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Determinants and Dynamics of Price Disparity in Onshore and Offshore Renminbi Forward Exchange Rate Markets

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  • Ka-Fai Li

    (Hong Kong Monetary Authority)

  • Cho-Hoi Hui

    (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research)

  • Tsz-Kin Chung

    (Hong Kong Monetary Authority)

Abstract

Price disparities between the renminbi onshore deliverable forward and offshore non-deliverable forward exchange rates is an intriguing puzzle in financial economics. This paper investigates the determinants of these price disparities focusing on the possibility of parameter uncertainty. In the presence of information asymmetry and market segmentation among onshore and offshore investors, it is possible that they formulate different views on the Mainland economy which translate into a different assessment of the outlook for Mainland interest rates. Through a no arbitrage condition that relates the forward rate to the spot rate and interest rate differential, a different assessment of the path of interest rates can lead to a different valuation of forward prices. We estimate a term structure model for the implied renminbi interest rate using a Bayesian approach, in which investors¡¯ model parameter uncertainty is represented by the posterior standard deviation of the volatility of the interest rate. We show that parameter uncertainty can help to explain price disparities, in addition to market-wide aggregate uncertainty and illicit capital flows in the Mainland¡¯s balance of payment.

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Bibliographic Info

Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 242012.

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Length: 25 pages
Date of creation: Oct 2012
Date of revision:
Handle: RePEc:hkm:wpaper:242012

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Keywords: Price Disparity; Renminbi Forward Exchange Rates; Onshore and Offshore Markets; Spot Rate Model;

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  1. Baba, Naohiko & Packer, Frank, 2009. "Interpreting deviations from covered interest parity during the financial market turmoil of 2007-08," Journal of Banking & Finance, Elsevier, vol. 33(11), pages 1953-1962, November.
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  8. Officer, Lawrence H & Willett, Thomas D, 1970. "The Covered-Arbitrage Schedule: A Critical Survey of Recent Developments," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 2(2), pages 247-57, May.
  9. Tang, Cheng Yong & Chen, Song Xi, 2009. "Parameter estimation and bias correction for diffusion processes," Journal of Econometrics, Elsevier, vol. 149(1), pages 65-81, April.
  10. Cai, Charlie X. & McGuinness, Paul B. & Zhang, Qi, 2011. "The pricing dynamics of cross-listed securities: The case of Chinese A- and H-shares," Journal of Banking & Finance, Elsevier, vol. 35(8), pages 2123-2136, August.
  11. Cho-Hoi Hui & Hans Genberg & Tsz-Kin Chung, 2009. "Funding Liquidity Risk and Deviations from Interest-Rate Parity During the Financial Crisis of 2007-2009," Working Papers 0913, Hong Kong Monetary Authority.
  12. Longstaff, Francis A & Schwartz, Eduardo S, 1992. " Interest Rate Volatility and the Term Structure: A Two-Factor General Equilibrium Model," Journal of Finance, American Finance Association, vol. 47(4), pages 1259-82, September.
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