CAUSALITY BETWEEN EXCHANGE RATES AND FOREIGN EXCHANGE RESERVES: SERBIAN CASE

Ivana Marjanović, Milan Marković

DOI Number
https://doi.org/10.22190/FUEO1904443M
First page
443
Last page
459

Abstract


The aim of this paper is to determine the relationship between the exchange rate (nominal and real) and foreign exchange reserves based on monthly data for the period from September 2006 to April 2019, using unit root tests and cointegration tests that take into account the possibility of structural break existence. The results of the causality test indicate that there is a long-term relationship between the nominal exchange rate and foreign exchange reserves. On the other hand, the existence of a long-term relationship between the real exchange rate and the foreign exchange reserves has not been confirmed, but there is a short-term causality, that is, the real exchange rate Granger-causes foreign exchange reserves.


Keywords

exchange rate, foreign exchange reserves, unit root tests, cointegration tests, Granger causality, Vector Error Correction Model

Full Text:

PDF

References


Abenoja, Z. (2003). Foreign exchange market intervention: a short review of transmission channels and practices. Bangko Sentral Review, 5 (2), 1–25.

Adler, G., Lisack, N. & Mano, R. (2019). Unveiling the effects of foreign exchange intervention: A panel approach. Emerging Markets Review, 1–40. https://doi.org/10.1016/j.ememar.2019.100620

Ahmad, A. H., & Aworinde, O. B. (2016). The role of structural breaks, nonlinearity and asymmetric adjustments in African bilateral real exchange rates. International Review of Economics & Finance, 45, 144–159.

Aizenman, J. & Marion, N. (2003). The high demand for international reserves in the Far East: What is going on?. Journal of the Japanese and international Economies, 17 (3), 370–400. https://doi.org/10.1016/s0889-1583(03)00008-x

Aizenman, J. & Riera-Crichton, D. (2008). Real exchange rate and international reserves in an era of growing financial and trade integration. The Review of Economics and Statistics, 90 (4), 812–815. https://doi.org/10.3386/w12363

Aizenman, J., Edwards, S. & Riera-Crichton, D. (2012). Adjustment patterns to commodity terms of trade shocks: the role of exchange rate and international reserves policies. Journal of International Money and Finance, 31 (8), 1990–2016. https://doi.org/10.1016/j.jimonfin.2012.05.003

Akinboade, O.A. & Makina, D. (2006). Mean reversion and structural breaks in real exchange rates: South African evidence. Applied financial economics, 16 (4), 347¬¬¬–358. https://doi.org/10.1080/09603100500401260

Basu, K. (2012). How to devalue exchange rates, without building up reserves: Strategic theory for central banking. Economics Letters, 117 (3), 758–761. https://doi.org/10.1016/j.econlet.2011.12.069

Baum, C.F., Barkoulas, J.T. & Caglayan, M. (1999). Long memory or structural breaks: can either explain nonstationary real exchange rates under the current float?. Journal of International Financial Markets, Institutions and Money, 9 (4), 359–376. https://doi.org/10.1016/s1042-4431(99)00018-9

Bayat, T., Senturk, M. & Kayhan, S. (2014). Exchange rates and foreign exchange reserves in Turkey: nonlinear and frequency domain causality approach. Theoretical & Applied Economics, 21 (11), 83–92.

Bouraoui, T. & Phisuthtiwatcharavong, A. (2015). On the determinants of the THB/USD exchange rate. Procedia Economics and Finance, 30, 137–145. https://doi.org/10.1016/s2212-5671(15)01277-0

Byrne, J.P. & Nagayasu, J. (2010). Structural breaks in the real exchange rate and real interest rate relationship. Global Finance Journal, 21 (2), 138–151. https://doi.org/10.1016/j.gfj.2010.06.002

Chowdhury, K. (2012). Modelling the dynamics, structural breaks and the determinants of the real exchange rate of Australia. Journal of International Financial Markets, Institutions and Money, 22 (2), 343–358. https://doi.org/10.1016/j.intfin.2011.10.004

Dominguez, K. & Frankel, J.A. (1990). Does foreign exchange intervention work?. Peterson Institute Press: All Books.

Dropsy, V. (1996). Real exchange rates and structural breaks. Applied Economics, 28 (2), 209–219. https://doi.org/10.1080/000368496328849

Edwards, S. (1983). The Demand for International Reserves and Exchange Rate Adjustments: TheCase of LDCs, 1964–1972. https://doi.org/10.3386/w1063

Engel, C. & Hakkio, C.S. (1993). Exchange rate regimes and volatility. Economic Review-Federal Reserve Bank of Kansas City, 78, 43–43.

Engle, R.F. & Granger, C.W. (1987). Co-integration and error correction: representation, estimation, and testing. Econometrica: Journal of the Econometric Society, 251–276. https://doi.org/10.2307/1913236

Fatum, R. & M. Hutchison, M. (2003). Is sterilised foreign exchange intervention effective after all? An event study approach. The Economic Journal, 113 (487), 390–411. https://doi.org/10.1111/1468-0297.00122

Flood, P. & Marion, N. (2002). Holding international reserves in an era of high capability mobility. IMF Working Paper, International Monetary Fund WP/02/62.

Frenkel, J.A. & Jovanovic, B. (1981). Optimal international reserves: a stochastic framework. The Economic Journal, 91 (362), 507–514. https://doi.org/10.2307/2232599

Frömmel, M., Garabedian, G. & Schobert, F. (2011). Monetary policy rules in Central and Eastern European Countries: Does the exchange rate matter?. Journal of Macroeconomics, 33 (4), 807–818. https://doi.org/10.1016/j.jmacro.2011.05.003

Gantt, R.P. (2010). Central bank holdings of foreign exchange reserves: why have they grown so fast? (Doctoral dissertation, Montana State University-Bozeman, College of Agriculture).

Glynn, J., Perera, N. & Verma, R. (2007). Unit root tests and structural breaks: A survey with applications. Journal of Quantitative Methods for Economics and Business Administration, 3 (1), 63-79.

Gokhale, M.S. & Raju, J.R. (2013). Causality between exchange rate and foreign exchange reserves in the Indian context. Global Journal of Management and Business Research.

Gosselin, M.A. & Parent, N. (2005). An empirical analysis of foreign exchange reserves in emerging Asia (pp. 4–6). Montreal, Quebec: Bank of Canada.

Granger, C.W. & Weiss, A.A. (1983). Time series analysis of error-correction models. In Studies in econometrics, time series, and multivariate statistics (pp. 255–278). Academic Press. https://doi.org/10.1016/b978-0-12-398750-1.50018-8

Granger, C.W. (1969). Investigating causal relations by econometric models and cross-spectral methods. Econometrica: Journal of the Econometric Society, 424–438. https://doi.org/10.2307/1912791

Granger, C.W. (1983). Co-integrated variables and error-correcting models (Doctoral dissertation, Discussion Paper 83–13. Department of Economics, University of California at San Diego).

Granger, C.W., Huangb, B.N. & Yang, C.W. (2000). A bivariate causality between stock prices and exchange rates: evidence from recent Asianflu. The Quarterly Review of Economics and Finance, 40 (3), 337–354. https://doi.org/10.1016/s1062-9769(00)00042-9

Gregory, A.W. & Hansen, B.E. (1996). Residual-based tests for cointegration in models with regime shifts. Journal of econometrics, 70 (1), 99–126. https://doi.org/10.1016/0304-4076(69)41685-7

Heller, H.R. (1966). Optimal international reserves. The Economic Journal, 76 (302), 296–311. https://doi.org/10.2307/2229716

Ito, T. (2002). Is foreign exchange intervention effective?: the Japanese experiences in the 1990s (No. w8914). National Bureau of Economic Research. https://doi.org/10.3386/w8914

Kasman, A. & Ayhan, D. (2008). Foreign exchange reserves and exchange rates in Turkey: Structural breaks, unit roots and cointegration. Economic Modelling, 25 (1), 83–92. https://doi.org/10.1016/j.econmod.2007.04.010

Kim, S. (2003). Monetary policy, foreign exchange intervention, and the exchange rate in a unifying framework. Journal of International Economics, 60 (2), 355–386. https://doi.org/10.1016/s0022-1996(02)00028-4

Kočenda, E. (2005). Beware of breaks in exchange rates: evidence from European transition countries. Economic Systems, 29 (3), 307–324. https://doi.org/10.1016/j.ecosys.2005.02.006

Kovačić Z. (1995). Time series analysis (In Serbian), University of Belgrade, Faculty of Economics.

Krusković, B. D. & Maričić, T. (2015). Empirical Analysis of the Impact of Foreign Exchange Reserves to Economic Growth in Emerging Economics. Applied economics and finance, 2 (1), 102–109. https://doi.org/10.11114/aef.v2i1.653

Liu, L. & Wan, J. (2012). The relationships between Shanghai stock market and CNY/USD exchange rate: New evidence based on cross-correlation analysis, structural cointegration and nonlinear causality test. Physica A: Statistical Mechanics and its Applications, 391 (23), 6051–6059. https://doi.org/10.1016/j.physa.2012.07.036

Lodha, S. (2017). A Cointegration and Causation Study of Gold Prices, Crude Oil Prices and Exchange Rates. IUP Journal of Financial Risk Management, 14 (1).

Lütkepohl, H. (2005). New introduction to multiple time series analysis. Springer Science & Business Media.

MacKinnon, J. G. (1991). Critical values for cointegration tests. In Engle R. and Granger C. (Eds.), Long-Run Economic Relationship: Readings in Cointegration, Oxford University Press

Mensi, W., Hammoudeh, S. & Yoon, S. M. (2015). Structural breaks, dynamic correlations, asymmetric volatility transmission, and hedging strategies for petroleum prices and USD exchange rate. Energy Economics, 48, 46-60. https://doi.org/10.1016/j.eneco.2014.12.004

National bank of Serbia (2019). Retrieved from: http://www.tvojnovac.nbs.rs/edukacija/latinica/40/teme/index.html Accessed on: 11/07/2019.

National bank of Serbia (2019a). Statistics. Retrieved from: https://www.nbs.rs/internet/cirilica/80/index.html Accessed on: 11/07/2019.

National bank of Serbia (2019b). Inflation Reports. Retrieved from: https://www.nbs.rs/internet/cirilica/90/90_5/ioi_02_2018.html Accessed on: 15/10/2019.

Ndoricimpa, A. (2013). Structural breaks and fiscal deficit sustainability in EAC countries: Empirical evidence. International Journal of Economics, Finance and Management Sciences, 1 (6), 391–399. https://doi.org/10.11648/j.ijefm.20130106.27

Neely, C.J. (2005). An analysis of recent studies of the effect of foreign exchange intervention. FRB of St. Louis Working Paper No. https://dx.doi.org/10.2139/ssrn.762524

Nowak, M.M., Hviding, M.K. & Ricci, M.L.A. (2004). Can higher reserves help reduce exchange rate volatility? (No. 4-189). International Monetary Fund.

Ojede, A. & Lam, E. (2017). The impact of changes in monetary aggregates on exchange rate volatility in a developing country: Do structural breaks matter?. Economics Letters, 155, 111–115. https://doi.org/10.1016/j.econlet.2017.03.024

Perron, P. (1989). The great crash, the oil price shock, and the unit root hypothesis. Econometrica: Journal of the Econometric Society, 1361–1401. https://doi.org/10.2307/1913712

Phillips, P.C. & Ouliaris, S. (1990). Asymptotic properties of residual based tests for cointegration. Econometrica, 58 (1), 165–193. https://doi.org/10.2307/2938339

Rapach, D.E. & Strauss, J.K. (2008). Structural breaks and GARCH models of exchange rate volatility. Journal of Applied Econometrics, 23 (1), 65–90. https://doi.org/10.1002/jae.976

Salisu, A.A., Adekunle, W., Alimi, W.A. & Emmanuel, Z. (2019). Predicting exchange rate with commodity prices: New evidence from Westerlund and Narayan (2015) estimator with structural breaks and asymmetries. Resources Policy, 62, 33–56. https://doi.org/10.1016/j.resourpol.2019.03.006

Umit, A.O. (2016). Stationarity of real exchange rates in the “fragile five”: analysis with structural breaks. International Journal of Economics and Finance, 8 (4), 254–270. https://doi.org/10.5539/ijef.v8n4p254

Viola, A.P., Klotzle, M.C., Pinto, A.C.F. & da Silveira Barbedo, C.H. (2019). Foreign exchange interventions in Brazil and their impact on volatility: A quantile regression approach. Research in International Business and Finance, 47, 251–263. https://doi.org/10.1016/j.ribaf.2018.08.002

Waheed, M., Alam, T. & Ghauri, S.P. (2006). Structural breaks and unit root: evidence from Pakistani macroeconomic time series. Available at SSRN 963958. https://doi.org/10.2139/ssrn.963958

Watson, P.K. & Teelucksingh, S.S. (2002). A practical introduction to econometric methods: Classical and modern. University of West Indies Press

You, K. & Sarantis, N. (2012). Structural breaks and the equilibrium real effective exchange rate of China: A NATREX approach. China Economic Review, 23 (4), 1146–1163. https://doi.org/10.1016/j.chieco.2012.08.002

Zivot, E. & Andrews, D.W.K. (2002). Further evidence on the great crash, the oil-price shock, and the unit-root hypothesis. Journal of business & economic statistics, 20 (1), 25–44. https://doi.org/10.2307/1391541




DOI: https://doi.org/10.22190/FUEO1904443M

Refbacks

  • There are currently no refbacks.


© University of Niš, Serbia
Creative Commons License CC BY-NC-ND
ISSN 0354-4699 (Print)
ISSN 2406-050X (Online)