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Handbook of Exchange Rates

Book Description

Praise for Handbook of Exchange Rates

"This book is remarkable. I expect it to become the anchor reference for people working in the foreign exchange field."

—Richard K. Lyons, Dean and Professor of Finance, Haas School of Business, University of California Berkeley

"It is quite easily the most wide ranging treaty of expertise on the forex market I have ever come across. I will be keeping a copy close to my fingertips."

—Jim O'Neill, Chairman, Goldman Sachs Asset Management

How should we evaluate the forecasting power of models? What are appropriate loss functions for major market participants? Is the exchange rate the only means of adjustment? Handbook of Exchange Rates answers these questions and many more, equipping readers with the relevant concepts and policies for working in today's international economic climate.

Featuring contributions written by leading specialists from the global financial arena, this handbook provides a collection of original ideas on foreign exchange (FX) rates in four succinct sections:

  • Overview introduces the history of the FX market and exchange rate regimes, discussing key instruments in the trading environment as well as macro and micro approaches to FX determination.

  • Exchange Rate Models and Methods focuses on forecasting exchange rates, featuring methodological contributions on the statistical methods for evaluating forecast performance, parity relationships, fair value models, and flow-based models.

  • FX Markets and Products outlines active currency management, currency hedging, hedge accounting; high frequency and algorithmic trading in FX; and FX strategy-based products.

  • FX Markets and Policy explores the current policies in place in global markets and presents a framework for analyzing financial crises.

Throughout the book, topics are explored in-depth alongside their founding principles. Each chapter uses real-world examples from the financial industry and concludes with a summary that outlines key points and concepts.

Handbook of Exchange Rates is an essential reference for fund managers and investors as well as practitioners and researchers working in finance, banking, business, and econometrics. The book also serves as a valuable supplement for courses on economics, business, and international finance at the upper-undergraduate and graduate levels.

Table of Contents

  1. Cover
  2. Series Page
  3. Title Page
  4. Copyright
  5. Dedication Page
  6. Preface
  7. Contributors
  8. Part I: Overview
    1. Chapter 1: Foreign Exchange Market Structure, Players, and Evolution
      1. 1.1 Introduction
      2. 1.2 Geography and Composition of Currency Trading
      3. 1.3 Players and Information in FX Market
      4. 1.4 Electronic Trading Revolution in FX Market
      5. 1.5 Survey of Multibank FX Platforms
      6. 1.6 Summary
      7. 1.7 Glossary
      8. 1.8 Acknowledgments
      9. References
    2. Chapter 2: Macro Approaches to Foreign Exchange Determination
      1. 2.1 Introduction
      2. 2.2 Models of the Nominal Exchange Rate
      3. 2.3 Real Models of the Real Exchange Rate
      4. 2.4 New Directions in Exchange-Rate Modeling
      5. 2.5 Conclusions
      6. 2.6 Acknowledgments
      7. References
    3. Chapter 3: Micro Approaches to Foreign Exchange Determination
      1. 3.1 Introduction
      2. 3.2 Perspectives on Spot-Rate Dynamics
      3. 3.3 Currency Trading Models and their Implications
      4. 3.4 Exchange Rates, Order Flows, and the Macro Economy
      5. 3.5 Conclusion
      6. 3.6 Appendix
      7. 3.7 Acknowledgment
      8. References
    4. Chapter 4: The Exchange Rate in a Behavioral Finance Framework
      1. 4.1 Introduction
      2. 4.2 Exchange Rate Puzzles
      3. 4.3 A Prototype Behavioral Model of the Foreign Exchange Market
      4. 4.4 Conclusion
      5. References
    5. Chapter 5: The Evolution of Exchange Rate Regimes and Some Future Perspectives
      1. 5.1 Introduction
      2. 5.2 A Brief History of Currency Regimes
      3. 5.3 Performance of the Laisser-Faire Exchange Rate System, 1973–2010
      4. 5.4 Trends in Currency Use
      5. 5.5 Prospects for the Future
      6. 5.6 Concluding Comments
      7. 5.7 Appendix A: A Formal Test of Hollowing Out
      8. References
  9. Part II: Exchange Rate Models and Methods
    1. Chapter 6: Purchasing Power Parity in Economic History
      1. 6.1 Introduction
      2. 6.2 Categorization of Purchasing-Power-Parity Theories
      3. 6.3 Historical Application of PPP: Premodern Periods
      4. 6.4 Techniques of Testing PPP Theory in Economic-History Literature
      5. 6.5 Price Variable in PPP Computations
      6. 6.6 Modern Period: Testing of PPP
      7. 6.7 Analysis of U.S. Return to Gold Standard in 1879
      8. 6.8 Establishment and Assessment of a Fixed Exchange Rate in Interwar Period
      9. 6.9 Conclusions
      10. References
    2. Chapter 7: Purchasing Power Parity in Tradable Goods
      1. 7.1 Introduction
      2. 7.2 The LOP and Price Indices
      3. 7.3 Empirical Evidence on the LOP
      4. 7.4 Purchasing Power Parity
      5. 7.5 Aggregating from the LOP to PPP: What Can We Infer?
      6. 7.6 Conclusion and Implications
      7. 7.7 Appendix: TAR modeling
      8. 7.8 Acknowledgments
      9. References
    3. Chapter 8: Statistical and Economic Methods for Evaluating Exchange Rate Predictability
      1. 8.1 Introduction
      2. 8.2 Models for Exchange Rate Predictability
      3. 8.3 Statistical Evaluation of Exchange Rate Predictability
      4. 8.4 Economic Evaluation of Exchange Rate Predictability
      5. 8.5 Combined Forecasts
      6. 8.6 Empirical Results
      7. 8.7 Conclusion
      8. 8.8 Appendix A: The Bootstrap Algorithm
      9. 8.9 Acknowledgments
      10. References
    4. Chapter 9: When Are Pooled Panel-Data Regression Forecasts of Exchange Rates More Accurate than the Time-Series Regression Forecasts?
      1. 9.1 Introduction
      2. 9.2 Panel Data Exchange Rate Determination Studies
      3. 9.3 Asymptotic Consequences of Pooling
      4. 9.4 Monte Carlo Study
      5. 9.5 An Illustration with Data
      6. 9.6 Conclusions
      7. References
    5. Chapter 10: Carry Trades and Risk
      1. 10.1 Introduction
      2. 10.2 The Carry Trade: Basic Facts
      3. 10.3 Pricing the Returns to the Carry Trade
      4. 10.4 Empirical Findings
      5. 10.5 Time-Varying Risk and Rare Events
      6. 10.6 Conclusion
      7. 10.7 Acknowledgments
      8. References
    6. Chapter 11: Currency Fair Value Models
      1. 11.1 Introduction
      2. 11.2 Models/Taxonomy
      3. 11.3 Implementation Choices and Model Characteristics
      4. 11.4 Conclusion
      5. 11.5 Acknowledgments
      6. References
    7. Chapter 12: Technical Analysis in the Foreign Exchange Market
      1. 12.1 Introduction
      2. 12.2 The Practice of Technical Analysis
      3. 12.3 Studies of Technical Analysis in the Foreign Exchange Market
      4. 12.4 Explaining The Success of Technical Analysis
      5. 12.5 The Future of Research on Technical Analysis
      6. 12.6 Conclusion
      7. 12.7 Acknowledgments
      8. References
    8. Chapter 13: Modeling Exchange Rates with Incomplete Information
      1. 13.1 Introduction
      2. 13.2 Basic Monetary Model
      3. 13.3 Information Heterogeneity
      4. 13.4 Model Uncertainty
      5. 13.5 Infrequent Decision Making
      6. 13.6 Conclusion
      7. 13.7 Acknowledgments
      8. References
    9. Chapter 14: Exchange Rates in a Stochastic Discount Factor Framework
      1. 14.1 Introduction
      2. 14.2 Exchange Rates and Stochastic Discount Factors
      3. 14.3 Empirical Evidence
      4. 14.4 Models
      5. 14.5 Conclusion
      6. References
    10. Chapter 15: Volatility and Correlation Timing in Active Currency Management
      1. 15.1 Introduction
      2. 15.2 Dynamic Models for Volatility and Correlation
      3. 15.3 The Economic Value of Volatility and Correlation Timing
      4. 15.4 Parameter Uncertainty in Bayesian Asset Allocation
      5. 15.5 Model Uncertainty
      6. 15.6 Empirical Results
      7. 15.7 Conclusion
      8. 15.8 Appendix A: Univariate Models for Volatility Timing
      9. 15.9 Appendix B: Parameter Uncertainty and the Predictive Density
      10. 15.10 Acknowledgments
      11. References
  10. Part III: FX Markets and Products
    1. Chapter 16: Active Currency Management Part I: Is There a Premium for Currency Investing (Beta)
      1. 16.1 Introduction
      2. 16.2 Beta in the Foreign Exchange Markets
      3. 16.3 Multiple Forms of FX Beta
      4. 16.4 Carry FX Indices from Banks
      5. 16.5 Trend-Following FX Indices from Banks
      6. 16.6 Conclusion
      7. References
    2. Chapter 17: Active Currency Management Part II: Is There Skill or Alpha in Currency Investing?
      1. 17.1 Introduction
      2. 17.2 Alternative Currency Management Mandates
      3. 17.3 Benchmarks for Currency Fund Management
      4. 17.4 Empirical Evidence with the Barclay Currency Traders Index and Individual Fund Managers
      5. 17.5 Empirical Evidence: Fund Managers on the DB FX Select Platform
      6. 17.6 Conclusions and Investment Implications
      7. References
    3. Chapter 18: Currency Hedging for International Bond and Equity Investors
      1. 18.1 Introduction
      2. 18.2 Overview of Empirical Hedging Studies
      3. 18.3 Return and Volatility Impact of Currency Hedging
      4. 18.4 Hedge Instruments—Currency Forwards versus Options
      5. 18.5 Managing Tracking Error in Forward Hedges
      6. 18.6 Conclusions
      7. References
    4. Chapter 19: FX Reserve Management
      1. 19.1 FX Reserve Management
      2. 19.2 FX Reserve Uses
      3. 19.3 FX Reserve Sources
      4. 19.4 Objectives of Reserves Management
      5. 19.5 Techniques of Reserve Management
      6. 19.6 Historical Perspective
      7. 19.7 What Assets Do Central Banks Hold?
      8. 19.8 Constraints
      9. 19.9 External Managers
      10. 19.10 Costs of Accumulation and Holding of Reserves
      11. 19.11 Diversification
      12. 19.12 Challenges to Diversification and Size of Reserves
      13. 19.13 Changing Role of the Dollar as the International Reserve Currency
      14. 19.14 Reserve Management if the Dollar is Replaced as the Reserve Currency
      15. 19.15 Conclusion
      16. 19.16 Acknowledgments
      17. References
    5. Chapter 20: High Frequency Finance: Using Scaling Laws to Build Trading Models
      1. 20.1 Introduction
      2. 20.2 The Intrinsic Time Framework
      3. 20.3 Scaling Laws
      4. 20.4 The Scale of Market Quakes
      5. 20.5 Trading Models
      6. 20.6 Conclusion
      7. 20.7 Acknowledgments
      8. References
    6. Chapter 21: Algorithmic Execution in Foreign Exchange
      1. 21.1 Introduction
      2. 21.2 Key Components of an Algorithmic Execution Framework
      3. 21.3 Types of Algorithms
      4. 21.4 What Execution Strategies are Most Effective?
      5. 21.5 Looking Forward
      6. 21.6 Appendix A
      7. References
    7. Chapter 22: Foreign Exchange Strategy Based Products
      1. 22.1 Introduction
      2. 22.2 Evolution of the Foreign Exchange Market
      3. 22.3 Foreign Exchange Investable Indices and Strategy-Based Products
      4. 22.4 Conclusion
      5. References
    8. Chapter 23: Foreign Exchange Futures, Forwards, and Swaps
      1. 23.1 Introduction
      2. 23.2 Market Basics and Size
      3. 23.3 Dislocations of the FX and Cross-Currency Swap Markets under Financial Crises
      4. 23.4 Conclusion
      5. 23.5 Acknowledgments
      6. References
    9. Chapter 24: FX Options and Volatility Derivatives: An Overview from the Buy-Side Perspective
      1. 24.1 Introduction
      2. 24.2 Why Would One Bother With an Option?
      3. 24.3 Market for FX Options
      4. 24.4 Volatility
      5. 24.5 FX Options from the Buy-Side Perspective
      6. 24.6 Acknowledgment
      7. References
  11. Part IV: FX Markets and Policy
    1. Chapter 25: A Common Framework for Thinking about Currency Crises
      1. 25.1 Introduction
      2. 25.2 The KFG Model
      3. 25.3 Extensions
      4. 25.4 Empirical Work
      5. 25.5 Conclusion
      6. References
    2. Chapter 26: Official Intervention in the Foreign Exchange Market
      1. 26.1 Introduction
      2. 26.2 Official FX Interventions and Reserve Accumulation: Stylized Facts, Motives, and Effects
      3. 26.3 Empirical Evidence on the Effectiveness of Official FX Interventions
      4. 26.4 Conclusions
      5. 26.5 Acknowledgements
      6. References
    3. Chapter 27: Exchange Rate Misalignment—The Case of the Chinese Renminbi
      1. 27.1 Introduction
      2. 27.2 Background
      3. 27.3 Undervalued or Overvalued
      4. 27.4 Concluding Remarks
      5. 27.5 Acknowledgments
      6. References
    4. Chapter 28: Choosing an Exchange Rate Regime
      1. 28.1 Five Advantages of Fixed Exchange Rates
      2. 28.2 Econometric Evidence on the Bilateral Trade Effects of Currency Regimes
      3. 28.3 Five Advantages of Floating Exchange Rates
      4. 28.4 How to Weigh Up the Advantages of Fixing Versus Floating
      5. 28.5 Country Characteristics That Should Help Determine the Choice of Regime
      6. 28.6 Alternative Nominal Anchors
      7. References
  12. Index
  13. Wiley Series