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The Credibility of the Link from the Perspective of Modern Financial Theory

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Listed:
  • Hans Genberg

    (Research Department, Hong Kong Monetary Authority)

  • Cho-hoi Hui

    (Research Department, Hong Kong Monetary Authority)

Abstract

Hong Kong¡¯s Linked Exchange Rate system (LERS) has been in operation for 25 years during which time many other fixed exchange rate systems have succumbed to shocks and/or speculative attacks. This fact alone suggests that the LERS is a robust system which enjoys a large measure of credibility in financial markets. This paper intends to investigate whether this is indeed the case, and whether it has been the case throughout its 25-year history. In particular we will use the tools of modern finance to extract information from financial-asset prices about market expectations that are related to the credibility of the LERS. The main focus is on how market participants 'judged' the various changes made to the LERS, such as the 'seven technical measures' introduced in September 1998 and the 'three refinements' made in May 2005. These changes have been characterised as making the system less discretionary over time, and we hypothesise that they have also made it more credible as revealed in the prices of exchange rate-related asset prices. We also investigate the relationship between interest rates and exchange rates in the current system in light of modern models of target-zone exchange rate systems. We will examine whether the intra-marginal intervention in November 2007 changed the dynamic properties of the exchange rate as suggested by such models.

Suggested Citation

  • Hans Genberg & Cho-hoi Hui, 2009. "The Credibility of the Link from the Perspective of Modern Financial Theory," Working Papers 0902, Hong Kong Monetary Authority.
    • Handle: RePEc:hkg:wpaper:0902
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    References listed on IDEAS

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    3. Michael Funke & Yu-Fu Chen & Nicole Glanemann, 2009. "A soft target zone model: Theory and application to Hong Kong," Quantitative Macroeconomics Working Papers 20912, Hamburg University, Department of Economics.
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    9. Roman Inderst, 2008. "'Irresponsible Lending' With A Better Informed Lender," Economic Journal, Royal Economic Society, vol. 118(532), pages 1499-1519, October.
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    More about this item

    Keywords

    Hong Kong dollar; Linked Exchange Rate system; target zone;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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