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Foreign exchange rate and financial market imperfections

Dong, Xue 2018. Foreign exchange rate and financial market imperfections. PhD Thesis, Cardiff University.
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Abstract

The thesis discusses exchange rate dynamics in a small open economy Real Business Cycle model with financial frictions, aiming to investigate whether financial frictions in the global capacity to bear exchange rate risk had influences on Sterling real exchange rate dynamics between 1975 and 2016. In the model, international financial intermediaries as arbitrageurs face credit constraints and bear the risks caused by imbalances in the supply and demand of international bonds. The model has been estimated by using a simulation-based Indirect Inference approach, which provides a natural framework for testing the hypothesis implied by the model. The basic idea of Indirect Inference estimation is to search across model’s parameter space for the parameter set that the simulated data and the observed data look statistically the same from the vantage point of the chosen auxiliary model. The result shows that a comfortable non-rejection of the hypothesis that exchange rate dynamics are affected by financial forces at 5% significant level. It implies that financiers indeed require a risk premium to intermediate capital flows, and the uncovered interest parity fails to hold. Monte Carlo experiments support that the power of the Indirect Inference test to reject a false hypothesis is high; hence the results could be relied on. Empirical studies based on estimated model address that financial frictions will act as amplifiers of external shocks on the real exchange rate and other key UK macroeconomic variables. In addition, shocks to financial forces are the main driving forces behind large and sudden depreciations of the sterling exchange rates in the aftermath of the collapse of Lehman Brothers and the Brexit vote.

Item Type: Thesis (PhD)
Date Type: Submission
Status: Unpublished
Schools: Business (Including Economics)
Funders: Julian Hodge Bank
Date of First Compliant Deposit: 26 April 2018
Last Modified: 27 Apr 2018 08:49
URI: http://orca.cf.ac.uk/id/eprint/111019

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