major events in currency markets The sixth edition appears against the background of a world only just recovering from the worst financial collapse in modern history and the ongoing crisis in the eurozone Since the last edition, this widelyused textbook has been extensively revised and restructured, with the addition of new material to take account of the most important events of recent years NEW TO THE SIXTH EDITION • A new chapter on heterogeneous information, the exchange rate disconnect puzzle and the scapegoat model • Extended coverage of risk and the currency carry trade • New material on the 2008 banking crisis • Extended coverage of the eurozone crisis • Discussion of China–US trade relations Exchange Rates and International Finance Sixth Edition Sixth Edition Exchange Rates and International Finance Laurence Copeland Sixth Edition Copeland This book is ideal for students of international finance, international macroeconomics or international money as a part of an economics or business programme at advanced undergraduate, MBA or specialist Masters levels Laurence Copeland is Emeritus Professor of Finance and Director of the Investment Management Research Unit at Cardiff University, UK CVR_COPE6047_06_SE_CVR.indd Front cover image: © Getty Images www.pearson-books.com 19/03/2014 14:51 Exchange Rates and International Finance A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM Sixth Edition Exchange Rates and International Finance Laurence S Copeland A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM Pearson Education Limited Edinburgh Gate Harlow CM20 2JE United Kingdom Tel: +44 (0)1279 623623 Web: www.pearson.com/uk First published 1989 (print) Second edition 1994 (print) Third edition 2000 (print) Fourth edition 2005 (print) Fifth edition 2008 (print) Sixth edition published 2014 (print and electronic) © Addison-Wesley Publishers Ltd 1989, 1994 (print) © Pearson Education Limited 2000, 2008 (print) © Pearson Education Limited 2014 (print and electronic) The right of Laurence S Copeland to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988 The print publication is protected by copyright Prior to any prohibited reproduction, storage in a retrieval system, distribution or transmission in any form or by any means, electronic, mechanical, recording or otherwise, permission should be obtained from the publisher or, where applicable, a licence permitting restricted copying in the United Kingdom should be obtained from the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS The ePublication is protected by copyright and must not be copied, reproduced, transferred, distributed, leased, licensed or publicly performed or used in any way except as specifically permitted in writing by the publishers, as allowed under the terms and conditions under which it was purchased, or as strictly permitted by applicable copyright law Any unauthorised distribution or use of this text may be a direct infringement of the author’s and the publishers’ rights and those responsible may be liable in law accordingly All trademarks used herein are the property of their respective owners The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners Contains public sector information licensed under the Open Government Licence (OGL) v2.0 www.nationalarchives.gov.uk/doc/open-government-licence The screenshots in this book are reprinted by permission of Microsoft Corporation Pearson Education is not responsible for the content of third-party internet sites The Financial Times With a worldwide network of highly respected journalists, The Financial Times provides global business news, insightful opinion and expert analysis of business, finance and politics With over 500 journalists reporting from 50 countries worldwide, our in-depth coverage of international news is objectively reported and analysed from an independent, global perspective To find out more, visit www.ft.com/pearsonoffer ISBN: 978-0-273-78604-7 (print) 978-0-273-78607-8 (PDF) 978-0-273-78609-2 (eText) British Library Cataloguing-in-Publication Data A catalogue record for the print edition is available from the British Library Library of Congress Cataloging-in-Publication Data Copeland, Laurence S Exchange rates and international finance/Laurence S Copeland – 6th Edition pages cm ISBN 978-0-273-78604-7 1. Foreign exchange rates. 2. International finance. I. Title HG3821.C78 2014 332.4′56–dc23 2013049374 10 9 8 7 6 5 4 3 2 1 17 16 15 14 13 Print edition typeset in 9.5/12.5 pt ITC Charter by 35 Print edition printed and bound in Great Britain by Ashford Colour Press Ltd, Gosport NOTE THAT ANY PAGE CROSS-REFERENCES REFER TO THE PRINT EDITION A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM Contents List of exhibits Preface and acknowledgements xi xii Introduction Introduction 1.1 1.2 1.3 1.4 1.5 1.6 What is an exchange rate? The market for foreign currency The balance of payments The DIY model Exchange rates since World War II: a brief history Overview of the book Summary Reading guide Notes Part The international setting Prices in the open economy: purchasing power parity 19 24 24 35 37 38 38 43 45 Introduction 45 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 46 53 57 60 65 71 76 77 The law of one price in the domestic economy The law of one price in the open economy A digression on price indices Purchasing power parity Purchasing power parity – the facts at a glance Purchasing power parity extensions Empirical research Conclusions Summary Reading guide Notes Financial markets in the open economy 79 80 81 84 Introduction 84 3.1 3.2 3.3 3.4 3.5 85 92 94 97 99 Uncovered interest rate parity Covered interest rate parity Borrowing and lending Covered interest rate parity – the facts Efficient markets – a first encounter v A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM Contents 3.6 The carry trade paradox 3.7 Purchasing power parity revisited 101 106 Summary Reading guide Notes 111 112 112 Open economy macroeconomics 115 Introduction 115 116 136 142 4.1 IS–LM model of aggregate demand 4.2 Aggregate supply 4.3 Conclusions Summary Reading guide Notes Part 2 Exchange rate determination 142 144 144 147 Flexible prices: the monetary model 149 Introduction 149 150 157 169 171 175 5.1 The simple monetary model of a floating exchange rate 5.2 The simple monetary model of a fixed exchange rate 5.3 Interest rates in the monetary model 5.4 The monetary model as an explanation of the facts 5.5 Conclusions Summary Reading guide Notes 175 176 176 Fixed prices: the Mundell–Fleming model 178 Introduction 178 179 182 182 184 186 187 189 192 193 6.1 Setting 6.2 Equilibrium 6.3 Monetary expansion with a floating exchange rate 6.4 Fiscal expansion with a floating exchange rate 6.5 Monetary expansion with a fixed exchange rate 6.6 Fiscal expansion with a fixed exchange rate 6.7 The monetary model and the Mundell–Fleming model compared 6.8 Evidence 6.9 Conclusions Summary Reading guide Notes 193 194 194 vi A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM Contents Sticky prices: the Dornbusch model 196 Introduction 196 197 202 205 210 215 217 7.1 Outline of the model 7.2 Monetary expansion 7.3 A formal explanation 7.4 Case study: oil and the UK economy 7.5 Empirical tests: the Frankel model 7.6 Conclusions Summary Reading guide Notes 217 218 218 Portfolio balance and the current account 220 Introduction 220 221 224 230 231 236 8.1 Specification of asset markets 8.2 Short-run equilibrium 8.3 Long-run and current account equilibrium 8.4 Evidence on portfolio balance models 8.5 Conclusions Summary Reading guide Notes 236 237 237 Currency substitution 239 Introduction 239 240 246 247 9.1 The model 9.2 Evidence on currency substitution 9.3 Conclusions Summary Reading guide Notes 248 248 249 10 General equilibrium models 251 Introduction 251 253 270 272 273 10.1 The Redux model 10.2 Extensions of Redux 10.3 Evidence 10.4 Conclusions Summary 274 Reading guide 275 Notes 276 Appendix 10.1: Derivation of price index (Equation 10.2) 278 Appendix 10.2: Derivation of household demand (Equations 10.6 and 10.6′) 279 Appendix 10.3: Log linearisation of model solution (Equations L1–L4) 280 Appendix 10.4: Sticky prices 282 vii A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM Contents Part 3 A world of uncertainty 283 11 Market efficiency and rational expectations 285 Introduction 285 286 289 292 294 294 297 298 300 303 11.1 Mathematical expected value 11.2 Rational expectations 11.3 Market efficiency 11.4 Unbiasedness 11.5 The random walk model 11.6 Testing for efficiency: some basic problems 11.7 Spot and forward rates: background facts 11.8 Results 11.9 Conclusions Summary Reading guide Notes 304 304 305 12 The ‘news’ model, exchange rate volatility and forecasting 308 Introduction 308 309 311 317 320 323 328 12.1 The ‘news’ model: a simple example 12.2 The monetary model revisited 12.3 Testing the ‘news’ 12.4 Results 12.5 Volatility tests, bubbles and the peso problem 12.6 Conclusions Summary Reading guide Notes 328 329 330 13 The risk premium 333 Introduction 333 334 335 338 346 348 13.1 Assumptions 13.2 A simple model of the risk premium: mean–variance analysis 13.3 A more general model of the risk premium 13.4 The evidence on the risk premium 13.5 Conclusions Summary Reading guide Notes Appendix 13.1: Derivation of Equation 13.16 Part 4 Fixed exchange rates 349 350 350 353 355 14 Target zones 357 Introduction 357 viii A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM Contents 14.1 What is a target zone 14.2 Effect of target zones 14.3 Smooth pasting 14.4 An option interpretation 14.5 A honeymoon for policymakers? 14.6 Beauty and the beast: the target zone model meets the facts 14.7 Intramarginal interventions: leaning against the wind 14.8 Credibility and realignment prospects 14.9 Conclusions 357 360 364 366 373 375 376 380 381 Summary Reading guide Notes Appendix 14.1: Formal derivation of the model 382 383 383 385 15 Crises and credibility 387 Introduction 387 388 395 404 410 413 15.1 First-generation model 15.2 Second-generation models 15.3 Third-generation models 15.4 The 2008 crisis 15.5 Conclusions Summary Reading guide Notes 414 415 416 16 Optimum currency areas, monetary union and the eurozone 419 Introduction 419 423 427 431 439 441 451 16.1 Benefits of monetary union 16.2 Costs of monetary union 16.3 Other considerations 16.4 Currency boards 16.5 The eurozone 16.6 Conclusions Summary Reading guide Notes Part 5 Alternative paradigms 451 453 453 459 17 Heterogeneous expectations and scapegoat models 461 Introduction 461 462 471 488 17.1 The market maker model 17.2 Introduction to expectations with heterogeneous information 17.3 Conclusions Summary Reading guide 489 490 ix A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM www.downloadslide.net Bibliography Meese R.A and Rogoff K (1983) The out-of-sample failure of empirical exchange rate models: sampling error or misspecification? In Frenkel J (ed.) Exchange Rates and International Macroeconomics Chicago, IL: University of Chicago Press Meese R.A and Singleton K.J (1983) On unit roots and the empirical modelling of exchange rates Journal of Finance, 37, 1029 –35 Menkhoff, L., Sarno, L., Schmeling, M and Schrimpf, A (2012) Carry Trades and Global Foreign Exchange Volatility, Journal of Finance, 67 (2), 681–718 Metzler L.A (1951) Wealth, saving and the rate of interest Journal of Political Economy, (2), 93 –116 Minford A.P.L and Peel D.A (2002) Advanced Macroeconomics: A Primer Cheltenham: Edward Elgar Mood A.M and Graybill F.A (1963) Introduction to the Theory of Statistics, 2nd edn New York: McGraw-Hill Mongeli F.P (2002) ‘New’ view on the optimum currency area theory: What is EMU telling us? ECB Working Paper No 138, April Mundell R.A (1961) A theory of optimum currency areas American Economic Review, 51, 509 –17 Mundell R.A (1962) The appropriate use of monetary and fiscal policy under fixed exchange rates IMF Staff Papers, 9, 70 –7 Mundell R.A (1968) International Economics New York: Macmillan Mussa M (1976) The exchange rate, the balance of payments and monetary policy under a regime of controlled floating Scandinavian Journal of Economics, 78, 228 – 48 Mussa M (1979) Empirical regularities in the behaviour of exchange rates and theories of the foreign exchange market In Brunner K and Meltzer A.H (eds) Policies for Employment, Prices, and Exchange Rates vol 11 Rochester, NY: Carnegie Rochester Conference Series Muth J.F (1961) Rational expectations and the theory of price movements Econometrica, 29, 315 –35 Newbold P., Carlson W.L and Thorne B.M (2013) Statistics for Business and Economics, 8th edn Pearson Education Obstfeld M (1996) Models of currency crises with self-fulfilling features European Economic Review, 40, 1037– 48 Obstfeld M (2001) International macroeconomics: beyond the Mundell–Fleming model IMF Staff Papers, 47 (special issue) Obstfeld M (2002) Exchange rates and adjustment: perspectives from the new open economy macroeconomics National Bureau of Economic Research Working Paper No 9118 Obstfeld M and Rogoff K (1995a) The mirage of fixed exchange rates Journal of Economic Perspectives, (4), 73 –96 Obstfeld M and Rogoff K (1995b) Exchange rate dynamics Redux Journal of Political Economy, 103, 624 – 60 Obstfeld M and Rogoff K (1996) Foundations of International Macroeconomics Cambridge, MA, and London: MIT Press Obstfeld M and Rogoff K (1998) Risk and exchange rates National Bureau of Economic Research Working Paper No 6694 560 Z02_COPE6047_06_SE_EM02.indd 560 3/7/14 4:02 PM www.downloadslide.net Bibliography Obstfeld M and Rogoff K (2000a) The six major puzzles in international macroeoconomics: is there a common cause? Center for International and Development Economics Research, University of California, Berkeley, Paper C00-112 Obstfeld M and Rogoff K (2000b) New directions for stochastic open economy models, Journal of International Economics, 50, 117–53 Officer L.H (1976) The purchasing power parity theory of exchange rates: a review article, IMF Staff Papers, 23, 1– 60 Parkin M.J (2013) Macroeconomics, 11th edn Pearson Peitgen H.-O., Jurgens H and Saupe D (1992) Chaos and Fractals: New Frontiers of Science New York: Springer-Verlag Rabin (2000) Risk Aversion and Expected-Utility Theory: A Calibration Theorem Econometrica 68 (5), 1281–92 Reinhart C.M and Rogoff K.S (2009) This Time is Different: Eight Centuries of Financial Folly Princeton, NJ: Princeton University Press Reinhart C.M and Rogoff K.S (2010) From Financial Crash to Debt Crisis National Bureau of Economic Research, Working Paper #15795 Rime D (2003) New electronic trading systems in foreign exchange markets In Jones D.C (ed.) New Economy Handbook San Diego, CA: Academic Press Rogoff K (1996) The purchasing power parity puzzle Journal of Economic Literature, XXXIV, 647– 68 Roll R (1979) Violations of purchasing power parity and their implications for efficient inter national commodity markets In Sarnat M and Szego G.P (eds) International Finance and Trade Cambridge MA: Bellinger Rubinstein M (1976) The valuation of uncertain income streams and the pricing of options Bell Journal of Economics, (2), 407–25 Sager M.J and Taylor M.P (2006) Aspects of foreign exchange market microstructure: editors’ introduction International Journal of Finance and Economics, 11, 1–2 Sarkovskii A.N (1964) Coexistence of cycles of a continuous map of a line into itself Ukrainian Mathematical Zeitung, 16, 61–71 Sarno, L (2005) Towards a Solution to the Puzzles in Exchange Rate Economics: Where Do We Stand? Warwick Business School Financial Econometrics Research Centre Working Paper No 05-11 Sarno L and Taylor M.P (2001) The microstructure of the foreign exchange market: a selective survey of the literature Princeton Studies in International Economics, 89 Sarno L and Taylor M.P (2002) Purchasing power parity and the real exchange rate IMF Staff Papers, 49 (1), 65 –105 Sercu P (2009) International Finance: Theory Into Practice Princeton, NJ: Princeton University Press Sharpe W.F (1985) Investments, 3rd edn Englewood Cliffs, NJ: Prentice-Hall Sheffrin S.S (1983) Rational Expectations Cambridge: Cambridge University Press Stewart I (1990) Does God Play Dice? London: Penguin Books Svensson L.E.O (1992) An interpretation of recent research on exchange rate target zones Journal of Economic Perspectives, (4), 119 – 44 561 Z02_COPE6047_06_SE_EM02.indd 561 3/7/14 4:02 PM www.downloadslide.net Bibliography Taylor M.P (1987) Covered interest parity: a high-frequency, high-quality data study Economica, 54, 429 –38 Taylor M.P (1988) What investment managers know? An empirical study of practitioners’ predictions Economica, 55 (218), 185 –202 Taylor, M.P (2003) Purchasing Power Parity Review of International Economics, 11 (3), 436 –52 Taylor M.P., Peel D.A and Sarno L (2001) Nonlinear mean-reversion in real exchange rates: toward a solution to the purchasing power parity puzzles International Economic Review, 42 (4), 1015 – 42 Tobin J (1958) Liquidity preference as behavior towards risk Review of Economic Studies, 25 (67), 65 – 86 Tobin J (1965) Money and economic growth Econometrica, 33, 671– 84 Tobin J (1969) A general equilibrium approach to monetary theory Journal of Money Credit and Banking, (1), 15 –29 Tsiang S.C (1959) The theory of forward exchange and effects of government intervention on the forward exchange market IMF Staff Papers, 7, 75 –106 Uribe, M (1997) Hysteresis in a Simple Model of Currency Substitution Journal of Monetary Economics, 40, 185 –202 Varian H.R (2005) Intermediate Microeconomics, 7th edn New York: Norton Vitale P (2004) A guided tour of the market microstructure approach to exchange rate determination CEPR Discussion Paper No 4530 Wachtel P (ed.) (1982) Crises in the Economic and Financial Structure Lexington, MA: Lexington Books West K.D (1987) A standard monetary model and the variability of the Deutschemark–dollar exchange rate Journal of International Economics, 23 (1/2), 57–76 Williamson J (1983) The Open Economy and the World Economy New York: Basic Books Wilson C.A (1979) Anticipated shocks and exchange rate dynamics Journal of Political Economy, 87 (3), 639 – 47 Wonnacott R.J and Wonnacott T.H (1977) Introductory Statistics, 3rd edn Chichester: John Wiley & Sons 562 Z02_COPE6047_06_SE_EM02.indd 562 3/7/14 4:02 PM www.downloadslide.net Index abandonment cost 397, 399, 400 absolute purchasing power parity 61, 64, 79 accuracy 511 ad valorem tax 56, 65 adding-up constraint 257 adjustment process 205 adjustment speeds 72–3 adjustment to disequilibrium 428 adjustment to purchasing power parity 71–3 adverse selection 465, 470, 471 aggregate demand 134 – 6, 202, 258, 397 aggregate supply 115 –16, 136 – 42, 202 alternative paradigms heterogeneous expectations and scapegoat models 461–94 nonlinearity, cycles and chaos 510 – 41 order flow analysis 487, 488, 495 –509 announcement/event studies 319 –20, 321 announcements and order flow analysis 505 aperiodic path 526, 532 appreciation bilateral vs trade-weighted exchange rates –7 bootstrap situation 171, 312 monetary model 154, 173, 189 ‘news’ approach 321 arbitrage 46 –57, 545 definition 47, 92 fear of arbitrage, common knowledge and hot potato 502–3, 504 Asian carry trade 105, 471 Asian crisis 31–3, 396, 404 – Asian tigers 33 ask or offer rate –9, 497 asset accumulation 227 asset markets 236 bootstrap feature 312 household budget constraint and 256 –7 specification of 221– assets 95, 121, 122 banking system 128, 129 assumptions currency substitution 241–2 Dornbusch model 197– market maker model 462–3, 465, 470 mean–variance 334 –5 monetary model 150 –1 Mundell–Fleming model 179 – 80 portfolio balance 220, 221 Redux model 253 – risk premium 334 –5, 343 – scapegoat models 473 – 4, 477, 479, 481–2 simple nonlinear model 512 target zones 361 autoregression 72, 481 vector 318 –19, 321 autoregressive conditional heteroscedasticity models 536 average market expectations 472, 475 –7, 480 –1 balance of payments 19, 131, 132, 179 – 82 capital account 22–3, 77, 78, 180 current account see separate entry locus 180 –2 Balassa–Samuelson 71 Bank of England 9, 127, 128, 131, 430 Bank of Japan 127, 131, 434, 473 banking system 127–32, 406, 407, 447– crises 29, 33, 35, 70, 164, 408 –13, 420, 444, 447– barter 426 base period 60 Bayesian learning 465 beggar-my-neighbour economic policies 271 behavioural finance 547– bid rate –9, 497 bifurcation 525 Big Mac index 68 –9 bilateral exchange rate –7, 235 binding constraint 375 binomial process 367 black market 46 boom 34 bootstrap situation 171, 312 see also bubbles borrowing and lending 94 –7 Bretton Woods system 161, 178, 432 1944 – 68 25 1968 –73: breakdown 25 –7, 395, 442 target zone 360 brokers 497, 498 –500 563 Z03_COPE6047_06_SE_EM03.indd 563 3/7/14 4:03 PM www.downloadslide.net Index broker’s book 499 bubbles 29, 33 – 4, 323 – 6, 327– 8 shadow exchange rate 394 –5 buffer stock 17–18, 131 bullishness 299 Bundesbank 26, 31, 396, 402, 403, 441, 442, 450 butterfly effect 529 –30, 531, 538 buying vs selling rates 7–9, 423 – 4 calibrated PTM models 273 Cambridge quantity equation 124 capital account 22–3, 77, 78, 180 capital gains 312, 391–2, 393, 397 capital service 20 –1 carry trade paradox 101– 6, 348, 471, 488 cascade 525 central banks 17, 18, 91, 126, 127–30, 131, 380, 420 currency boards 439 gold 26 order flow analysis 503 see also individual banks chaebol 407 change in monetary policy 245 – 6 chaos 526, 528 –38 time path of exchange rate 513 –38 < α < 516 –20 < α < 520 –2 < α < 522–3 < α < 3.68 523 – 6 3.68 < α < 526 –7 phase portrait 514 –16 Chartism 289 China 29, 34, 274, 402 and the USA 162–4 Asian crisis 406, 407 circularity 392, 396 City of London 424 cobweb 522, 523 coefficient of relative risk aversion 342 collateral for borrowing 409 colonial powers 439 common currency 53 – 4, 88, 431–3 common market and 438 –9 eurozone see separate entry common knowledge, fear of arbitrage and hot potato 502–3, 504 common market and common currency 438 –9 competitiveness 24, 25, 31, 33, 117–18, 120, 136, 231, 235 conditional (mathematical) expectation 288, 289, 358 connected lending 407 conservative countries 435, 436, 443 constant elasticity of substitution 254 constraint asset markets and household budget 256 –7 binding 375 government budget 126 –7, 433 speculative opportunity line 337– 8 consumer price index 58 – 60, 431 consumer’s problem, solution to 259 consumption 107– 8, 252, 259, 263, 264, 266 –7 contagion 408 convergence criteria 436, 437 convertibility 17, 25, 247 correlation 533 costs monetary union 427–31 transaction see separate entry transition 437– 8 uncertainty 424 – 6 countercyclical fiscal policy 435 coupon 434 covariance 334, 339 – 41, 348, 425 covered interest rate parity 92– 4, 343 facts 97–9 hypothesis 94 crawling peg regime 381 credibility 422, 436, 441, 442 crises and 387– 418 currency board 440 target zones 361, 380 –1 credit squeeze 410 crises: July 1997 to Aug 1998 31–3, 396, 404 – 8 crises and credibility 387– 418 2008 crisis 70, 164, 410 –13, 444 first-generation model 388 –95, 403 second-generation models 395 – 404, 422, 442 third-generation models 404 –10 cross-exchange rate 6, crowding out 136, 183 – 4, 185, 188, 190, 191, 192, 214 cultural heterogeneity 438 currency boards 439 – 41 basic principle 439 – 40 Gold Standard 441 mechanisms 440 currency market structure 496 –500 currency substitution 239 –50, 343, 451, 546, 548 evidence 246 –7 model 240 – 6 currency swap deal 97 currency wars 412–13 current account 20, 79, 252 balance 21–2, 77– 8, 117–18 564 Z03_COPE6047_06_SE_EM03.indd 564 3/7/14 4:03 PM www.downloadslide.net Index currency substitution 240, 243, 245, 246, 247 deficit 28 –9, 77– 8, 397 goods and services 20 –1 Mundell–Fleming model 179 – 82 portfolio balance and 220 –38 cycles, nonlinearity and chaos 510 – 41 data snooping 273 dealers 497–500 debasement of currency 161 deflation 154, 407, 431, 432 demand for money 120, 121– 6 interest sensitivity 204 demand and supply curves 9 –15 deposit guarantees 408 –9, 448 depreciation 269 bilateral vs trade-weighted exchange rates 4 –7 monetary model 153 Mundell–Fleming model 189 desired exchange rate 397, 400 deterministic vs stochastic models 511–12, 536 – 8 devaluation 24, 30, 74, 166 –9, 231, 271 crises and credibility see separate entry wages 430 –1 difference equation 315 diffusion process 385 dirty float 19, 132 disequilibrium 207–9, 260, 263 –5, 401, 428, 496 disguised dollarisation 439 disintegration 420, 430 diversification 222– 4 DIY model 24, 154 domestic asset decrease 226 domestic credit 130 –2, 158 – 62, 389, 390, 392, 394 domestic strategy: uncovered interest rate parity 85 –7 Dornbusch model 142, 196 –219, 512, 546 empirical tests: Frankel model 215 –16 formal explanation 205 –10 monetary expansion 202–5 oil and UK economy 210 –15 outline of 197–202 double-entry bookkeeping 22 Dutch disease 213 –14 econometrics 2–3, 76 –7, 272, 327, 535, 536 economic integration economies of scale 423, 424 effective exchange rate 4 –7, efficient markets 99 –101, 285 – 6, 292–3, 303, 507 definition 101 mathematical expected value 286 – 8 ‘news’ approach 316 –17 random walk model 294 –7 rational expectations 289 –91, 303 results 300 –3 spot and forward rates 298 –9 testing for efficiency 297– 8 unbiasedness 294, 303 weakly 293 electronic trade 78 –9 11 September 2001 34 empirical research order flow analysis 504 – 6 purchasing power parity 76 –7 empirical tests of Dornbusch model 215 –16 EMS see European Monetary System EMU see eurozone endogenous variables 223, 260 equilibria, multiple 396 –7, 399 – 401, 487 equilibrium 409, 447, 496, 501 Dornbusch model: long-run 200, 202, 207, 214 heterogeneous expectations 479 – 80 mean–variance analysis 338 monetary model 152, 190, 428 Mundell–Fleming model 182, 190 portfolio model: long-run 230 –1 price level 14 Redux model: long-run 263 –5, 267–9 scapegoat models 479 – 80, 493 – 4 short-run 208 –9, 224 –9, 267–9 temporary and permanent disturbances 18 uncovered interest rate parity 88 –92 ‘equilibrium’ prices 499 ERM see European Monetary System escape clauses 434 EU Regional Fund 433 Euler equations 259, 266 Eurobond 449 European Central Bank 31, 413, 432, 434, 435, 436, 443, 449, 450 European Monetary System 421–2, 432 1979 –93 30 –1, 360, 375, 376, 380 1993 –93: ERM crisis 396, 401– 4, 441–2 eurozone 1, 31, 35, 420, 441, 451 accession and the peso problem 326 –7 collapse of ERM 441–2 common currency and common market 438 –9 convergence criteria 436, 437 crisis 410, 413, 420, 422–3, 444 –50 currency boards 440 early years 442–3 fiscal sovereignty 433 – 6 global banking crisis 420, 444, 447– 8 inflation 77, 432 international unit of account 426 –7 565 Z03_COPE6047_06_SE_EM03.indd 565 3/7/14 4:03 PM www.downloadslide.net Index eurozone (continued) labour mobility 430 Stability and Growth Pact 434, 449 structural problems 445 – 7 Target2 balances 447 transaction costs 424, 438 transition costs 437– 8 way forward: breaking up 450 way forward: preserving 448 –9 event/announcement studies 319 –20, 321 evidence currency substitution 246 –7 Mundell–Fleming model 192–3 nonlinearity and chaos 532–7 portfolio balance models 231– 6 Redux model 272–3 risk premium 346 – 8 excess supply 242–3 excess volatility or variance bound tests 324 – 6, 327 exchange rate determination currency substitution 239 –50, 343, 546, 548 fixed prices: Mundell–Fleming model 140, 178 –95, 546 flexible prices: monetary model 149 –77, 546 general equilibrium models 251– 82, 546 portfolio balance and current account 220 –38, 342–3, 546 sticky prices: Dornbusch model 142, 196 –219, 512, 546 exchange rate disconnect puzzle 174, 322, 462, 487– 8, 489 hot potato effect 502–3 exchange rate mechanism see European Monetary System exchange rate regimes crawling peg 381 currency boards 439 – 41 fixed exchange rates see separate entry floating exchange rates see separate entry managed floating 19, 132, 373 monetary union see separate entry exchange rates bilateral vs trade-weighted 4 –7 buying vs selling 7–9, 423 – 4, 497 DIY model 24, 154 expressing 3 – 4, 54 since World War II 24 –35 spot vs forward exercise price 366 exogenous variables 224, 260, 264 expectations bias 303 and financial markets 198 –200 fully rational 289, 291 heterogeneous see separate entry and interest rates 189 –92 purchasing power parity 109 –10 rational 289 –91, 303, 316, 319 –20, 482–3, 548 subjective 289 weakly rational 291 ‘wrong’ 400 expected utility 334, 338 –9, 342, 547, 548 expected value 286 – 8, 334, 335, 336, 337, 339, 342 expenditure-switching effects 269, 270 exports/exporters 13, 14 –15, 16, 271, 424 eyeball test 235 facts covered interest rate parity 97–9 monetary model 171– 4 purchasing power parity 65 –71 target zones 375 – 6, 381 fear of arbitrage 502–3, 504 Federal Reserve 33 – 4, 35, 104, 127, 128, 131, 434, 442, 443 feedback 396 –7, 448, 506 fiat money 413 filter rule 301–2 financial markets and expectations 198 –200 financial markets in the open economy 84 –114 borrowing and lending 94 –7 carry trade paradox 101– 6, 348, 471, 488 covered interest rate parity 92– 4, 97–9, 343 efficient markets 99 –101 purchasing power parity 106 –11 uncovered interest rate parity 85 –92, 96, 397, 411, 545 Financial Times 8, 9, 10 –12 financial variables 320, 326 first-generation crisis model 388 collapsing bubble 394 –5 how collapse occurs 391– 4 monetary model of fixed exchange rate 388 –9 money stock 389 –90 post-collapse exchange rate 390 –1 shortcomings of 395, 403 timing of collapse 394 fiscal expansion with fixed exchange rate 187– 8 with floating exchange rate 184 –5 fiscal integration 448 –9 fiscal policy 117, 127, 185 countercyclical 435 fiscal sovereignty 448 treasury and 433 – 6 fiscal stabilisers 432–3 566 Z03_COPE6047_06_SE_EM03.indd 566 3/7/14 4:03 PM www.downloadslide.net Index Fisher equation 107–9, 110 –11 fixed exchange rates 16 –18, 19, 34, 131, 132, 142 Bretton Woods see separate entry common currency vs 431–3 crises and credibility 387– 418 European Monetary System see separate entry fiscal expansion with 187– 8 monetary expansion with 186 –7 monetary model of 157– 69, 388 –9, 402, 428 target zones 18, 357– 86 fixed prices 139 – 40, 178 –95 flexible prices 137–9, 149 –77, 269 float, post-collapse 390 –1 floating exchange rates 15 –16, 27, 131–2, 429 fiscal expansion with 184 –5 floating rate era 19, 27–30, 470 –1 managed floating 19, 132, 373 monetary expansion with 182– 4 monetary model of 150 –7, 428 floating rate era 19, 470 –1 1973 –79 27–30 forecasts/forecasting 2, 221, 236, 288, 300, 303 ‘news’ model, exchange rate volatility and 308 –32 nonlinearity and chaos 432, 511–12, 530 –1, 532, 535 – 6 rational expectations 289 –91 scapegoat model 489 foreign currency accounting 247 foreign currency asset decrease 227 foreign currency market 9 –19 structure of 496 –500 foreign investors 13, 14, 16 foreign price increase under fixed exchange rates 165 – 6 floating exchange rates 155 – 6 foreign strategy: uncovered interest rate parity 87– 8 forward exchange rates 92–3 efficiency studies: background facts 298 –9 Financial Times spot vs spread 8 –9 forward premium (discount) 94, 317, 425 – 6, 471, 545 see also market maker model fractional reserve banking 440, 448 franc fort policy 403 Frankel model 215 –16 frequency distribution 376 Friedman, Milton 27, 124 fully rational expectations 289, 291 future research 547– 8 general equilibrium models 251– 82 evidence 272–3 extensions of Redux model 270 –2 Redux model 253 –70, 546 general model of risk premium 338 conditional model 345 – 6 other possible extensions 343 – 4 risk premium and portfolio balance models 342–3 simple model revisited: mean–variance assumptions 341–2 solution 339 – 41 speculator’s decision problem 338 –9 stochastic discount factor 344 –5 global banking crisis 35, 70, 164, 410 –13, 420, 444, 447– 8 global welfare 269 globalisation 1, 162–3 Gold Standard 25, 161, 441 Gold Window 25, 26 goods market 200 –1 wealth effect in 211–12 goods and services 20 –1, 52 non-traded goods 52–3, 57, 70, 71, 242–3, 271–2, 427 government 117, 257– 8, 271, 274, 431–3 see also crises and credibility government budget constraint 126 –7, 433 government securities 128, 129, 413, 433 – 4, 444, 448 guarantee(s) 93 deposit 408 –9, 448 hat values 264 haven currencies 413 hedge funds 407 heterogeneous expectations and scapegoat models 461–94 average expectations 472, 475 –7, 480 –1 beauty contest 480 –1 budget constraint 477– 8 information structure 481–3 investor’s decision 477–9, 492–3 law of iterated expectations 473 – 6, 480 market equilibrium 479 – 80, 493 – 4 market maker model 462–71, 488, 507 scapegoat effect 485 – 6 scapegoat model 462, 471, 486 – 8 solution for exchange rate 483 – 4, 494 history of rates since WWII 24 1944 – 68: Bretton Woods 25, 161, 178, 360 1968 –73: breakdown 25 –7, 395 1973 –79: floating rate era 27–30 567 Z03_COPE6047_06_SE_EM03.indd 567 3/7/14 4:03 PM www.downloadslide.net Index history of rates since WWII (continued) 1979 –93: European Monetary System 30 –1, 360, 375, 376, 380, 396, 401– 4, 421–2 1999 onwards: European Monetary Union 31, 35 crises: July 1997 to Aug 1998 31–3, 396, 404 – 8 crisis: twenty-first century 35, 410 –13 twenty-first century 33 –5 see also eurozone honeymoon effect 27, 373 – 6, 378 –9 hot potato effect 502–3, 504 house prices 34, 35 household budget constraint and asset markets 256 –7 household demand 255, 279 household sector 116 Hume, David 149 hyperinflation 70, 72, 90, 174, 247 iceberg model 73 – 4, 272 IID error term 536 illiquidity 122 IMF 25, 408, 450 import propensity 118 imports/importers 13, 14 –15, 16, 431 income increase under fixed exchange rates 165 floating exchange rates 153 – 4 incomplete pass-through and pricing to market 74 – 6, 270 inconsistency 409 inconvertible currencies 17 increase in stock of foreign currency assets 227–9 independent identically distributed error term 536 indices Big Mac index 68 – 9 price see separate entry indifference map 335 – 6 Industrial Revolution 21 inertia 141 inflation 174, 230, 413, 442 hyperinflation 70, 72, 90, 174, 247 monetary union 430, 432–3 purchasing power parity 68, 70, 72, 77 risk premium 334, 343 information costs of collecting and processing 291, 305n7 fear of arbitrage, common knowledge and hot potato 502–3, 504 heterogeneity 410, 461–94 inside 294, 470 –1 ‘news’ model see separate entry order flow analysis 496, 501–7 weakly efficient market 293 initial steady state 260 –1 inside information 294, 470 –1 integration costs 424 integration, fiscal 448 –9 interdealer trade 497, 498 interest rates and currency wars 413 interest rates in monetary model 169 –71 interest rates and target zones 375 international setting financial markets in the open economy 84 –114 open economy macroeconomics 115 – 46 purchasing power parity see separate entry international unit of account 426 –7 internet shoppers 78, 427 internet-based currencies 413 interregional price differentials 438 Intertemporal Capital Asset Pricing Model 344 intramarginal interventions 361, 373, 376 –9 irrationality 297, 302–3, 410 irrational exuberance 34 see also rational expectations IS curve 116 –20, 142 IS–LM model of aggregate demand 115, 116 –36 aggregate demand 134 – 6 IS curve 116 –20, 142 money market 120 –34 Ito’s lemma 385 J-curve 168 –9 joint hypothesis problem 99, 109, 297 Krugman model 359, 373, 375, 379, 380, 385 labour markets 137, 402, 403, 428 –31, 445 mobility 429 –30 openness 430 –1 labour–leisure choice 259 lagged forward rates 298 –9, 321–2 lagged ‘news’ terms 321 lagged spot rates 322 law of iterated expectations 313 –14, 473 – 6, 480 law of one price in domestic economy 46 –53 law of one price in open economy 53 –7, 77, 78 leaning against the wind 376 –9 Lehman Brothers 412 lending and borrowing 94 –7 liabilities 95 banking system 128, 129 LIBOR 411 limit order 498, 499 liquid assets 120 –2 liquidity effect 203 LM curve 132– 4 568 Z03_COPE6047_06_SE_EM03.indd 568 3/7/14 4:03 PM www.downloadslide.net Index log linear approximation 260, 262–3, 274, 280 –1 long position 95 long-run effect of monetary expansion 202–3 long-run equilibrium Dornbusch model 200, 202, 207, 214 portfolio model 230 –1 Redux model 263 –5, 267–9 loss function 397–9 Lyapunov exponent 536 macroeconomics 62, 74, 115 – 46 managed floating 19, 132, 373 marginal propensity in import 118 marginal rate of substitution 345 marginal utility 137, 334, 340 –1, 343, 345, 347 market average expectations 472, 475 –7, 480 –1 market efficiency 99 –101, 285 – 6, 292–3, 303, 507 mathematical expected value 286 – 8 ‘news’ approach 316 –17 random walk model 294 –7 rational expectations 289 –91, 303 results 300 –3 spot and forward rates 298 –9 testing for efficiency 297– 8 unbiasedness 294, 303 weakly efficient market 293 market for foreign currency 9 –19 market maker model 462–71, 488, 507 assumptions 465 comments on 470 –1 market maker’s problem 465 – 8 setting 462– 4 solution 468 –70 market microstructure approach see order flow analysis market order 498 mathematical expected value 286 – 8 mean–variance analysis 335 – 8, 341–2 constraint: speculative opportunity line 337– 8 equilibrium 338 indifference map 335 – 6 measure of an interval 526 menu costs 75, 266 microstructure approach see order flow analysis mid-market rates 8, mobility of labour 429 –30 monetary disintegration 420, 430 monetary expansion 395, 443 adjustment process 205 Dornbusch model 202–5, 209 –10 with fixed exchange rate 186 –7 with floating exchange rate 182– 4 impact effect 203 – 4 long-run effect 202–3 ‘news’ approach 321 monetary model 62, 149 –77, 322, 546 compared with Mundell–Fleming model 189 –92 as explanation of facts 171– 4 of a fixed exchange rate 157– 69, 388 –9, 402, 428 of a floating exchange rate 150 –7, 428 interest rates in 169 –71 ‘news’ model: interest rate parity 311–17, 318, 321 monetary policy 18, 127, 132, 185, 245 – 6, 271, 402 monetary shock 266 –9 monetary union 419 –58 benefits of 423 –7 common currency and common market 438 –9 common currency vs fixed exchange rate 431–3 costs of 427–31 currency boards 439 – 41 definition 421 eurozone see separate entry fiscal sovereignty 433 – 6 other considerations 431–9 transition costs 437– 8 money 120 –1, 413 unit of account 426 –7 money illusion 108, 139 money market 120 –34, 142 currency substitution 244 –5 demand for money 121– 6 government budget constraint and money supply 126 –7 LM curve 132– 4 oil and UK economy: transactions effect in 212–13 supply of money in open economy 127–32 money supply or stock 18, 77, 124 –7, 142, 274, 321, 412 currency boards 439, 440 first-generation crisis model 389 –90, 391, 392– 4 Gold Standard 441 increase, domestic asset decrease 226 –7 increase, foreign currency asset decrease 227 increase in long run 230 –1 increase under fixed exchange rates 158 – 64, 402 increase under floating exchange rates 153 open economy 127–32 printing money 18, 26, 31, 128, 139, 409, 413, 433 – 4, 440, 442 target zones 360, 361, 363 – 4, 378 unanticipated increase 202–5, 209 –10, 266 –9 money transfer technology 1–2 569 Z03_COPE6047_06_SE_EM03.indd 569 3/7/14 4:03 PM www.downloadslide.net Index money wages 139, 141, 428, 429, 430, 431, 445 monopolistic behaviour 266, 270 monotonic convergence 520 moral hazard 408, 449 mortgage rate changes 402 multi-currency variance–covariance matrix 343 multilateral exchange rate multiple equilibria 396, 396 –7, 399 – 401, 487 multiple-currency portfolios 451 multiplier effect 189 multivariate time series 318 –19, 320, 321 Mundell–Fleming model 140, 178 –95, 546 compared with monetary model 189 –92 equilibrium 182 evidence 192–3 fiscal expansion with fixed exchange rate 187– 8 fiscal expansion with floating exchange rate 184 –5 monetary expansion with fixed exchange rate 186 –7 monetary expansion with floating exchange rate 182– 4 setting 179 – 82 national income 123 national sovereignty 422, 432 fiscal 433 – 6, 448 nationalisation 412, 445 natural resource discovery 210 –15 net position/exposure 425 ‘news’ model 308 –32 information set 310 monetary model with interest rate parity 311–17, 318, 321 results 320 –2 simple example 309 –10 testing the ‘news’ 317–20 volatility tests, bubbles and the peso problem 323 – 8 nominal exchange rates 63, 67, 78, 271 nominal interest rates 108 nominal wage growth 446 non-tariff barriers 56, 57 non-traded goods 52–3, 57, 70, 71, 242–3, 271–2, 427 nonlinearity 510 – 41 chaos 526, 528 –38 deterministic vs stochastic models 511–12, 536 – 8 evidence 532–7 simple nonlinear model 512–13 time path of exchange rate 513 –28 North American Free Trade Association 438 North Sea oil 210 not fully convertible currencies 17 offer or ask rate 8 –9, 497 oil and UK economy 210 –15 general case 213 –14 limitations and extensions 214 –15 transactions effect in money market 212–13 wealth effect in goods market 211–12 online shoppers 78, 427 OPEC 29, 215 open economy financial markets 84 –114 labour market 430 –1 macroeconomics 62, 74, 115 – 46 purchasing power parity 45 – 83 supply of money in 127–32 open market purchase 129, 226 opportunity cost of holding money 122, 125, 478 opportunity line, speculative 337– 8 optimum currency areas 419 –58 benefits of monetary union 423 –7 costs of monetary union 427–31 currency boards 439 – 41 eurozone see separate entry other considerations 431–9 option interpretation 366 –73 benchmark model 367–9 effect of barrier 369 –73 order flow analysis 487, 488, 495 –509 defining flow order 500 –2 empirical studies 504 – 6 fear of arbitrage, common knowledge and hot potato 502–3, 504 pricing process 503 – 4 structure of foreign currency market 496 –500 order-driven vs quote-driven trade 498 –500 overshooting Dornbusch model 197, 204, 209 –10, 213, 214, 215 portfolio balance model 231 pricing to market 270 –1 Redux model 267, 270 –1 parity value 18 partial equilibrium models 251 People’s Bank of China 127 period-doubling pattern 525 periodicity 524, 525, 526, 532 peso problem 326 –7 phase portrait 514 –16 Phillips curve 214 policy anticipation hypothesis 321 570 Z03_COPE6047_06_SE_EM03.indd 570 3/7/14 4:03 PM www.downloadslide.net Index political issues 402, 422, 432, 433, 435, 437, 438, 441, 446 –7, 449, 451 populist mercantilism 271 portfolio analysis 341 portfolio balance and current account 220 –38, 546 evidence 231– 6 long-run and current account equilibrium 230 –1 risk premium 220 –1, 222–3, 224, 235, 342–3 short-run equilibrium 224 –9 specification of asset markets 221– 4 post-collapse exchange rate 390 –1 PPP see purchasing power parity price differentials, interregional 438 price discrimination 75 – 6, 252 price indices 57– 60, 62–3, 171, 254, 431 derivation 278 –9 risk premium 343 – 4 share 320 prices fixed 139 – 40, 178 –95 flexible 137–9, 149 –77, 269 sticky 69, 78, 141–2, 196 –219, 265 – 6, 269, 271, 274, 282 prices in the open economy law of one price: domestic economy 46 –53 law of one price: open economy 53 –7 price indices see separate entry purchasing power parity see separate entry pricing process and order flow model 503 – 4 pricing to market 74 – 6, 270 –1, 273 printing money 18, 26, 31, 128, 139, 409, 413, 433 – 4, 440, 442 private sector 227, 254 – 6, 396 production sector 242–3 productivity 71, 445 protectionism 25, 412 proxy-dollar regime 439 public goods 63 purchasing power parity 45 – 83, 117, 255, 427 empirical research 76 –7 extensions 71– 6 facts 65 –71 incomplete pass-through and pricing to market 74 – 6, 270 law of one price 46 –57, 77, 78 price indices 57– 60, 62–3 real exchange rate and 109 –11 real interest rates and Fisher equation 107–9, 110 –11 summary 79 – 80 trade costs: iceberg model 73 – 4 trade costs and adjustment to 71–3 traded vs non-traded goods 71 pure floating exchange rate regime 16, 131 quadratic utility function 342, 347 quantitative easing 413 quantity theory 124, 125, 153 quotas 56, 57, 78 quote-driven trade 497 order-driven vs 498 –500 random walk 76, 110, 294 –7, 299, 322, 361 randomness 537, 538 rate of time preference 259 rational bubbles 323 – 6, 327– 8 rational expectations 289 –91, 303, 316, 319 –20, 482–3, 548 fully 289, 291 weakly 291 real exchange rate 63, 117–18, 142, 230 –1, 271 purchasing power parity and 109 –11 real interest rates and Fisher equation 107–9, 110 –11 real wages 137–9, 142, 428 –9, 430 –1 realignment prospects and credibility 380 –1 recession 29, 30, 31, 401–2, 432, 435 Redux model 253 –70, 546 asset markets and household budget constraint 256 –7 evidence 272–3 extensions of 270 –2 graphic analysis 267–70 private sector 254 – 6 setting 253 – 4 solution of 258 – 67, 280 –2 reflation 30, 431, 432 relative purchasing power parity hypothesis 64 representative agent 474 research agenda 547– 8 reserves 18, 19, 23, 127, 130, 131, 132, 387– 8 sterilisation of reserve changes 161– 4 resistance cost 398 results market efficiency 300 –3 ‘news’ model 320 –2 nonlinearity 536 –7 Retail Price Index 60, 62 reunification of Germany 30 –1, 402, 403, 442 Ricardian equivalence 191–2 risk 96 arbitrage: absence of 49, 92 risk averters 89, 106, 108, 222, 334, 337, 339, 358 risk lovers 89 571 Z03_COPE6047_06_SE_EM03.indd 571 3/7/14 4:03 PM www.downloadslide.net Index risk premium 89, 317, 322, 333 –53, 425 assumptions 334 –5, 343 – 4 carry trade 104, 348 credit squeeze 410 evidence 346 – 8 general model of 338 – 46 market efficiency 292, 293, 294, 296, 298, 301, 302, 303 mean–variance analysis: simple model of 335 – 8, 341–2 portfolio balance model 220 –1, 222–3, 224, 235, 342–3 risk-neutral agents 89, 108, 294, 339, 341, 358 rule of thumb 291 Russian crisis (1998) 33 sampling problem 327 scalpers 47–50 scapegoat models 461–2, 471–94 average expectations 472, 475 –7, 480 –1 beauty contest 480 –1 conclusions 487– 8, 489 implications and tests of 486 –7 information structure 481–3 investor’s decision 477–9, 492–3 law of iterated expectations 473 – 6, 480 market equilibrium 479 – 80, 493 – 4 order flow 487, 488 scapegoat effect 485 – 6 solution for exchange rate 483 – 4, 494 second-generation crisis models 395 – 404, 422 ERM crisis (1992–93) 401– 4, 442 simplified model 397– 401 seignorage 258, 395, 432, 433, 450 selling vs buying rates 7–9 semi-elasticity 209 September 11, 2001 34 services and goods 20 –1, 52 non-traded goods 52–3, 57, 70, 71, 242–3, 271–2, 427 shadow exchange rate 389, 390, 392, 394 –5 share price index 320 share price volatility 325 – 6 shoe-leather cost 478 short position 95, 401 short-run arbitrage 76 short-run equilibrium 208 –9, 267–9 portfolio balance 224 –9 short-run production function 138 single currency zone see monetary union Smithsonian Agreement 26 smooth pasting 364 – 6 social wages 445 Soros, George 401, 402, 403 sovereign debt crisis in eurozone 410, 413, 420, 422–3, 444 –50 sovereign loans 29 sovereignty 422, 432 fiscal 433 – 6, 448 specification of asset markets 221– 4 speculative opportunity line 337– 8 speculators 13 –14, 15, 50, 55, 215, 303, 341, 396, 401 filter rule 301 forward premium 292 fundamentals 170 holding period 358 windfall gain 338 ‘wrong’ expectations 400 speculator’s decision problem 338 –9 spot exchange rates 92 efficiency studies: background facts 298 –9 forward vs spread 8 –9 spread bid/ask 8 –9, 423 – 4, 497 standard deviation 104, 106, 334, 335, 424 sterilisation of reserve changes 161– 4 sticky prices 70, 78, 141–2, 196 –219, 265 – 6, 269, 271, 274, 282 stochastic discount factor 344 –5, 348 stochastic vs deterministic models 511–12, 536 – 8 structure of foreign currency market 496 –500 subjective expectation 289 supply and demand curves 9 –15 survey data 319, 346 target zones 18, 357– 86 credibility and alignment prospects 380 –1 effect of 360 – 4 facts 375 – 6, 381 honeymoon for policymakers 373 – 6, 378 –9 intramarginal interventions 361, 373, 376 –9 option interpretation 366 –73 smooth pasting 364 – 6 tariffs 56, 57, 65, 78 taste parameter 259 taxation 63, 78, 191–2, 258, 433, 434 tariffs 56, 57, 65, 78 TED spread 411 testing chaos 533 – 6 efficiency 297– 8 ‘news’ 317–20 third-generation crisis models 404 –10 2008 crisis 410 –13 572 Z03_COPE6047_06_SE_EM03.indd 572 3/7/14 4:03 PM www.downloadslide.net Index Asian crisis (1997–99) 404 – 8 currency wars 412–13 modelling issues 408 –10 touts 47–50 trade costs adjustment to purchasing power parity and 71–3 iceberg model 73 – 4 trade war 439 trade-weighted exchange rate 4 –7, traded vs non-traded goods: Balassa–Samuelson 71 traders 50 trading range transaction costs 48, 49, 51, 52, 53, 55, 292, 301–2, 305n7, 497 benefits of monetary union 423 – 4 collecting and processing information 291, 305n7 common currency and common market 438 covered interest rate parity 98 definition 47 internet shoppers 427 money 122 multiple-currency portfolios 451 purchasing power parity 64 –5, 71, 73 transition costs 437– 8 transparency 392 treasury and fiscal sovereignty 433 – 6 tuning parameter 513 two-country model of floating exchange rate 156 –7 unanticipated money supply increase 202–5, 209 –10, 266 –9 unbiasedness 100, 101, 294, 303 uncertainty 215, 272 behavioural finance 547 benefits of monetary union 424 – 6, 427 certain uncertainty 510 – 41 heterogeneous expectations 478 market efficiency and rational expectations 285 –307 ‘news’ model, exchange rate volatility and forecasting 308 –32 risk premium see separate entry scapegoating 487 twenty-first century crisis 35 uncovered interest rate parity 85 –92, 96, 397, 411, 545 domestic strategy 85 –7 equilibrium 88 –92 foreign strategy 87– 8 uncovered interest rate parity condition 91 undershooting 214 unemployment 397, 399, 401–2, 403, 430, 432, 435, 443, 446 unit of account 426 –7 univariate time series 318, 320, 321 utility maximisation 137, 251, 255 – 6, 259, 339, 546 variance 334, 424 variance bound tests 324 – 6, 327 vector autoregression 318 –19, 321 volatility 2, 16 –18, 29 –30, 70, 217, 269, 270, 273, 536 carry trade 348 chaos 528, 531 ‘news’ model, forecasting and exchange rate 308 –32 over day: Financial Times scapegoat model 487, 489 share price 325 – 6 target zones 373 –5, 376 tests, bubbles and the peso problem 323 – 8 war(s) currency 412–13 trade 439 weakly efficient market 293 weakly rational expectations 291 wealth effect in goods market 211–12 increase in stock of foreign currency assets 227–9 Wholesale Price Index 60 Wiener process 385 World Trade Organization 439 ‘wrong’ expectations 400 xenophobia 396 zero-mean shocks 76, 361 573 Z03_COPE6047_06_SE_EM03.indd 573 3/7/14 4:03 PM www.downloadslide.net Z03_COPE6047_06_SE_EM03.indd 574 3/7/14 4:03 PM ... Data Copeland, Laurence S Exchange rates and international finance/ Laurence S Copeland – 6th Edition pages cm ISBN 978-0-273-78604-7 1. Foreign exchange rates. 2. International finance. .. .Exchange Rates and International Finance A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM A01_COPE6047_06_SE_FM.indd 3/7/14 4:48 PM Sixth Edition Exchange Rates and International Finance Laurence... demand and the smaller the supply Conversely, when the dollar is expensive, there will be a smaller demand and greater supply At some exchange rate – $1 = £0.50 in the diagram – the demand and