Description

Group Project (only 2 or 3 students in a group)

Research Topics

1.      Test whether the conventional theory of forward exchange or modern theory of forward exchange rate holds for Saudi Arabia by estimating the following equations:

ft = α+βf*t+ ut                                Keynesian Theory of Forward Exchange Rate

ft = α+βf*t+ γst+1+ut                      Modern Theory of Forward Exchange Rate

ft is the logarithm of the actual forward rate (F), F* is the logarithm of of the interest parity forward rate (F* = [S((1+r/400)/(1+r*/400))]). The above relationship states that the logarithm of the actual forward exchange rate (e.g. 3-month) is determined by the logarithm of the current spot exchange rate adjusted for the interest rate differential (3-month domestic and foreign treasury bill rates). The interest rates must be de-annualized, since they are always quoted on annual basis.

(i)                 Collect quarterly data on 3-month outright forward and spot exchange rates vis-à-vis the US dollar, British pound, Swiss franc and euro and LIBOR rates (US dollar, the British pound and Swiss franc) and the relevant interest rate for Saudi Arabia or Kuwait over the period 2000q1-2018q4.

(ii)               Use cointegration analysis to test whether the theory of forward exchange holds in the long run and interpret your results.

(iii)             What conclusion would you derive from these results?

References

(i)           Moosa, I.A. and Bhatti, R.H. (1994), “Testing the Effectiveness of Arbitrage and Speculation under Flexible Exchange Rates", Economia Internazionale, 47, 393-408.

(ii)           Callier, P (1980), Speculation and the forward foreign exchange rate: a note, Journal of Finance

2.      Test exchange-rate pass through between Saudi Arabia and its trading partners (China, India, Japan, South Korea and Euro Area) by testing purchasing power parity theory and an extended model of Exchange Rate Pass-Through, which are given as follows:

log Pt = β0 + β1log P*t + β2log St +ut

log Pt = β0 + β1log P*t + β2log NERt + β3log Mt + β4log Poilt+ut

References

(i)                Bhatti, R.H. (1996), “A Correct Test of Purchasing Power Parity: The Case of Pak-rupee Exchange Rates”, Pakistan Development Review, Papers and Proceedings, 35, 671-682.

(ii)             Campa, J. M. & Goldberg, L. S. (2005). “Exchange Rate Pass-Through into Import Prices”. Review of Economics and Statistics, 87(4), 679-690.