Empirical Exercise: Predicting the Weights in RMB Currency Basket

You have a spread sheet of daily data on exchange rates, against the Swiss Franc and the Australian Dollar, for the following countries:

US, China, Japan, Great Britain, Euro Zone, Korea, Canada, Malaysia, Russia, Thailand, and Singapore.

The question of this exercise is to see if we can infer how the Chinese are moving their “adjustable” peg against the dollar. To do so we have to find a “numeraire” currency. Many economists recommend the Swiss Franc or the Australian Dollar, since the Chinese have stated that neither of these currencies are being used in their peg.

We have the daily data in levels. We are interested in how the peg is being adjusted from day to day. We thus have to convert the levels of the exchange rate each day to daily rates of changes. In the spreadsheet, data.xlsx, you will find the series. For each exchange rate, start a new column, converting the rate to a daily rate of change. For example, in column B we find the US D against the Swiss Franc, starting at row 4. Go to the far end of the spread sheet, starting in column AB, and in row 5, insert the command, ‘=ln(B5)-ln(B4)’. This converts the dollar/franc series to a daily rate of change. This spreadsheet ends in Oct. 2014.

We are interested in the correlations through time, specifically before and after July 2005, between the RMBI-Swiss Franc exchange rate and the US Dollar/Swiss Franc exchange rate. We would expect to find a high correlation of these two before July 2005, with a low correlation between the RMBI-Swiss Franc and the other currencies with respect to the Swiss Franc. After July 2005 we would expect the correlations between the RMBI and Swiss Franc and US Dollar to Swiss Franc to be lower, with a higher correlation between the RMBI/Swiss Franc and the other currencies to the Swiss Franc. **Which ones have higher correlations and thus figure into the still unknown basket-indexing schemes of the Peoples Bank of China?**

**Find the correlations, we can use excel data analysis package. Click on data analysis on tools, hit correlations, fill in the ranges of the variables in the spreadsheet. You will see that the correlations differ through time, if you put in different ranges depending on the dates.**

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A correlation coefficient is not a weight in the exchange rate index of the People’s Bank of China. We can obtain regression coefficients (weights) by hitting in the regression package. In this case copy your transformed data to a new sheet. Just take the data relevant to the Swiss Franc in daily rates of change. Put in the first column the RBMI/Swiss Franc exchange rate and in the other columns the dollar and other currencies against the Swiss Franc. Under regress, take the RMBI/Swiss Franc column as the Y variable and the columns and rows for the other variables as the X matrix. Take the whole period and then sub-periods and click on regress. You will obtain some interesting results. But surprisingly the weight on the dollar in the Chinese basket-indexing scheme does not change very, very much. China is still linking to the dollar very strongly in their currency basket.

**Examine the coefficients, how they vary across sub-periods and report your results in a short essay. Remember no spread sheet Xeroxing. Just a few paragraphs and a well designed table, or graph, with regression coefficients. . Use your creative imagination.**

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Subject | Business |

Due By (Pacific Time) | 10/15/2015 12:00 am |

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