Cointegration and Causality among the Onshore and Offshore Markets for China's Currency

Owyong, David and Wong, Wing-Keung and Horowitz, Ira (2015): Cointegration and Causality among the Onshore and Offshore Markets for China's Currency. Published in: Journal of Asian Economics , Vol. 41, (2015): pp. 20-38.

Abstract

China has taken steps to develop offshore markets for renminbi trading and to liberalize exchange-rate determination in its onshore market. We examine the interaction between onshore and offshore markets with attention to how the interaction has been affected by widening of the onshore trading band first in April 2012 and further in March 2014. Ties between the onshore and offshore markets were closest before the first band widening and steadily loosened thereafter. We further study the cointegration and lead-lag effects between offshore and onshore spot and forward markets and show that there is a long-term equilibrium relationship between any pair of them. Our results suggest stronger causality running from the spot onshore rate to the spot offshore rate than vice versa. Between the spot and forward markets, there is evidence of bidirectional linear and nonlinear causality, which implies foreign impulses have had an influence on the domestic market.

• Item Type: MPRA Paper
• Language: English
• Keywords: RMB; onshore and offshore markets; spot and forward markets; liberalization; cointegration
• Subjects: F - International Economics > F3 - International Finance > F31 - Foreign Exchange; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates

References

Bai, Zhidong, Wing-Keung Wong & Bingzhi Zhang (2010). Multivariate Linear and Non-Linear Causality Tests, Mathematics and Computers in Simulation 81, 5–17.

Cadarajat, Yarat, & Lubis, Alexander (2012). Offshore and onshore IDR Market: evidence on information spillover. Bulletin of Monetary Economics and Banking, 14(4), 323-347.

Cai, Bill, Charlie Cai & Kevin Keasey (2007). Influence of cultural factors on price clustering and price resistance in China’s stock markets. Accounting and Finance, 47, 623–641.

Chiang, Thomas C., Zhuo Qiao, & Wing-Keung Wong (2010). New evidence on the relation between return volatility and trading volume. Journal of Forecasting, 29(5), 502–515.

Colavecchio, Roberts, & Funke, Michael (2008). Volatility transmissions between renminbi and Asia-Pacific on-shore and off-shore U.S. dollar futures. China Economic Review, 19(4), 635-648.

Colavecchio, Roberts, & Funke, Michael (2009). Volatility dependence across Asia-Pacific onshore and offshore currency forwards markets. Journal of Asian Economics, 20(2), 174–196.

Ding, David K., Tse, Yiuman, & Williams, Michael R. (2013). The price discovery puzzle in offshore yuan trading: Different contributions for different contracts. Journal of Futures Markets, 34(2), 103-123.

Engle, Robert F., & Granger, Clyve W. J. (1987). Cointegration and error correction: representation, estimation and testing. Econometrica, 55(2), 251-276.

Fung, Hung-Gay, Leung, Wai K., & Zhu, Jiang (2004). Nondeliverable forward market for Chinese RMB: A first look. China Economic Review, 15(3), 348−352.

Granger, Clive W.J., Huang, Bwo-Nung. & Yang, Chin-Wei (2000). A bivariate causality between stock prices and exchange rates: evidence from recent Asian flu. The Quarterly Review of Economics and Finance, 40(3), 337-354.

Gu, Li, & McNellis, Paul D. (2012). Yen/Dollar volatility and Chinese fear of floating: Pressures from the NDF market. Pacific-Basin Finance Journal, 22, 37-49.

Hiemstra, C. & Jones, J.D. (1994). Testing for linear and nonlinear Granger causality in the stock price–volume relation. Journal of Finance, 49, 1639–1664.

Jeon, Bang Nam, & Seo, Beongseon (2003). The impact of the Asian financial crisis on foreign exchange market efficiency: The case of East Asian countries. Pacific-Basin Finance Journal, 11(4), 509-525.

Johansen, Søren (1991). Estimation and hypothesis testing of cointegration vectors in Gaussian autoregressive models. Econometrica, 5(6), 1551-1580.

Liu, Li-Gang, & Pauwels, Laurent L. (2012). Do external political pressures affect the Renminbi exchange rate? Journal of International Money and Finance, 31(6), 1800-1818.

McCracken, Michael W. (2007). Asymptotics for out of sample tests of Granger causality. Journal of Econometrics, 140(2), 719–752.

Ouyang, Alice Y., Rajan, Rankishen S., & Willett, Thomas D. (2010). China as a reserve sink: The evidence from offset and sterilization coefficients. Journal of International Money and Finance 29(5), 951-972.

Park, Jinwoo (2001). Information flows between non-deliverable forward (NDF) and spot markets: Evidence from Korean currency. Pacific-Basin Finance Journal, 9(4), 363-377.

Park, Daekeum, & Rhee, Changyong (2001). Measuring the degree of currency misalignment using offshore forward exchange rates: The case of the Korean financial crisis. Journal of Asset Management, 2(1), 84-95.

Peng, Wensheng, Shu, Chang, & Yip, Raymond (2007). Renminbi derivatives: Recent development and issues. China and World Economy, 15(5), 1–17.

Perron, Pierre (1989). The great crash, the oil price shock, and the unit root hypothesis. Econometrica, 57(6), 1361-1401.

Qiao, Zhuo, McAleer, Michael, & Wong, Wing Keung (2009). Linear and nonlinear causality of consumption growth and consumer attitudes, Economics Letters, 102(3), 161-164.

Rashid, Abdul, (2007). Stock prices and trading volume: An assessment for linear and nonlinear Granger causality. Journal of Asian Economics, 18(4), 595-612.

Sargan, John D. (1964). Wages and prices in the United Kingdom: A study in Econometric methodology. In Peter E. Hart, Gordon Mills, & John K. Whittaker (eds) Econometric Analysis for National Economic Planning. London: Butterworths, 25-54.

Tian, Lei, & Chen, Langnan (2013). A reinvestigation of the new RMB exchange rate regime. China Economic Review, 24(1), 16-25.

Yang, Jian, & Leatham, David J. (2001). Currency convertibility and linkage between Chinese official and swap market exchange rates. Contemporary Economic Policy, 19(3), 347–35.