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Modelling Opportunity Cost Effects in Money Demand due to Openness

Author

Listed:
  • Sophie van Huellen

    (Department of Economics, SOAS University of London, UK)

  • Duo Qin

    (Department of Economics, SOAS University of London, UK)

  • Shan Lu

    (School of Economics and Management, Beihang University, China PR.)

  • Huiwen Wang

    (School of Economics and Management, Beihang University, China PR.)

  • Qingchao Wang

    (Department of Economics, SOAS University of London, UK)

  • Thanos Moraitis

    (Department of Economics, SOAS University of London, UK)

Abstract

We apply a novel model-based approach to constructing composite international financial indices (CIFIs) as measures of opportunity cost effects that arise due to openness in money demand models. These indices are tested on the People’s Republic of China (PRC) and Taiwan Province of China (TPC), two economies which differ substantially in size and degree of financial openness. Results show that a) stable money demand equations can be identified if accounting for foreign opportunity costs through CIFIs, b) the monetary policy intervention in the PRC over the global financial crisis period temporarily mitigated disequilibrating foreign shocks to money demand, c) CIFIs capture opportunity costs due to openness more adequately than commonly used US interest rates and d) CIFI construction provides valuable insights into the channels through which foreign financial markets affect domestic money demand.

Suggested Citation

  • Sophie van Huellen & Duo Qin & Shan Lu & Huiwen Wang & Qingchao Wang & Thanos Moraitis, 2019. "Modelling Opportunity Cost Effects in Money Demand due to Openness," Working Papers 225, Department of Economics, SOAS, University of London, UK.
  • Handle: RePEc:soa:wpaper:225
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    References listed on IDEAS

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    More about this item

    Keywords

    money demand; opportunity cost; open economy;

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • O53 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Asia including Middle East

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