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News announcements and price discovery in the RMB–USD market

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Abstract

This study investigates the impact of improved central parity quotations in the Chinese Renminbi on price discovery in onshore (USD/CNY) and offshore (USD/CNH) markets. Chinese news releases refer to the gross domestic product, trade balances, and foreign exchange reserves; U.S. news features information on the meetings, statements, and minutes of the Federal Open Market Committee. They all have positive impacts on price discovery in the USD/CNH market. The greater contribution by the USD/CNH market to price discovery can be attributed to an improved quotation policy, which has enabled central parity to incorporate and transmit more USD/CNH information to the USD/CNY market.

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Notes

  1. The International Monetary Fund (IMF) welcomed China’s move to improve its foreign exchange formation system and stated that a more market-oriented exchange rate would facilitate the operation of special drawing rights if the RMB were included in the basket of currencies. An IMF spokesperson stated, “the new mechanism for determining the central parity of the RMB announced by the PBC appears to be a welcome step, as it should allow market forces to have a greater role in determining the exchange rate.”

  2. Price discovery is the process by which the market incorporates information to arrive at an equilibrium price.

  3. Funke et al. (2015) determine that market liquidity in offshore markets has an important role in explaining the CNH–CNY differential; policymakers (inside and outside of China) attempt to extract information about the fundamental value of the RMB from the two rates. Cheung and Rime (2014) find that the USD/CNH exchange rate exerts an increasing impact on the USD/CNY rate, as well as significant predictive power on the official RMB central parity rate. Zhang et al. (2013) show that order flows, as a measure of excess demand pressure, can explain a significant proportion of the fluctuations in the exchange rate of the RMB against the U.S. dollar.

  4. The term Yuan is analogous to the term dollar in English. The Chinese Yuan was first issued by the PBC on 1 December 1948.

  5. China’s capital controls affect cross-border transactions, including restrictions on outbound investments, offshore loans, outbound payments by individuals, and outbound payments by corporations, according to the China Law and Practice website. For outbound payments by individuals, there is an annual quota of US$50,000 for each citizen, and the rules make it more difficult for individuals to pool their quotas to make large overseas investments. On 28 December 2016, the PBC released the Measures for the Administration of the Reporting of Large Transactions and Suspicious Transactions by Financial Institutions, which require financial institutions in China to report any cash transactions of more than 50,000 RMB and any cross-border cash transfers of more than 200,000 RMB. The bank may restrict large-scale purchases of foreign currency by customers under this regulation. These restrictions on cross-border transactions also may affect arbitrage opportunities between onshore and offshore RMB markets. We thank an anonymous reviewer for suggesting the need to discuss arbitrage limits between onshore and offshore markets.

  6. The Wind Information Company provides real-time fundamental data, exchange rate data, and estimated earnings data for financial professionals. In China, it serves more than 90% of financial institutions, including hedge funds, asset management firms, securities companies, insurance companies, banks, research institutions, and regulatory bodies. Overseas, it serves 75 percent of all Qualified Foreign Institutional Investors.

  7. Gonzalo and Granger (1995) ignore the correlation between the two markets’ price movements and attribute the leading role solely to the market that adjusts least to price movements in the other market (error correction process).

  8. For practical purposes, this calculation can be normalized to make the elements add up to 1.

  9. We thank an anonymous referee for pointing out the potential impacts of relative CNH–CNY liquidity, relative CNH–CNY price differentials, market sentiment, and CNH funding on price discovery.

  10. Chakravarty et al. (2004) show that price discovery in options markets relates positively to relative trading volume, relative bid–ask spread, and underlying volatility; Mizrach and Neely (2008) and Fricke and Menkhoff (2011) also find that relative bid–ask spreads, trading volume, and realized volatility have statistically significant influences on daily price discovery in the U.S. Treasury market. According to Chen and Gau (2009), bid–ask spreads and tick size rules within the stock market exert statistically significant influences on price discovery in both stock and futures markets. Choy and Zhang (2010) support the trading costs hypothesis which predicts that the market with the lower trading costs will react more quickly to new information. Chang et al. (2013) and Chen et al. (2016) show that the relative sizes of open interest among hedgers and speculators have statistically significant influences on price discovery within the FX futures market. Chen et al. (2019) find that foreigners trades make a significant contribution to price discovery in Taiwan futures markets.

  11. Crain and Lee (1995) and Chatrath and Song (1998) also note that the volatility spillover from the FX futures market to the spot market tends to be more prominent on news announcement days.

  12. Please see https://www.reuters.com/article/us-china-yuan-midpoint-idUSKBN0UL07Z20160107, https://www.nytimes.com/2016/01/09/business/dealbook/asia-china-renminbi-currency-devaluation.html, for a more detailed discussion. We also examine RMB price discovery during a second devaluation period in January 2016 and find that USD/CNH prices provide greater contributions to price discovery than USD/CNY prices during this period, consistent with the first devaluation in August 2015. We acknowledge the helpful guidance of an anonymous referee in pointing out the occurrence of this second devaluation.

  13. We also estimated relative (modified) information shares for the USD/CNH and USD/CNY rates in Eq. (8) but do not report them due to space constraints. The effect of the central parity rate and macroeconomic news announcements on relative (modified) information shares are very similar to our common factor component weight results. These results are available on request.

  14. We thank an anonymous referee for pointing out the potential impact of U.S.–China market uncertainty due to the election of Donald Trump on RMB price discovery.

  15. VXChinat is a measure of near-term implied volatility based on the China Large-Cap ETF, available from 16 March 2011. Fatum et al. (2017) and Xiao et al. (2019) also use it to measure Chinese market uncertainty.

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Acknowledgements

The author would like to thank the anonymous reviewers for their comments and suggestions. The author gratefully acknowledges financial support from the Ministry of Science and Technology (MOST 106-2410-H-033-008-MY3).

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  1. Department of Finance, College of Business, Chung Yuan Christian University, 200 Chung Pei Rd., Jhongli, Taoyüan, 32023, Taiwan

    Yu-Lun Chen

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Chen, YL. News announcements and price discovery in the RMB–USD market. Rev Quant Finan Acc 54, 1487–1508 (2020). https://doi.org/10.1007/s11156-019-00832-5

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