IFchapter 8B Forex II国际金融论第八章第二节.docx

1、IF chapter 8B Forex II国际金融论第八章第二节IF 2008 Chapter 8B How is the Exchange Rates Determined?I. International Parity Theory The Law of One Price for One Good Interest Rate Parity Theory Purchasing Power Parity Theory Fisher Effect Expectation Theory International Fisher EffectII. Macroeconomic Approache

2、s Balance of Payment Approach (Keynesian Model)1. the Elasticity Approach Model 2. Mundell-Flemming Model Capital Market Approach3. the Flexible Price Model4. Overshooting Theory (Dornbusch Theory; the Sticky Price Model)5. Portfolio Balance Theory Other Approaches6. la Theorie Psycologique du Chang

3、e7. News Model I. International Parity Theory The Law of One Price for One Good This law states that identical goods must have identical prices8. This law stipulates that two markets are integrated when identical goods or assets are priced identically across borders This theory implies competitive m

4、arket: No barriers to trade No transaction cost Perfect information Example: an ounce of gold should have the same price (expressed inU.S. dollars) in London as it does in Zurich otherwise gold would flow from one city to the other (the role of arbitragers) Purchasing Power Parity Theory Spot exchan

5、ge rates between currencies will change to the differential in inflation rates between countries. ABSOLUTE PURCHASING POWER PARITY9. Price levels adjusted for exchange rates should be equal between countries10. One unit of currency has same purchasing power globally.11. RELATIVE PURCHASING POWER PAR

6、ITY12. the exchange rate of one currency against another will adjust to reflect changes in the price levels of the two countries.13. In mathematical terms: et = future spot rate e0 = spot rate ih = home inflation if = foreign inflation t = the time period14. If purchasing power parity is expected to

7、 hold, then the best prediction for the one-period spot rate should be15. A more simplified but less precise relationship is 16. the percentage change should be approximately equal to the inflation rate differential. PPP says that 17. The currency with the higher inflation rate is expected to deprec

8、iate relative to the currency with the lower rate of inflation. Big Mac Index (BMI) BMI is based on the theory of purchasing-power parity The notion: a dollar should buy the same amount in all countries. In the long run, the exchange rate between two countries should move toward the rate that equali

9、zes the prices of an identical basket of goods and services in each country The basket is a McDonalds Big Mac, which is produced in about 120 countries The Big Mac PPP is the exchange rate that would mean hamburgers cost the same in the United States as abroad. Comparing actual exchange rates with P

10、PPs indicates whether a currency is under- or overvalued. Example: New York: $3.10 Beijing: 15.5 RMB ( = $2.15) Big Mac PPP = $2.15/$3.10 *100 = 69.3% 30.7% under-valued The Economists Big Mac Price Index (2006) US $3.10 UK 1.94 $3.82 Japan 250 $2.11 Swiss Sfr6.30 $5.18 Euro Area 2.94 $3.88 China 10

11、.5 RMB $1.34 Interest Rate Parity Theory The Theory states: 18. the forward rate (F) differs from the spot rate (S) at equilibrium by an amount equal to the interest differential (rh - rf) between two countries. The forward premium or discount equals the interest rate differential. (F - S)/S = (rh -

12、 rf) rh = the home rate rf = the foreign rate In equilibrium, returns on currencies will be the same - No profit will be realized and interest parity exists which can be written Interest Rate Parity states: 1. Higher interest rates on a currency offset by forward discounts. 2. Lower interest rates a

13、re offset by forward premiums. Fisher Effect Fisher Effect states: 19. Nominal interest rates (r) are a function of the real interest rate (a) and a premium (i) for inflation expectations. R = a + i Real Rates of Interest 1. Should tend toward equality everywhere through arbitrage. 2. With no govern

14、ment interference nominal rates vary by inflation differential rh - rf = ih - if According to the Fisher Effect,20. countries with higher inflation rates have higher interest rates Due to capital market integration globally, interest rate differentials are eroding. Expectation Theory (THE UNBIASED F

15、ORWARD RATE MODEL) Expectation Theory states If the forward rate is unbiased, then it should reflect the expected future spot rate. Stated as ft = et Theory Implication: Market-Based Forecast The current forward rate contains implicit information about exchange rate changes for one year. Interest ra

16、te differentials may be used to predict exchange rates beyond one year. International Fisher Effect (IFE) IFE STATES:21. the spot rate adjusts to the interest rate differential between two countries22. IFE = PPP + FE Simplified IFE equation: (if rf is relatively small) Fisher postulated1. The nomina

17、l interest rate differential should reflect the inflation rate differential2. Expected rates of return are equal in the absence of government intervention. Implications of IFE 1. Currency with the lower interest rate is expected to appreciate relative to the one with a higher rate. 2. Financial mark

18、et arbitrage insures interest rate differential is an unbiased predictor of change in future spot rate. INTERNATIONAL PARITY THEORY - SUMMARYInflation Rates Differential P - P Interest Rates Differential i ifFisher EffectPurchasing Power ParityInterest Rate Parity TheoryInternational Fisher EffectEx

19、pected Change ofSpot Rate (S - S)/SDifferential in Spot Rate & Forward Rate (F S)/SExpectationTheoryIII. Macroeconomic ApproachesA. Balance of Payment Account Balance of Payment (BOP) Account1. record all the economic transactions in a specific time interval between residents of a country and the re

20、st of the world. Two types of transactions:1. Current Account: Transactions that involves goods and services 2. Capital Account: Transactions that involves assets Payment to foreigners: debit (-) Receipt from foreigners: credit (+) Balance of Payment Approach (Keynesian Model)a) The Elasticity Appro

21、ach Model (Current Account centered) S = f (P/P*, Y-Y*, r-r*, Z) S : exchange rate P : domestic price level P* : foreign countrys price level Y : domestic real income Y* : foreign countrys real income r : domestic interest rate r* : foreign countrys interest rate z : other factors Foreign Currency S

22、upply DOWNDemand UPImport UPExport DOWNExchange Rate UPDomesticPrice UPThe Impact of Domestic Price Level Change The Impact of Domestic Income ChangeNational Income UP Import Demand UP Current Account ( - ) Exchange Rate UP The Impact of Interest Rate Change Interest Rate UP Foreign Currencies ( + )

23、 Exchange Rate DOWNb) Mundell-Fleming Model (Capital Account Considered) The Mundell-Fleming model focuses on the short to medium run The model lays out the policy options and the responses to inside and outside shocks for an open economy that interacts with other countries via trade in goods and se

24、rvices as well as cross-border capital flows. BP = CA + KA = ( X IM ) + k ( r r* ) = 0 k: capital flow sensitivity to interest rate differentials The differential of interest rates impacts the flow of the capital accountIV. Capital Market Approach1. the Flexible Price Model Focus on Money Supply and

25、 Demand among various financial assets Prices are sufficiently flexible market clears all the changes effectively Conditions for Balance Domestic Market: M/P = L ( Y, r ) Foreign Market: M*/P* = L* ( Y*, r*) M : money supply, L : money demand Then, S = P/P* = M/M* L*(Y*, r*)/L(Y, r) According to thi

26、s model Domestic money supply UP Exchange Rage UP Domestic income UP Money Demand UP Domestic Currency Value UP Exchange Rate DOWN ( the opposite result from Keynsian Model)b) Overshooting Theory (Dornbusch Theory; the Sticky Price Model) Dornbusch model is a an hybrid: short-run features as the Mun

27、dell-Fleming model long-run features as in the Monetary Model. Sticky price model: prices are fixed in the short run they adjust slowly towards the long run equilibrium Main features: dichotomy between speed of adjustment in goods - slow financial markets instantaneous Main result: overshooting Inst

28、ability of exchange rates can be the result of interaction of sluggishadjustment on goods markets/instantaneous adjustment on asset marketsP1P0S0 S1 S2ExchangeRatePriceS = P P* Initial balance (P0, S0) Money Supply UP long-term equilibrium moves along the S = P P* (45) Long-Term Equilibrium (P1, S1)

29、 Due to the stiky price of goods, price level maintains at P0 Then, the increase in money supply results in the lower interest rate in the short-term Exchange rate will be higher to S2 (overshooting) Short-term equilibrium (P0, S2) S2S1S0Exchange RateAs time passes by, the prices of goods rise, the equilibrium moves to long-term equilibrium (P1, S1)Timec) Portfolio Balance Theory This theory co