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Determinants and Dynamics of Price Disparity in Onshore and Offshore Renminbi Forward Exchange Rate Markets

Ka Fai Li, Cho-Hoi Hui and Tsz-Kin Chung
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Cho-Hoi Hui: Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research
Tsz-Kin Chung: Hong Kong Monetary Authority

No 242012, Working Papers from Hong Kong Institute for Monetary Research

Abstract: Price disparities between the renminbi onshore deliverable forward and offshore non-deliverable forward exchange rates is an intriguing puzzle in financial economics. This paper investigates the determinants of these price disparities focusing on the possibility of parameter uncertainty. In the presence of information asymmetry and market segmentation among onshore and offshore investors, it is possible that they formulate different views on the Mainland economy which translate into a different assessment of the outlook for Mainland interest rates. Through a no arbitrage condition that relates the forward rate to the spot rate and interest rate differential, a different assessment of the path of interest rates can lead to a different valuation of forward prices. We estimate a term structure model for the implied renminbi interest rate using a Bayesian approach, in which investors¡¯ model parameter uncertainty is represented by the posterior standard deviation of the volatility of the interest rate. We show that parameter uncertainty can help to explain price disparities, in addition to market-wide aggregate uncertainty and illicit capital flows in the Mainland¡¯s balance of payment.

Keywords: Price Disparity; Renminbi Forward Exchange Rates; Onshore and Offshore Markets; Spot Rate Model (search for similar items in EconPapers)
JEL-codes: C11 F31 G15 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2012-10
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