International Parity Relations and Economic Shock: Evidence from Swiss Franc Unpegging

Abstract

In this paper, we examine the association between the macroeconomic variables -interest and inflation rate, and the expected spot rate of Swiss franc against Euro around the abandonment of the ceiling on the Swiss franc by the Swiss National Bank (SNB), January 15, 2015, using the two international parity relationships, International Fisher effect (IFE) and Purchase Power Parity (PPP). We use the regression analysis to examine the significance of change in daily interest rates and monthly inflation rates on the change in actual daily spot rates. While our empirical results indicate no significant statistical relationship between the two inputs before unpeg period, our additional analysis examining both the magnitude and directional deviation of the actual spot rate compared to the spot rate for both unpeg and peg period predicted using the two parity relations suggest that spot rates predicted based on the IFE relations, in general, is relatively better in predicting the daily spot rate compared to that of the PPP relations. Although both parity relations are not perfect models for predicting daily exchange rates, they can be used as a framework to guide financiers to gain additional insight regarding the short-term directional trend of the spot rate.

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“…If trade barriers were lifted, this would usually occur bilaterally so that the ratio of export to import prices was not strongly affected. The appreciation of the Swiss franc to most other currencies between 2009 and 2011 (Jo et al , 2016) may have had some, however limited, impact on the ratio. Similarly, changes in productivity in Switzerland during the last few decades have been more or less in pace with worldwide developments.…”

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“…Frenkel (1979Frenkel ( , 1981aFrenkel ( , 1981b reported that, whilst PPP did little to explain U.S. dollar versus European currency exchange rates in the short-run, PPP did perform much better as an explanatory of exchange rate behavior between sets of European currencies. Adding to Frenkel"s research and motivated by a dearth of academic literature on parity relations" validity as a predictor of daily spot rates in the short-term, Jo et al (2016), explored whether PPP and IFE were viable frameworks to predict the expected spot rate of Swiss franc against the Euro following the unpegging of the Swiss franc by the Swiss National Bank in January 2015. They concluded that whilst PPP and IFE were not perfect predictor models, they still proved very useful to gain an insight into the directional trend of spot rates in the short-term.…”

“…They concluded that whilst PPP and IFE were not perfect predictor models, they still proved very useful to gain an insight into the directional trend of spot rates in the short-term. As our study is also reviewing relationships between economic variables in Europe the observations of Frenkel (1981b) and Jo et al (2016) are particularly relevant. One conclusion Frenkel formed is that closer geographic proximity allowed lower transportation costs and, when coupled with lower trade barriers, allowed more rapid correction of exchange rates in response to changes in the inflation rate differential.…”