Speculation and Hedging in the Currency Future Markets: Are They Informative to Spot Exchange Rates?

Journal of Futures Markets, 2012

This study presents an empirical analysis investigating the relationship between the futures trading activities of speculators and hedgers and the potential movements of major spot exchange rates. A set of trader position measures are employed as regression predictors, including the level and change of net positions, an investor sentiment index, extremely bullish/bearish sentiments, and the peak/trough indicators. We find that the peaks and troughs of net positions are generally useful predictors to the evolution of spot exchange rates, but other trader position measures are less correlated with future market movements. In addition, speculative position measures usually forecast price-continuations in spot rates while hedging position measures forecast price-reversals in these markets.


Exchange Rate Puzzles and Distorted Beliefs

Journal of International Economics, 2004

We propose a new explanation for the foreign exchange forward-premium and delayedovershooting puzzles. We show that both puzzles arise from a systematic distortion in investors’ beliefs about the interest rate process. Accordingly, the forward premium is always a biased predictor of future depreciation; the bias can be so severe as to lead to negative coefficients in the ‘Fama’ regression. Delayed overshooting may or may not occur depending upon the persistence of interest rate innovations and the degree of misperception. We document empirically the extent of this distortion using survey data for G-7 countries against the U.S. and find that it is strong enough to account for these irregularities.


Fixed vs. Flexible Exchange Rates: Which Provides More Fiscal Discipline?

Journal of Monetary Economics, 2000

Conventional wisdom holds that "fixed rates provide more "fiscal discipline than do flexible rates. In this paper we show that this wisdom need not hold in a standard model in which "scal policy is endogenously determined by a maximizing "scal authority. The claim that "xed rates induce more discipline stresses that sustained adoption of lax "scal policies must eventually lead to an exhaustion of reserves and thus to a politically costly collapse of the peg. Hence, under "xed rates bad behavior today leads to punishment tomorrow. Under #exible rates bad behavior has costs as well. The di!erence is in the intertemporal distribution of these costs: #exible rates allow the e!ects of unsound "scal policies to manifest themselves immediately through movements in the exchange rate. Hence, bad behavior today leads to punishment today. If "scal authorities are impatient, #exible rates * by forcing the costs to be paid up-front * provide more "scal discipline and higher welfare for the representative private agent. The recent experience of sub-Saharan countries supplies evidence that matches the predictions of the model.


Fiscal Discipline and the Choice of Nominal Anchor in Stabilization

Journal of International Economics, 1998

The conventional wisdom is that exchange rate-based stabilizations induce more fiscal discipline than money-based programs. The Latin American experience does not support this view. Among the major stabilization programs implemented since 1960, the mean increase in the primary balance-to-GDP ratio was 3.2 percentage points under money-based programs, as opposed to only 0.2 percentage points under exchange rate-based programs. We present a model – where fiscal policy is set by an optimizing but non-benevolent government – that replicates this stylized fact. If the policy maker is impatient, a money-based stabilization provides more discipline, and higher welfare for the representative agent, than does an exchange rate-based stabilization.


Fiscal Discipline and the Choice of Exchange Rate Regime

European Economic Review, 1995

The conventional wisdom claims that fixed exchange rates provide more fiscal discipline than do flexible rates, but the recent experience in Europe, the record of Sub-Saharan countries in the 1980s and the history of stabilization attempts in Latin America cast empirical doubts on this wisdom. We present a standard intertemporal model with perfect capital mobility and price flexibility in which fiscal policy is endogenously determined by a maximizing fiscal authority. The model shows that the difference between regimes lies in the intertemporal distribution of the costs of fiscal laxity. Fixed rates push these costs into the future, while flexible rates allow the effects of unsound fiscal policies to manifest themselves immediately through movements in the exchange rate. Which system provides more discipline depends on the authorities’ discount rate.