Detecting Currency Manipulation: An Application of a State-Space Model with Markov Switching

33 Pages Posted: 25 Mar 2018 Last revised: 5 Aug 2018

Date Written: July 31, 2018

Abstract

Following an idea of Milton Friedman’s "plucking model," we propose to use a state-space model with Markov switching as an auxiliary tool for detecting currency manipulation. Without imposing any a priori restrictions, our model tests if fluctuations of a country’s exchange rate are symmetric or if there exists a time-varying support level or resistance level of exchange rate. Using weekly and monthly data of countries on the "monitoring list" of the US Treasury as of April 2017, we find that exchange rates of China, South Korea, Switzerland, and Taiwan rarely fall below their time-varying trends, but are plucked upward from time to time by transitory shocks, suggesting that the FX (foreign exchange) authorities of these countries may have been intervening more actively against appreciation shocks. Our subsample analysis reveals that our model accurately captures the period of Switzerland's minimum exchange rate policy with probability of one and Japan’s exchange rate rarely falls below its trend after implementing Abenomics. We discuss the difficulties of detecting FX intervention along with the relative advantage of our approach.

Keywords: Plucking Model, State-Space Model, Asymmetry, FX (Foreign Exchange) Intervention

JEL Classification: C32, E60, F31

Suggested Citation

Park, Ki Young and Kim, Soohyon, Detecting Currency Manipulation: An Application of a State-Space Model with Markov Switching (July 31, 2018). Available at SSRN: https://ssrn.com/abstract=3148952 or http://dx.doi.org/10.2139/ssrn.3148952

Ki Young Park (Contact Author)

Yonsei University ( email )

Yonsei University
Seoul
Korea, Republic of (South Korea)

Soohyon Kim

The Bank of Korea ( email )

39, Namdaemun-ro, Jung-gu
Seoul, 04531
Korea, Republic of (South Korea)

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