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Using the Special Drawing Right in the Frankel-Wei regression framework

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  • Kunkler, Michael

Abstract

The Frankel-Wei regression framework measures the comovements between currencies, and assumes that all foreign exchange rates share a common numéraire. The International Monetary Fund's (IMF) Special Drawing Right (SDR) is a regular choice for the common numéraire. However, the five-currency basket of the SDR lacks diversification, which results in significant positive comovements between the basket currencies and the SDR currency basket. Consequently, the estimator of the regression coefficient is biased away from its true value. We suggest that the common numéraire be a large well-diversified currency basket, rather than a small undiversified currency basket, such as the five-currency SDR.

Suggested Citation

  • Kunkler, Michael, 2022. "Using the Special Drawing Right in the Frankel-Wei regression framework," Finance Research Letters, Elsevier, vol. 46(PB).
    • Handle: RePEc:eee:finlet:v:46:y:2022:i:pb:s1544612321004591
    DOI: 10.1016/j.frl.2021.102482
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    References listed on IDEAS

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    1. Jeffrey Frankel & Sergio Schmukler & Luis Serven, 2000. "Verifiability and the Vanishing Intermediate Exchange Rate Regime," NBER Working Papers 7901, National Bureau of Economic Research, Inc.
    2. Kunkler, Michael & MacDonald, Ronald, 2015. "Half-lives of currencies and aggregation bias," Economics Letters, Elsevier, vol. 135(C), pages 58-60.
    3. Ethan Ilzetzki & Carmen M Reinhart & Kenneth S Rogoff, 2019. "Exchange Arrangements Entering the Twenty-First Century: Which Anchor will Hold?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 134(2), pages 599-646.
    4. Michael Bleaney & Mo Tian, 2017. "Measuring exchange rate flexibility by regression methods," Oxford Economic Papers, Oxford University Press, vol. 69(1), pages 301-319.
    5. Kunkler, Michael, 2021. "The Chinese renminbi's co-movement with the US dollar: Addressing the numéraire issue," Finance Research Letters, Elsevier, vol. 40(C).
    6. Jeffrey A. Frankel & Shang-Jin Wei, 1994. "Yen Bloc or Dollar Bloc? Exchange Rate Policies of the East Asian Economies," NBER Chapters, in: Macroeconomic Linkage: Savings, Exchange Rates, and Capital Flows, pages 295-333, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Kunkler, Michael, 2022. "Implied betas for the Frankel–Wei regression framework," Economics Letters, Elsevier, vol. 218(C).

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    More about this item

    Keywords

    Foreign Exchange Rates;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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