Wednesday, May 26, 2004

Blog Recommendation Edition: OUBS blog and Blame India Watch

Every once in a while it's good to read new blogger material. Two of my recent finds are OUBS Blog which is an business interest blog and Blame India Watch Blog.

For instance OUBS Blog has saved me the trouble of writing an article about foreign exchange rate mechanisms because they have already done so.

Forecasting foreign exchange rates

Unless you want to hedge all your currency exposure, you need to think about how to decide when to do it. There are four concepts that are said to explain international exchange rates, forming the four-way equivalence model together.

The purchasing power parity (PPP) is based on the idea that something should cost the same everywhere. Higher inflation will lead to adjustments in the exchange rates so that things cost the same again. In the short term, there are too many market imperfections for PPP to hold, but it does seem to work for the long term.

The fisher effect can be put into a formula:
1 + Nominal rate = (1+Real rate)(1+Expected inflation rate)
The real rates are thought to be the same worldwide, meaning that differences in nominal rates have to come from differences in the expected inflation rate.

The fisher effect together with PPP makes up the International Fisher effect, saying that interest rate differentials will be reflected in forward exchange rates. This means that on top of a devaluaton of the home currency in case of higher inflation, there will also be an increase in home interest rate relative to the foreign market.

The interest rate parity theory (IRP) is about the idea that the difference between interest rates should be equal to the difference between forward and spot rates of exchange. The arbitrage relationship is key to this parity condition.

Expectations theory is linked to the EMH, meaning all relevant information is reflected in market rates. So the forward rate of exchange reflects what the spot rate in the future will be. All these four theories together give the four-way equivalence model, meaning that they all come to the same conclusion. (Forward - Spot rates = interest rates difference)

There is actually a Big Mac index, linked to PPP, which actually allows some prediction on future movements. Yes, that's the price of Big Macs in different countries.

To forecast future exchange rates, some look at movements in a country's capital account (movements in financial investments) and current account (movements of import and export). e.g. if the current account goes into a deficit, there will be a bigger demand for foreign currency to pay for those imports and that will put pressure on the exchange rate.

The monetarist approach is about looking at the money supply.

Technical analysis is rather about a long term study of the market over time, with the chartists using graphics of prices and trading volumes. They believe the market takes long to reflect new information, while fundamental analysts state that the EMH would not allow for such a thing to take place. The EMH might not hold on the currency markets though as some countries might support a set currency over the long term.

If you have different estimates you can combine them in currency histograms, weighting them by their perceived reliability.

Read the rest, it's great. Blame India Watch on the other hand is dedicated toward outsourcing and business issues related to India.

Or, "Country, or Corporation: Whose War is This, Anyway?"

Though it's now passed into Last Week's News (hey! a new segment idea for BIW?) at least someone is still thinking about the issue of mistreatment of Indian staffers and military contractors. BIW brought up the issue in the wake of news about mistreatment of Indian staffers and military contractors, as it broke.

These are nice sites. Next however I think I'll respond to Dan Drezner's Foreign Affairs Magazine piece on outsourcing and address the FPIF piece that discusses the same topic. Both of these are long articles so it's going to take some time to go through them bit by bit.


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