Convertibility restriction in China’s foreign exchange market and its impact on forward pricing
In contrast to the well established markets such as the dollar-euro market, recent CIP deviations observed in the onshore dollar-RMB forward market were primarily caused by conversion restrictions in the spot market rather than by changes in credit risk and/or liquidity constraint. This paper proposes a theoretical framework by which the Chinese authorities impose conversion restrictions in the spot market in an attempt to achieve capital flow balance, but face the tradeoff between achieving such balance and disturbing current account transactions. Consequently, the level of conversion restriction should increase with the amount of capital account transactions and decrease with the amount of current account transactions. Such conversion restriction in turn places a binding constraint on forward traders’ ability to cover their forward positions, resulting in the observed CIP deviation. More particularly, the model predicts that the onshore forward rate will equal a weighted average of the CIP-implied forward rate and the market’s expectation of the future spot rate, were the weighting is determined by the level of conversion restriction. As a secondary result, the model also implies that offshore non-deliverable forwards reflect the market’s expectation of the future spot rate. Our empirical results are consistent with these predictions.
|Date of creation:||27 Nov 2012|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: + 358 10 831 2268
Fax: + 358 10 831 2294
Web page: http://www.suomenpankki.fi/bofit_en/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Yin-Wong Cheung & XingWang Qian, 2010.
"Capital Flight: China's Experience,"
062010, Hong Kong Institute for Monetary Research.
- Guonan Ma & RobertN McCauley, 2008. "Efficacy Of China'S Capital Controls: Evidence From Price And Flow Data," Pacific Economic Review, Wiley Blackwell, vol. 13(1), pages 104-123, 02.
- Q. Farooq Akram, & Dagfinn Rime & Lucio Sarno, 2005.
"Arbitrage in the foreign exchange market: Turning on the microscope,"
2005/12, Norges Bank.
- Akram, Q. Farooq & Rime, Dagfinn & Sarno, Lucio, 2008. "Arbitrage in the foreign exchange market: Turning on the microscope," Journal of International Economics, Elsevier, vol. 76(2), pages 237-253, December.
- Akram, Q. Farooq & Rime, Dagfinn & Sarno, Lucio, 2006. "Arbitrage in the Foreign Exchange Market: Turning on the Microscope," SIFR Research Report Series 42, Institute for Financial Research.
- Akram, Farooq & Rime, Dagfinn & Sarno, Lucio, 2008. "Arbitrage in the Foreign Exchange Market: Turning on the Microscope," CEPR Discussion Papers 6878, C.E.P.R. Discussion Papers.
- Guonan Ma & Corrinne Ho & Robert N McCauley, 2004. "The markets for non-deliverable forwards in Asian currencies," BIS Quarterly Review, Bank for International Settlements, June.
- Fung, Hung-Gay & LEUNG, Wai K. & Zhu, Jiang, 2004. "Nondeliverable forward market for Chinese RMB: A first look," China Economic Review, Elsevier, vol. 15(3), pages 348-352.
- Holmes, Mark J., 2001. "Some new evidence on exchange rates, capital controls and European Union financial integration," International Review of Economics & Finance, Elsevier, vol. 10(2), pages 135-146.
When requesting a correction, please mention this item's handle: RePEc:hhs:bofitp:2012_028. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Päivi Määttä)
If references are entirely missing, you can add them using this form.