Convertibility restriction in China s foreign exchange market and its impact on forward pricing
Yi David Wang
No 28/2012, BOFIT Discussion Papers from Bank of Finland, Institute for Economies in Transition
In contrast to the well established markets such as the dollar-euro market, recent CIP deviations observed in the onshore dollar-RMB forward market were primarily caused by con-version restrictions in the spot market rather than by changes in credit risk and/or liquidity constraint. This paper proposes a theoretical framework by which the Chinese authorities impose conversion restrictions in the spot market in an attempt to achieve capital flow balance, but face the tradeoff between achieving such balance and disturbing current account transactions. Consequently, the level of conversion restriction should increase with the amount of capital account transactions and decrease with the amount of current account transactions. Such conversion restriction in turn places a binding constraint on forward traders' ability to cover their forward positions, resulting in the observed CIP deviation. More particularly, the model predicts that the onshore forward rate will equal a weighted average of the CIP-implied forward rate and the market's expectation of the future spot rate, were the weighting is determined by the level of conversion restriction. As a secondary result, the model also implies that offshore non-deliverable forwards reflect the market's expectation of the future spot rate. Our empirical results are consistent with these predictions. Keywords: forward foreign exchange, China, convertibility JEL: F30, F31, F33.
JEL-codes: F30 F31 F33 (search for similar items in EconPapers)
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed
Published in Published in Journal of Banking and Finance, Volume 50, January 01, 2015, Pages 616-631.
Downloads: (external link)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:bof:bofitp:2012_028
Access Statistics for this paper
More papers in BOFIT Discussion Papers from Bank of Finland, Institute for Economies in Transition Bank of Finland, BOFIT, P.O. Box 160, FI-00101 Helsinki, Finland. Contact information at EDIRC.
Bibliographic data for series maintained by Minna Nyman ().