THE EMPIRCAL STUDY OF CURRENCY SUBSTITUTION ON REOPENED FORWARD EXCHANGE MARKET IN TAIWAN

• Main Authors: Huang Chia-Wen, 黃佳雯
• Other Authors: 蕭文宗
• Format: Others
• Language: zh-TW
• Published: 2004
• Online Access: http://ndltd.ncl.edu.tw/handle/64516302936218743551

碩士 === 國立臺北大學 === 經濟學系 === 92 === With financial liberation and yearly increasing in income, foreign currency deposits increased. The ratio of foreign to domestic currency deposits elevated gradually. If there is currency substitution, the central bank will lose partial independence in monetary policy even if the regime of floating exchange rate is adopted. We utilized forward exchange premium as the variation of exchange rate to detect the relationship (between the expected changes in exchange rate and the ratio of monetary assets) and to examine currency substitution. Because the forward exchange market is not reopened until November 1991, we made the study by using the monthly data of Taiwan from November 1991 to December 2003. Following the portfolio balance model of Rodriguez and Turner (2003), we apply Johansen-Juselius’s cointegration method to find out the long-run relationship between the ratio of assets and other variables (including domestic interest rate, foreign interest rate, domestic income, and the rate of change of the exchange rate). It is found that there is only one cointegrating vector among the variables and the coefficient of the rate of change of the exchange rate is positive and statistically significant. That means currency substitution indeed exists in Taiwan. When domestic expected rate of depreciation soared, the foreign currency deposits increased relative to domestic currency deposits. According to β restriction test, foreign interest rate, domestic income and foreign exchange variation rate have severe impact in long run. In short-run dynamic model, the coefficient of error correction is negative significantly, which means the system can adjust toward equilibrium while in disequilibrium. With diagnosis test conducted, this portfolio balance model seems to be a good fit. In accordance with the money-in-the-utility model provided by Imrohorglu (1994), we may assume the utility function of representative agent is separable and linear in consumption and liquidity service. Using the data at the same period, Hansen’s (1982) GMM procedure is implemented to estimate the parameters of the Euler equations, obtained by solving the problem that representative maximized utility function. The results show that elasticity of substitution between domestic and foreign currency is relatively high and statistically significant, because domestic residents’ foreign currency demands are quite sensitive. Once the marginal substitution changes somewhat, the asset ratio will fluctuate extremely. This paper successfully provides a consistent result, currency substitution indeed exists in Taiwan after the foreign exchange market reopened, either using the portfolio balance model or the money-in-the-utility model.