Fundamentals and Exchange Rates: Evidence from ASEAN-5

Rashid, Abdul and Ling, Jeffrey (2009): Fundamentals and Exchange Rates: Evidence from ASEAN-5.

Abstract

Utilizing the combined-form of PPP and UIP we estimate the cointegrating relations for ASEAN-5 economies. The study uses quarterly data over the period from 1980 to 2008. The findings reveal that exchange rate, interest rates and prices are cointegrated, implying that there is co-movement among them in the long run. We also find that the hypothesis – PPP augmented by interest rates forms a cointegrating vector – cannot be rejected. This piece of evidence is consistent with the capital enhanced equilibrium exchange rates (CHEERs) approach, which states that the deviations from PPP can be explained by the interest rates differentials. These evidences defiantly would provide the help in formulating exchange rate policies in ASEAN-5 countries.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange rate, PPP, UIP, ASEAN-5, Cointegration Analysis
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; F - International Economics > F3 - International Finance; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

References

Awad, M. A., and Goodwin, B. K., 1998. Dynamic Linkages among Real Interest Rates in International Capital Markets, Journal of International Money and Finance, Vol. 17 (6), 881-907.

Bjørnland, H. C. and Hungnes, H., 2005. The Importance of Interest rates for Forecasting the Exchange Rate, Journal of Forecasting.

Borensztein, E., J. Zettelmeyer, and T. Philippon., 2001. Monetary Independence in Emerging Markets: Does the Exchange Rate Regime Make a Difference? IMF Working Paper, WP/01/1.

Calvo, A. G. and C. M. Reinhart, 2000. Fear of Floating, Working Paper 7993, NBER Working Paper Series.

Choy, W., 2000. Were the East Asian Currencies Overvalued According to Purchasing Power Parity and Uncovered Interest Rate Parity?: A Co-integration Approach, mimeo, New Zealand Treasury.

Cumby, R., and Obstfeld, M., 1984. International Interest Rate and Price Level Linkages under Flexible Exchange Rates: A Review of Recent Evidence, In: Bilson, J., Marston, R.C. (Eds.), Exchange Rate Theory and Practice. University of Chicago Press, Chicago.

De Brouwer, G., 1999. Financial Integration in East Asia, Cambridge University Press. New York.

Edwards, S., 1998. Interest Rate Volatility, Contagion and Convergence: An Empirical Investigation of the Cases of Argentina, Chile and Mexico, Journal of Applied Economics, Vol. I (1), 55-86.

Fischer, S., 2001. The International Financial System: Crises and Reform, The Robbins Lectures, London, U.K.: London School of Economics.

Frankel, J. A., and Okongwu, C., 1995. Liberalized Portfolio Capital Inflows in Emerging Markets: Sterilization, Expectations, and the Incompleteness of Interest Rate Convergence, NBER Working Paper No. 5156.

Frankel, J. A., S. L. Schmukler, and Luis S., 2002. Global Transformation of Interest Rates: Monetary Independence and Currency Regime, NBER Working Paper N0. 8828.

Fujii, E., Chinn, M.D., 2000. Fin de Sie´cle Real Interest Parity, NBER Working Paper No. 7880.

Goldstein, M., (1999), ‘Safeguarding in a Global Financial System: The Future International Financial Architecture Report of An Independence Task Force’ Washington, DC: Institute for International Economics for the Council on Foreign Relations.

Goldberg, L., G., Lothian, J. R., and Okunev, J., 2003. Has International Financial Integration Increased? Open Economies Review, Vol. 14 (3), 299-317.

Habib, M. M., 2002. Financial Contagion, Interest Rates and the Role of the Exchange Rate as Shock Absorber in Central and Eastern Europe, BOFIT Discussion Papers, No. 7.

Johansen, S. and Juselius, K., 1992. Testing Structural Hypothesis in a Multivariate Cointegration Analysis of the PPP and the UIP for UK, Journal of Econometrics, Vol. 53, 211-244.

Jose R. and Prazmowski, Peter A. (2004), “PPP, Random Walks, and UIP after Interest Rate Liberalisation in a Small Developing Economy,” Economics Bulletin, Vol. 6, 1-7.

McKinnon, R. I., 2000. The East Asian Dollar Standard: Life after Death? Economic Notes, Vol. 29, 31-82.

Mishkin, F. S., 1984. Are Real Interest Rates Equal Across Countries? An Empirical Investigation of International Parity Conditions, Journal of Finance, Vol. 39 (5), 1345-1357.

Obstfeld, M., J. C. Shambaugh, and A. M. Taylor., 2004. The Trilemma in History: Tradeoffs among Exchange Rates, Monetary Policies, and Capital Mobility, NBER Working Paper No. 10396.

Rogoff, K., 2004. Extending the Limits of Global Financial Integration, Journal of Policy Modeling, Vol. 26, 519-523.

Shambaugh, J. C., 2004. The Effects of Fixed Exchange Rates on Monetary Policy, Quarterly Journal of Economics, Vol. 119, 301-52.

Stephen, D., 2004. The Equilibrium Exchange Rate According to PPP and UIP, Discussion Paper Series, Reserve Bank of New Zealand.

Svensson, L.E.O., 1992. The Foreign Exchange Rate Risk Premium in a Target Zone with Devaluation Risk, Journal of International Economics, Vol. 33, 21-40.