Abstract Most of literature and studies on prediction of exchange rate focus on main industrial countries with few discussions on the exchange rate of the developing countries. For model residual differences can be found in a linear model, so the linear model will adjust to find equilibrium at a fixed speed. However, it is difficult for the linear model to capture the character of dynamic adjustment behavior if a non-linear adjustment relationship exists (Sarno, 2002). Moreover, in case the trading costs exist in the foreign exchange market or the technical analysis is widely used among traders, then the deviations from equilibrium exchange rate may present a non-linear adjustment trend. In view of this, this study employed the STAR (smooth transition autoregression) model developed by Granger and Terasvirta (1993) to discuss the dynamic adjustment process of the deviations from UIP in the seven countries in Latin America. In most of the experimental studies conducted in the past, it was found difficult to establish the assumptions of uncovered interest parity (UIP). Therefore, this study is aimed to verify the experimental studies on UIP in the Latin America under the non-linear framework by means of non-linear model analysis.

Thesis advisor: Peter Ireland / Thesis advisor: Rosen Valchev / This dissertation consists in three chapters, each making a distinct contribution. Chapter 1 empirically tests classic and new Uncovered Interest Parity puzzle in an innovative way. Findings suggest that government debt is significant and economically relevant for UIP puzzles estimation.Chapter 2 shows that a class of macroeconomic models reproduce the UIP puzzle under a standard parametrization and adding convenience yields exogenous dynamics. Chapter 3 is a theoretical model that links financial crises to the election of populists parties, matching empirical evidence from Europe. / Thesis (PhD) — Boston College, 2021. / Submitted to: Boston College. Graduate School of Arts and Sciences. / Discipline: Economics.

<p>Essay 1 - To evaluate measures of expectations I examine and compare some of the most common methods for capturing expectations: the futures method which utilizes financial market prices, the VAR forecast method, and the survey method. I study average expectations on the Federal funds rate target, and the main findings can be summarized as follows: i) the survey measure and the futures measure are highly correlated; the correlation coefficient is 0.81 which indicates that the measures capture the same phenomenon, ii) the survey measure consistently overestimates the realized changes in the interest rate, iii) the VAR forecast method shows little resemblance with the other methods.</p><p>Essay 2 - This paper takes a critical look at available proxies of uncertainty. Two questions are addressed: (i) How do we evaluate these proxies given that subjective uncertainty is inherently unobservable? (ii) Is there such a thing as a general macroeconomic uncertainty? Using correlations, some narrative evidence and a factor analysis, we find that disagreement and stock market volatility proxies seem to be valid measures of uncertainty whereas probability forecast measures are not. This result is reinforced when we use our proxies in standard macroeconomic applications where uncertainty is supposed to be of importance. Uncertainty is positively correlated with the absolute value of the GDP-gap.</p><p>Essay 3 - The co-movements of exchange rates and interest rates as the economy responds to shocks is a potential source of deviations from uncovered interest rate parity. This paper investigates whether an open economy macro model with endogenous monetary policy is capable of explaining the exchange rate risk premium puzzle. When the central bank is engaged in interest rate smoothing, a negative relationship between exchange rate changes and interest differentials emerge for realistic parameter values without assuming an extremely large and variable risk premium as done in previous studies.</p><p>Essay 4 - This paper shows how market expectations as a function of the forecasting horizon can be constructed and used to analyse issues like how far in advance monetary policy actions are anticipated and how the market’s understanding of monetary policy has developed over time. On average about half of a monetary policy action is anticipated one month before a policy meeting. The share of fully anticipated FOMC policy decisions increase from less than 10% at the two-month horizon, to about 70% at the one-day horizon. The market ability to predict policy has improved substantially after 1999 as the fraction of fully anticipated meetings has quadrupled at the monthly horizon. This improvement can be described as an effect of increased central bank transparency.</p>

Essay 1 - To evaluate measures of expectations I examine and compare some of the most common methods for capturing expectations: the futures method which utilizes financial market prices, the VAR forecast method, and the survey method. I study average expectations on the Federal funds rate target, and the main findings can be summarized as follows: i) the survey measure and the futures measure are highly correlated; the correlation coefficient is 0.81 which indicates that the measures capture the same phenomenon, ii) the survey measure consistently overestimates the realized changes in the interest rate, iii) the VAR forecast method shows little resemblance with the other methods. Essay 2 - This paper takes a critical look at available proxies of uncertainty. Two questions are addressed: (i) How do we evaluate these proxies given that subjective uncertainty is inherently unobservable? (ii) Is there such a thing as a general macroeconomic uncertainty? Using correlations, some narrative evidence and a factor analysis, we find that disagreement and stock market volatility proxies seem to be valid measures of uncertainty whereas probability forecast measures are not. This result is reinforced when we use our proxies in standard macroeconomic applications where uncertainty is supposed to be of importance. Uncertainty is positively correlated with the absolute value of the GDP-gap. Essay 3 - The co-movements of exchange rates and interest rates as the economy responds to shocks is a potential source of deviations from uncovered interest rate parity. This paper investigates whether an open economy macro model with endogenous monetary policy is capable of explaining the exchange rate risk premium puzzle. When the central bank is engaged in interest rate smoothing, a negative relationship between exchange rate changes and interest differentials emerge for realistic parameter values without assuming an extremely large and variable risk premium as done in previous studies. Essay 4 - This paper shows how market expectations as a function of the forecasting horizon can be constructed and used to analyse issues like how far in advance monetary policy actions are anticipated and how the market’s understanding of monetary policy has developed over time. On average about half of a monetary policy action is anticipated one month before a policy meeting. The share of fully anticipated FOMC policy decisions increase from less than 10% at the two-month horizon, to about 70% at the one-day horizon. The market ability to predict policy has improved substantially after 1999 as the fraction of fully anticipated meetings has quadrupled at the monthly horizon. This improvement can be described as an effect of increased central bank transparency.

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The current intellectual climate regarding economics seems to be at an agreement regarding the theory of uncovered interest parity and its unreliability within real life application. The purpose of this thesis is to test how the theory holds over periods with varying economic stability, both using a short- and long-horizon test in order to establish the usefulness of uncovered interest parity as a predictor for exchange rate movements. The short-horizon test will utilize the interbank offering rate, and the long-horizon test the yield to maturity of government 10-year benchmark bonds as the interest rate. The sample period is 2000 to 2018, covering the financial crisis of 2007. We will focus on three different time periods: pre-crisis, crisis and post-crisis. We will use ordinary least squares (OLS) regression and an extreme sampling. From the regressions we conclude that most of the time periods move against the uncovered interest parity, where only the crisis period is in line with the theory. The extreme sampling supports this result, as larger interest differentials provide the rational expectations with more predictive power of the future spot exchange rate.

After two world wars, the West European Economy goes through serious recession. Through the cold war, the representatives of west European countries, German and France, feel that they must cooperate. Hence, by the bases of economic co-operations, the West Europe starts to integrate their resources and political alliances. From the ¡§Economic Community (EC)¡¨ to ¡§Economic and Monetary Union (EMU)¡¨, most West European countries go through several obstacles, like the Collapse of Bretton Woods System in 1971 and the European Crisis in 1992,¡K¡K, etc. Finally, in 1th, Jan., 1999, 11 countries of European Union establish EMU and expect to take Euro as their single currency formally in 2002. They also establish European Central Bank (ECB) to execute the Euro zone¡¦s single monetary policy. The status of Euro after 1th Jan., 1999 is the purpose of this study. This article tries to use the Exchange Rate decision theories, Purchasing Power Parity (PPP) and Interest Rate parity (IRP), to investigate the relationship between Euro and USD. From several statistical empirical tests, it reveals that the trends of Euro couldn¡¦t correspond with the theoretical wants, ie PPP and IRP can¡¦t catch the trends of Euro. By the outcome of ¡§Sign Test¡¨ and ¡§Wilcoxon Sign-Rank Test¡¨, it can be found obviously that the Euro indeed is undervalued from the establishment to Apr., 2000 if we don¡¦t take the transaction costs into account. As a result of the outcome of empirical finds, the article starts to investigate the reasons why the theoretical values from exchange rate decision theories are not equal with real ones. One is that if the empirical models ignore some important factors which lead to the biases of models¡Fthe other is if Euro is undervalued during this observation periods. From the economic macro-environmental analyses, the article can infer that because of the Kosov Wars, Russian economic reform problems, the increase of short interest rate gap between USD and Euro, the different economic reform paces among member countries of EMU,¡K¡K, etc. result in the main factors of the weak currency - Euro.

This study aims to investigate currency substitution and financial dollarization in Turkey. The extend of dollarization in Turkey appears to be very high according to both the conventional currency substitution and the recently developed financial dollarization measures. This has serious policy implications as a source of financial fragility through currency/maturity mismatches and balance sheet effects. The empirical part of this study contained an investigation of the long run relationships between the variables in a system containing currency substitution ratio, expected exchange rate change and rates of return on domestic and foreign currency denominated assets. The results of the Johansen cointegration analysis based on quarterly data for the 1987-2004 period appeared not to be strongly supporting the General Portfolio Balance Model (GPBM). The theoretical part of this study suggests that the GPBM can be reduced to the Sequential Portfolio Balance Model (SPBM) under the uncovered interest parity (UIP) hypothesis. Consequently, the GPBM may be misleading under UIP. The Johansen cointegration results suggested the validity of the UIP for the Turkish data. The estimation of the SPBM suggested that there is a long-run relationship between currency substitution and expected exchange rate change in Turkey. The elasticity of currency substitution appeared to be high but consistent with those estimated for other high inflation developing countries. The results further supported the presence of a ratchet/hysteresis effect proxied by a trend variable. All these results are consistent with the argument that currency substitution and financial dollarization are important especially in high inflation countries.

One of the most popular investment and trading strategies over the last decade, has been the currency carry trade, which allows traders and investors to buy high-yielding currencies in the Foreign Exchange spot market by borrowing, low or zero interest rate currencies in the form of pairs, such as the Australian Dollar/Japanese Yen (AUD/JPY), with the purpose of investing the proceeds afterwards into fixed-income securities.To be able to determine the causality between the returns of equity markets and the foreign exchange market, we choose to observe the sensitivity and influence of two equity indexes on several pairs involved in carry trading. The reason for studying these relationships is to further explain the causes of the uncovered interest parity puzzle, thus adding our contribution to the academic field through this thesis.To accomplish our goals, data was gathered for daily quotes of 16 different currency pairs, grouped by interest differentials, and two equity indexes, the S&amp;P 500 and FTSE All-World, along with data for the VIX volatility index, for the 2003-2012 period. The data was collected from Thomson Reuters Datastream and the selected ten year span was divided into three different periods. This was done in order to discover the differences on how equity indexes relate to typical carry trade currency pairs, depending on market developments before, during and after the world financial crisis.The tests conducted on the collected data measured the correlations, influences and sensitivity for the 16 different currency pairs with the S&amp;P 500 Index, the FTSE All-World index, and the volatility index between the years of 2003-2012. For influences and sensitivity, we performed Maximum Likelihood (ML) regressions with Generalized Autoregressive Conditional Heteroscedasticity (GARCH) [1,1], in Eviews software.After analyzing the results, we found that, during our chosen time period, the majority of currency pair daily returns are positively correlated with the equity indexes and that the FX pairs show greater correlation with the FTSE All-World, than with the S&amp;P 500. Factors such as the interest rate of a currency and the choice of funding currency played an important role in the foreign exchange markets, during the ten year time span, for every yield group of FX pairs.Regarding the influence and sensitivity between currency pairs and the S&amp;P 500 with its VIX index, we found that our models explanatory power seems to be stronger when the interest rate differential between the currency pairs is smaller. Our regression analysis also uncovered that the characteristics of an individual currency can show noticeable effects for the relationship between its pair and the two indexes.