The puzzling peso
In the past decade, some observers have noted an unusual aspect of the Mexican peso's behavior: During periods when the U.S. dollar has risen (fallen) against other major currencies such as the euro, the peso has risen (fallen) against the dollar. Very few other currencies display this behavior. In this paper, we attempt to explain the unusual pattern of the peso's correlation with the dollar by developing some general empirical models of exchange rate correlations. Based on a study of 29 currencies, we find that most of the cross-country variation in exchange rate correlations with the dollar and the euro can be explained by just a few variables. First, a country's currency is more likely to rise against the dollar as the dollar rises against the euro, the closer it is to the United States and the farther it is from the euro area. In this result, distance likely proxies for the role of economic integration in affecting exchange rate correlations. Second, and perhaps more surprisingly, a country's currency is more likely to exhibit this unusual pattern when its sovereign credit rating is more risky. This may reflect that currencies of riskier countries are less substitutable in investor portfolios than those of better-rated countries. All told, these factors well explain the peso's unusual behavior, as Mexico both is very close to the United States and has a lower credit rating than most industrial economies.
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References listed on IDEAS
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- Nelson C. Mark, 2009.
"Changing Monetary Policy Rules, Learning, and Real Exchange Rate Dynamics,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 41(6), pages 1047-1070, 09.
- Nelson C. Mark, 2005. "Changing Monetary Policy Rules, Learning, and Real Exchange Rate Dynamics," NBER Working Papers 11061, National Bureau of Economic Research, Inc.
- Frankel, Jeffrey A., 1986. "The implications of mean-variance optimization for four questions in international macroeconomics," Journal of International Money and Finance, Elsevier, vol. 5(1, Supple), pages 53-75, March.
- Jeffrey A. Frankel, 1985. "The Implications of Mean-Variance Optimization for Four Questions in International Macroeconomics," NBER Working Papers 1617, National Bureau of Economic Research, Inc.
- Engel, Charles & West, Kenneth D., 2006. "Taylor Rules and the Deutschmark: Dollar Real Exchange Rate," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(5), pages 1175-1194, August.
- Charles Engel & Kenneth D. West, 2004. "Taylor Rules and the Deutschmark-Dollar Real Exchange Rate," NBER Working Papers 10995, National Bureau of Economic Research, Inc.
- Molodtsova, Tanya & Papell, David H., 2009. "Out-of-sample exchange rate predictability with Taylor rule fundamentals," Journal of International Economics, Elsevier, vol. 77(2), pages 167-180, April.
- Marcel Fratzscher, 2008. "US shocks and global exchange rate configurations," Economic Policy, CEPR;CES;MSH, vol. 23, pages 363-409, 04.
- Fratzscher, Marcel, 2007. "US shocks and global exchange rate configurations," Working Paper Series 0835, European Central Bank.
- Richard Clarida & Daniel Waldman, 2007. "Is Bad News About Inflation Good News for the Exchange Rate?," NBER Working Papers 13010, National Bureau of Economic Research, Inc. Full references (including those not matched with items on IDEAS)
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