Bonds of Swiss non-government borrowers offered higher daily excess returns ('alphas') than suggested by their sensitivities to standard risk factors over the sample period from 2007 to 2014. By contrast, comparable bonds (same currency denomination and credit rating category) issued by foreign entities did not offer significant risk-adjusted returns and exhibited markedly different sensitivities to Swiss and global risk factors. However, the positive risk-adjusted returns on Swiss bonds disappear when controlling for measures of uncertainty such as stock price volatility. Swiss bond prices rose when stock market volatility was high thus offering insurance in times of uncertainty.
This paper studies the ability of external imbalances to indicate subsequent exchange rate returns. We propose a simple twist of the Gourinchas and Rey (2007) approximation to the intertemporal budget constraint which is valid for countries that are net creditors (or net debtors) consistently throughout the sample. Our approach offers two advantages. First, it does not require the specification of trend shares for external assets, external liabilities, exports and imports. This avoids a potential source of measurement error and can make the approximation more accurate. Second, it can be applied to countries which have historically been simultaneously net exporters and net creditors (or equivalently net importers and net debtors) on average, with the usual assumption that the no-Ponzi condition is satisfied asymptotically. This is relevant for a number of countries, e.g. Switzerland, where the original Gourinchas and Rey (2007) approximation cannot be used. We find that measures of deviations from trends in Swiss net foreign assets and net exports provide signals for future Swiss franc nominal effective exchange rate movements, both in and out of sample.
Inflation expectations are a key variable in conducting monetary policy. However, these expectations are generally unobservable and only certain proxy variables exist, such as surveys on inflation expectations. This paper offers guidance on the appropriate quantification of household inflation expectations in the Swiss Consumer Survey, where answers are qualitative in nature. We apply and evaluate different variants of the probability approach and the regression approach; we demonstrate that models which include answers on perceived inflation and allow for time-varying response thresholds yield the best results; and we show why the originally proposed approach of Fluri and Spörndli (1987) has resulted in heavily biased inflation expectations since the mid-1990s. Furthermore, we discuss some of the key features of Swiss household inflation expectations, i.e. the fact that there has been a shift in expectation formation since 2000 (expectations are better anchored and less adaptive, and there is lower disagreement of expectations). We suggest that this may be linked to the Swiss National Bank's adjustment of its monetary policy framework around this time. In addition, we outline how expectation formation in Switzerland is in line with the sticky information model, where information disseminates slowly from professional forecasters to households.
We analyse nominal exchange rate and price dynamics after risk premium shocks with short-term interest rates constrained by the zero lower bound (ZLB). In a small-open-economy DSGE model, temporary risk premium shocks lead to shifts of the exchange rate and the price level if a central bank implements an inflation target by means of a traditional Taylor rule. These shifts are strongly amplified and become more persistent once the ZLB is included in the model. We also provide empirical support for this finding. Using a Bayesian VAR for Switzerland, we find that responses of the exchange rate and the price level to a temporary risk premium shock are larger and more persistent when the ZLB is binding. Our theoretical discussion shows that alternative monetary policy rules that stabilise price-level expectations are able to dampen exchange rate and price fluctuations when the ZLB is binding. This stabilisation can be achieved by including either the price level or, alternatively, the nominal exchange rate in the policy rule.
We sketch a model that shows how skill-biased technological change may reverse the classic Balassa-Samuelson effect, leading to a negative relationship between productivity in the tradable sector and the real exchange rate. In a small open economy, export goods are produced with high-skilled labor, in conjunction with capital and low-skilled labor, and are traded for imported consumption goods. Non-tradable services are produced with low-skilled labor only. A rise in the productivity of capital has two effects: (1) It may reduce the demand for labor in the tradable sector if the substitutability of low-skilled labor and capital in the tradable sector is high; and (2) it increases the demand for non-tradables and associated labor input. Overall demand for low-skilled labor declines if the labor force of the tradable sector is large relative to the labor force of the non-tradable sector. This leads to lower wages and thus to lower prices and real exchange rate depreciation.
We conduct an empirical investigation of the determinants of the Swiss franc real exchange rate. Theory and related empirical papers suggest various specific factors as potential determinants. We select some of these factors, and test their significance and magnitude in affecting the course of the CHF real exchange rate. Results stemming from a co-integration approach point to terms of trade and relative government spending as the most significant explanatory variables. Balassa-Samuelson effects do not play any significant role. Our results also confirm that this kind of empirical approach is sensitive to the choice of explanatory variables, panel countries and sample periods. In our case, the importance of GDP per capita and net foreign assets as explanatory variables depends on the inclusion in the panel of the JPY/CHF exchange rate.
This paper explores the robustness of behavioural equilibrium exchange rate (BEER) models, focusing on a panel specification with Swiss franc real bilateral rates as dependent variables. We use Bayesian model averaging to illustrate model uncertainty, and employ real exchange rates computed from price level data to explore robustness to the inclusion or exclusion of fixed effects. We find that the estimated coefficients - and therefore also the implied equilibrium values - are sensitive to (1) the combination of explanatory variables included in the model, (2) the set of currencies included in the panel and (3) the inclusion of fixed effects. Increases in government consumption and net foreign assets and improvements in the terms of trade in Switzerland relative to foreign countries are associated with a Swiss franc real appreciation, as predicted by economic theory. By contrast, several macroeconomic variables commonly thought to be linked to real exchange rates are found not to exhibit a robust relationship with Swiss franc real rates. Our findings can help policymakers in understanding the uncertainty associated with estimates of equilibrium exchange rates.
This study describes a compact dynamic stochastic general equilibrium (DSGE) model fitted for the Swiss economy with Bayesian techniques. The model features two economies (small home economy, large foreign economy), five types of agents (households, producers of tradables, producers of non-tradables, retailers, monetary authority), nominal and real frictions, and a number of shocks. The study gives details on the specification and the estimation of the model. The evaluation is based on impulse responses and variance decompositions, a DSGE-VAR to assess misspecifications, and results of forecasting experiments. The model is one of the tools used for policy analysis and forecasting at the Swiss National Bank.
In this empirical study, we analyze the relationship between carry trade positions and some key financial as well as macroeconomic variables using a multivariate threshold model. It is often stated that the Swiss franc serves as a funding currency. We therefore focus on carry trades based on the USD/CHF and EUR/CHF currency pairs over the period from 1995 to mid-2008. We conclude that carry trades are driven to a large extent by changes in investors' risk sentiment, movements in stock market prices and exchange rate fluctuations. The adjustments of carry trade positions to unexpected movements in these variables vary between periods of high and low interest-rate differentials (IRD). While a positive shock to the IRD is followed by a rise in carry trade positions during a period of low IRD, it will trigger a decline in these positions during a period of high IRD. These results suggest that the shock to the IRD itself is not enough to compensate investors for the increased foreign exchange risk. Moreover, a positive stock market price shock is associated with a rise in carry trade positions, since investors may use stock portfolios as collateral for liquidity. A sudden unwinding of carry trades leads to significant Swiss franc appreciation. Furthermore, carry trade activities 'Granger-cause' the nominal exchange rate in periods of low IRD. The Granger causality test results further indicate feedback trading.
Some observers argue that increased real integration has led to greater co-movement of prices internationally. We examine the evidence for cross-border price spillovers among economies participating in the pan-Asian cross-border production networks. Starting with country-level data, we find that both producer price and consumer price inflation rates move more closely together between those Asian economies that trade more with one another, ie that share a higher degree of trade intensity. Next, using a novel data set based on the World Input-Output Database (WIOD), we examine the importance of the supply chain for cross-border price spillovers at the sectoral level. We document the increasing importance of imported intermediate inputs for economies in the Asia-Pacific region and examine the impact on domestic producer prices of changes in costs of imported intermediate inputs. Our results suggest that real integration through the supply chain matters for domestic price dynamics in the Asia-Pacific region.
