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Exchange Rates and Net Portfolio Flows: A Markov-Switching Approach

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Hidden Markov Models in Finance

Part of the book series: International Series in Operations Research & Management Science ((ISOR,volume 209))

Abstract

In this paper we investigate the impact of net bond and equity portfolio flows on exchange rate changes. Two-state Markov-switching models are estimated for Canada, the euro area, Japan and the UK exchange rates vis-à-vis the US dollar. Our results suggest that the relationship between net portfolio flows and exchange rate changes is nonlinear for all currencies considered but Canada.

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Notes

  1. 1.

    The model is based on the Markov switching representation proposed by Hamilton [16, 17].

  2. 2.

    Regime 1 is labelled as the low regime, whereas regime 2 as the high regime.

  3. 3.

    The data are obtained from the US Treasury Department website: http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/country-longterm.aspxhe

  4. 4.

    In the euro area, net bond flows exhibit only excess kurtosis, whereas exchange rate changes exhibit only skewness.

  5. 5.

    The p-value is calculated according to the method described in Hansen [19], using 1,000 random draws from the relevant limiting Gaussian processes and bandwidth parameter M = 0, 1, …, 4. See Hansen [18] for details.

  6. 6.

    We use the AIC to choose the best fitted model among the candidate models considered. For example, in the cases of US/Canada and US/UK, Model II is favored according to the AIC. This implies that in both cases the switching in exchange rate changes is driven primarily by the mean, but not the variance.

  7. 7.

    The exchange rate lag dimension is chosen according to the SBC (allowing up to four lags), Lags found insignificant are excluded.

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Author information

Authors and Affiliations

  1. Department of Economics and Finance, Brunel University London, Uxbridge, Middlesex, UB8 3PH, UK

    Faek Menla Ali, Fabio Spagnolo & Nicola Spagnolo

  2. Centre for Applied Macroeconomic Analysis (CAMA), Canberra, Australia

    Nicola Spagnolo

Authors
  1. Faek Menla Ali
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  2. Fabio Spagnolo
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  3. Nicola Spagnolo
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Correspondence to Fabio Spagnolo .

Editor information

Editors and Affiliations

  1. Dept of Statistical & Actuarial Sciences, University of Western Ontario, London, Ontario, Canada

    Rogemar S. Mamon

  2. School of Mathematics, University of Adelaide, Adelaide, Australia

    Robert J. Elliott

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Ali, F.M., Spagnolo, F., Spagnolo, N. (2014). Exchange Rates and Net Portfolio Flows: A Markov-Switching Approach. In: Mamon, R., Elliott, R. (eds) Hidden Markov Models in Finance. International Series in Operations Research & Management Science, vol 209. Springer, Boston, MA. https://doi.org/10.1007/978-1-4899-7442-6_5

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