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Assessment on estimations of currency basket weights—With coefficient correction for common factor dominance

Ping Wang and Peijie Wang

International Journal of Finance & Economics, 2022, vol. 27, issue 1, 1401-1418

Abstract: This paper proposes an approach to correcting parameter misrepresentation under the dominance of a common factor, a customarily overlooked phenomenon. Meanwhile, it provides a general solution to a specific regression bias, namely coefficient correction for common factor dominance in econometrics, which is commonly encountered in the research on currency interactions and co‐movements and beyond. The RMB basket weights are then scrutinized exhaustively, going through all stages of the evolving RMB regime and reforms. Correct and sensible currency basket weights are derived accordingly. It has been found that only the introduction of the central parity regime in 2015 has changed the RMB exchange rate patterns notably. The RMB market behavior and patterns virtually did not change during the prior reforms that had widened the band of daily fluctuation in the RMB exchange rate against the US dollar from 0.3% through to 2%, given the band's unique link to the US dollar.

Date: 2022
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