Research Article


DOI :10.26650/ISTJECON2019-0004   IUP :10.26650/ISTJECON2019-0004    Full Text (PDF)

Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach

Süleyman Hilmi Kalİlhami Gündüz

This paper studies whether dynamic relationship between exchange rate and economic and financial fundamentals vary depending on exchange rate is overvalued and undervalued with respect to its fundamental value. To achieve this, we implement two-state Markov Switching Vector Auto Regression (MSVAR) model with time varying transition probabilities to investigate whether the relationship among exchange rate, interest rate and inflation dynamics depend on overvaluation and undervaluation of exchange rates for the pre-crises period between years 1972-2009. We govern the transition between the undervalued and overvalued states by using Sharpe Ratios of debt and equity investments of the currency to assess whether risk adjusted returns induce overvaluation or undervaluation of the currencies. We employ this model to the bilateral exchange rate, which is defined between US Dollar and four highly traded currencies (AUD, CAD, JPY, and UKS). We provide evidence that the relationship among these variables varies in terms of on magnitude, direction and statistical significance in between the overvalued and undervalued regimes. Furthermore, we show that risk adjusted excess debt and equity returns influence the overvaluation and the undervaluation of the currencies.

JEL Classification : D51 , F31 , O16
DOI :10.26650/ISTJECON2019-0004   IUP :10.26650/ISTJECON2019-0004    Full Text (PDF)

Küresel Sermaye Akımları, Zamana Göre Değişen Temeller ve Geçişken Kur Dinamikleri: Bir MS-VAR Yaklaşımı

Süleyman Hilmi Kalİlhami Gündüz

Bu çalışma döviz kurları ile ekonomik ve finansal değişkenler arasındaki dinamik ilişkinin kurun temel değerine göre daha değerli ve az değerli olmasına bağlı olarak nasıl değiştiğini araştırmaktadır. Bu maksatla, kriz öncesi 1972-2009 yılları arasında, döviz kuru, faiz oranı ve enflasyon dinamikleri arasındaki ilişkinin kurun daha değerli ve az değerli olmasına bağlı olup olmadığını incelemek için zamanla değişen geçiş olasılıklarını kullanan MSVAR yöntemi uygulanmıştır. Riske uyarlanmış getirinin, para birimlerinin daha değerli veya az değerli olmasına neden olup olmadığını belirlemek için, borç ve öz kaynak yatırımlarının Sharpe oranları kullanılarak daha değerli ve az değerli durumlar arasındaki geçişler sağlanmıştır. Bu model en fazla işlem hacmine sahip olan, Amerikan Doları ve 4 para birimi (AUD, CAD, JPY ve UKS) arasındaki ikili döviz kurları için uygulanmıştır. Bu değişkenler arasındaki ilişkinin daha değerli ve az değerli rejimler arasında yön, büyüklük ve istatiksel anlamlılık açısından değiştiği belgelenmiştir. Ayrıca, riske uyarlanmış hisse senedi ve borç senedi getirilerinin kurların daha değerli olmasını ve az değerli olmasını etkilediği gösterilmiştir.

JEL Classification : D51 , F31 , O16

PDF View

References

  • Abiad, A. G. (2002). Early Warning Systems for Currency Crises: A Markov Switching Approach with Applications to Southeast Asia. (Doctoral dissertation, University of Pennsylvania, Philadelphia). Retrieved from: https://www.researchgate.net/publication/268200580_Early_Warning_Systems_ For_Currency_Crises_A_Markov-Switching_Approach_with_Application_to_Southeast_Asia. google scholar
  • Bekaert, G., & Hodrick, R. J. (2001). Expectations Hypotheses Tests. The Journal of Finance, 56, 1357–1394. google scholar
  • Bekaert, G., Min, W., & Yuhang, X. (2002). Uncovered Interest Rate Parity and the Term Structure, NBER Working Paper No. 8795 (Cambridge, Massachusetts: National Bureau of Economic Research) google scholar
  • Bjorland, H. C., & Hungness, H. (2002). Fundamental determinants of the long-run real exchange rate: the case of norway, memorandum, Department of Economics, Oslo, Universty of Oslo, 1–36. google scholar
  • Boschen, J. F., & Smith, K. J. (2012). The Uncovered Interest Rate Parity Anomaly and Foreign Exchange Market Turnover. International Business and Economics Research Journal, 11, 299–306. google scholar
  • Chinn, M. D., & Meredith, G. (2001). Testing Uncovered Interest Parity at Short and Long Horizons During the Post-Bretton Woods Era. NBER Working Paper Series, 11077. google scholar
  • Chinn, M. D., & Alquist, R. (2006). Conventional and Unconventional Approaches to Exchange Rate Modeling and Assessment. NBER Working Paper Series, 12481. google scholar
  • Clarida, R. H., Sarno, L., Taylor, M. P., & Valente, G. (2001). The Out-of Sample Success of Term Structure Models as Exchange Rate Predictors: A Step Beyond. Journal of International Economics, 60(1), 61–83. google scholar
  • De Grauwe, P., & Vansteenkiste, I. (2001). Exchange Rates and Fundamentals a Non-Linear Relationship?. CES ifo Working Paper Series, 577. google scholar
  • Diebold, F. X., Lee, J.-H., & Weinbach, G. C. (1994). Regime Switching with Time-Varying Transition Probabilities. In C. Hargreaves (ed.), Nonstationary Time Series Analysis and Cointegration, (pp. 283-302). Oxford, UK: Oxford University Press. google scholar
  • Engel, C. (1994). Can the Markov Switching Model Forecast Exchange Rates?. Journal of International Economics, 36, 151–165. google scholar
  • Fama, E. F. (1984). Forward and Spot Exchange Rates. Journal of Monetary Economics, 14, 314–338. google scholar
  • Fisher, I. (1930). The Theory of Interest, New York: Macmillan Company. Froot, K. A. (1990). On the Efficiency of Foreign Exchange Markets. (Unpublished Mimeograph), November 16. google scholar
  • Froot, K. A., & Rogoff, K. (1995). Perspectives on PPP and Long-Run Real Exchange Rates. Handbook of International Economics, 3, 679–747. google scholar
  • Froot, K. A., & Thaler, R. H. (1990). Foreign exchange. Journal of Economic Perspectives, 4(3), 179– 192. Retrieved from: https://sites.hks.harvard.edu/fs/jfrankel/ITF-220/readings/Froot&Thaler_ Anomalies.pdf. google scholar
  • Frommel, M., MacDonald, R., & Menkhoff, L. (2005). Markov Switching Regimes in a Monetary Exchange Rate Model. Economic Modelling, 22(3), 485–502. Retrieved from: https://www. sciencedirect.com/science/article/pii/S0264999304000537. google scholar
  • Goldfeld, S. M., & Quandt, R. E. (1973). A Markov Model for Switching Regressions. Journal of Econometrics, 1(1), 3–15. Retrieved from: https://www.sciencedirect.com/science/article/ pii/030440767390002X. google scholar
  • Hamilton, J. D. (1989). A new approach to the economic analysis of nonstationary time series and the business cycle. Econometrica: Journal of the Econometric Society, 357–384. google scholar
  • Hamilton, J. D. (1990). Analysis of Time Series Subject to Changes in Regime. Journal of Econometrics, 45, 39–70. google scholar
  • Hamilton, J. D. (1994). Time Series Analysis. New Jersey: Princeton University Press. google scholar
  • Johansen, S. J., & Juselius, K. K. (1992). Testing structural hypothesis in a multivariate cointegration analysis of the PPP and the UIP for UK. Journal of Econometrics, 53(21), 1–244. google scholar
  • Juselius, K. (1991). ”Long-run relations in a well-defined statistical model for the data generating process. Cointegration analysis of the PPP and the UIP relations for Denmark and Germany” in Econometric Decision Models, Springer, Berlin-Heidelberg, pp. 336–357. google scholar
  • Juselius, K. (1995). Do purchasing power parity and uncovered interest rate parity hold in the long run? An example of likelihood inference in a multivariate time-series model. Journal of econometrics, 69(1), 211–240. google scholar
  • Juselius, K., & MacDonald, R. (2003). International Parity Relationships Between Germany and the United States: A Joint Modelling Approach. Finance Research Unit (FRU), No: 2004/08, Institute of Economics, University of Copenhagen, pp. 1–34. google scholar
  • Kanas, A. (2006). Purchasing Power Parity and Markov Regime Switching. Journal of Money Credit and Banking, 38, 1669–1687. google scholar
  • Kanas, A. (2005). Regime linkages in the US/UK real exchange rate-real interest differential relation. Journal of International Money and Finance, 24, 257–274. google scholar
  • Krolzig, H. M., & Autoregressions, M. S. V. (1997). Modelling, statistical inference and application to Business Cycle Analysis. Lecture Notes in Economics and Mathematical Systems, Springer, New York. google scholar
  • Lee, H. T., & Yoon, G. (2007). Does Purchasing Power Parity Hold Sometimes? Regime Switching in Real Exchange Rates. Economics Working Paper Christian-Albrechts –Universitat Kiel, Department of Economics. google scholar
  • Lothian, J. R., & Wu, L. (2005). Uncovered Interest-Rate Parity over the Past Two Centuries. Journal of International Money and Finance, 30, 448–473. google scholar
  • MacDonald, R., & Marsh, I. W. (1997). On fundamentals and exchange rates: a Casselian perspective. Review of Economics and Statistics, 79(4), 655–664. google scholar
  • MacDonald, R., & Marsh, J. (1999). Employment, unemployment and social polarization: young people and cyclical transitions. The Sociological Review, 47(2_suppl), 120–140. google scholar
  • Marsh, I. W. (2000). High-frequency Markov Switching Models in Foreign Exchange Market. Journal of Forecasting, 19, 123–134. google scholar
  • Martinez, P., & Maria, S. (2002). A Regime-Switching Approach to Studying Speculative Attacks: A Focus on European Monetary System Crises. Empirical Economics, 27, 299–334. google scholar
  • MayHodrick, R. J. (1987). The Empirical Evidence on the Efficiency of Forward and Futures Foreign Exchange Markets. Chur, Switzerland: Harwood Academic Publishers. google scholar
  • Meese, R. A., & Rogoff, K. (1983). Empirical Exchange Rate Models of the Seventies: Do They Fit Out of Sample? Journal of International Economics, 14, 3–24. google scholar
  • Omer, M., De Haan, J., & Scholtens, B. (2012). Testing Uncovered Interest Rate Parity Using LIBOR. CESifo Working Papers, 3839. google scholar
  • Olivier, J., & Masson, P. (2000). Currency crises, sunspots and Markov-switching regimes. Journal of International Economics, 50, 327–350. google scholar
  • Peria, M. S. M. (2002). A regime-switching approach to the study of speculative attacks: A focus on EMS crises. In Advances in Markov-Switching Models (pp. 159–194). Physica, Heidelberg. google scholar
  • Quandt, R. E. (1958). The Estimation of Parameters of Linear Regression System Obeying Two Separate Regimes. Journal of the American Statistical Association, 55, 873–880. google scholar
  • Sarno, L., & Taylor, M. P. (2002). Purchasing power parity and the real exchange rate. IMF Staff Papers, 49(1), 65–105. google scholar
  • Sercu, P., Uppal, R., & Van Hulle, C. (2012). The Exchange Rate in the Presence of Transaction Costs: Implications for Tests of Purchasing Power Parity. The Journal of Finance, 50, 1309–1319. google scholar
  • Sims, C. A. (1980). Macroeconomics and reality. Econometrica: Journal of the Econometric Society, 1–48. google scholar
  • Taylor, M. P. (1995). The Economics of Exchange Rates. Journal of Economic Literature, 33, 13–47. google scholar
  • Taylor, A. M. (2002). A century of purchasing-power parity. Review of Economics and Statistics, 84(1), 139–150. google scholar
  • Tsangyao, C., & Chi-Wei, S. (2013). Revisiting purchasing power parity for East Asian countries using the rank test for nonlinear cointegration, Applied Economics, 45(19), 2847–2852, DOI: 10.1080/00036846.2012.657354. google scholar
  • Van Norden, S. (1996). Regime Switching as a Test for Exchange Rate Bubbles. Journal of Applied Econometrics, 11, 219–51. google scholar

Citations

Copy and paste a formatted citation or use one of the options to export in your chosen format


EXPORT



APA

Kal, S.H., & Gündüz, İ. (2019). Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach. Istanbul Journal of Economics, 69(1), 1-22. https://doi.org/10.26650/ISTJECON2019-0004


AMA

Kal S H, Gündüz İ. Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach. Istanbul Journal of Economics. 2019;69(1):1-22. https://doi.org/10.26650/ISTJECON2019-0004


ABNT

Kal, S.H.; Gündüz, İ. Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach. Istanbul Journal of Economics, [Publisher Location], v. 69, n. 1, p. 1-22, 2019.


Chicago: Author-Date Style

Kal, Süleyman Hilmi, and İlhami Gündüz. 2019. “Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach.” Istanbul Journal of Economics 69, no. 1: 1-22. https://doi.org/10.26650/ISTJECON2019-0004


Chicago: Humanities Style

Kal, Süleyman Hilmi, and İlhami Gündüz. Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach.” Istanbul Journal of Economics 69, no. 1 (Feb. 2023): 1-22. https://doi.org/10.26650/ISTJECON2019-0004


Harvard: Australian Style

Kal, SH & Gündüz, İ 2019, 'Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach', Istanbul Journal of Economics, vol. 69, no. 1, pp. 1-22, viewed 4 Feb. 2023, https://doi.org/10.26650/ISTJECON2019-0004


Harvard: Author-Date Style

Kal, S.H. and Gündüz, İ. (2019) ‘Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach’, Istanbul Journal of Economics, 69(1), pp. 1-22. https://doi.org/10.26650/ISTJECON2019-0004 (4 Feb. 2023).


MLA

Kal, Süleyman Hilmi, and İlhami Gündüz. Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach.” Istanbul Journal of Economics, vol. 69, no. 1, 2019, pp. 1-22. [Database Container], https://doi.org/10.26650/ISTJECON2019-0004


Vancouver

Kal SH, Gündüz İ. Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach. Istanbul Journal of Economics [Internet]. 4 Feb. 2023 [cited 4 Feb. 2023];69(1):1-22. Available from: https://doi.org/10.26650/ISTJECON2019-0004 doi: 10.26650/ISTJECON2019-0004


ISNAD

Kal, SüleymanHilmi - Gündüz, İlhami. Global Capital Flows, Time Varying Fundamentals and Transitional Exchange Rate Dynamics: An MS-VAR Approach”. Istanbul Journal of Economics 69/1 (Feb. 2023): 1-22. https://doi.org/10.26650/ISTJECON2019-0004



TIMELINE


Submitted13.03.2019
Accepted17.06.2019
Published Online28.06.2019

LICENCE


Attribution-NonCommercial (CC BY-NC)

This license lets others remix, tweak, and build upon your work non-commercially, and although their new works must also acknowledge you and be non-commercial, they don’t have to license their derivative works on the same terms.


SHARE




Istanbul University Press aims to contribute to the dissemination of ever growing scientific knowledge through publication of high quality scientific journals and books in accordance with the international publishing standards and ethics. Istanbul University Press follows an open access, non-commercial, scholarly publishing.