A Simple Explanation of Biased Movements of Renminbi Exchange Rate

International Journal of Financial Engineering, Vol. 05, No. 04, 1850040 (2018)

18 Pages Posted: 8 Jan 2019 Last revised: 20 Jan 2019

See all articles by Cho-Hoi Hui

Cho-Hoi Hui

Hong Kong Monetary Authority - Research Department

Chi-Fai Lo

The Chinese University of Hong Kong

Date Written: December 26, 2018

Abstract

The central parity of the renminbi is determined by the closing rate on the previous day according to the central parity formation mechanism following the August 2015 reform. This paper develops a simple model to study how this mechanism affects the currency’s exchange rate dynamics. The central parity is shown to be under monotonic decay or growth conditional on its rate relative to the expected exchange rate determined by a generic stochastic process. Such dynamics requires the central bank to engage in vigorous intra-marginal intervention to halt currency depreciation (or appreciation). Such upward (or downward) bias will disappear if a randomizing factor subject to market conditions is incorporated into the mechanism. The analysis is consistent with the observations in the renminbi foreign exchange market, and the theories and results in the previous studies on target zones.

Keywords: China’s exchange rate policy, renminbi, target zones, stochastics

JEL Classification: F31, G13

Suggested Citation

Hui, Cho-Hoi and Lo, Chi-Fai, A Simple Explanation of Biased Movements of Renminbi Exchange Rate (December 26, 2018). International Journal of Financial Engineering, Vol. 05, No. 04, 1850040 (2018). Available at SSRN: https://ssrn.com/abstract=3306483

Cho-Hoi Hui (Contact Author)

Hong Kong Monetary Authority - Research Department ( email )

Hong Kong
China

Chi-Fai Lo

The Chinese University of Hong Kong ( email )

Department of Physics
Shatin, N.T., Hong Kong
China

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