Determinants and Dynamics of Price Disparity in Onshore and Offshore Renminbi Forward Exchange Rate Markets
AbstractPrice 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 InfoPaper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 242012.
Length: 25 pages
Date of creation: Oct 2012
Date of revision:
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Price Disparity; Renminbi Forward Exchange Rates; Onshore and Offshore Markets; Spot Rate Model;
Find related papers by JEL classification:
- C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
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