As is by now well-known, the exchange rate regimes that countries follow in practice (de facto) often depart from the regimes that they announce officially (de jure). Many countries that say they float and/or fix in fact intervene heavily in the foreign exchange market. Countries that say they target a basket of major currencies, effectively fiddle with the weights.
Once such currency is the Kuwaiti Dinar(KWD). In May 2007, Kuwait de-pegged the Dinar from the USD after being at parity with it, within a band of ±3.5% starting at 299.63 fils. The primary reason that marked the KWD’s shift towards an unknown basket of currencies was to hedge against the negative impact of a single currency on KWD that renders it uncompetitive.
Employing Frankel and Wei’s (2008) methodology in tandem with Bai and Perron’s technique (1998) for assessing and dating structural breaks in the co-efficients in a regression model, we learn that akin to currencies de-pegging from a single currency, the switch wasn’t immediate. Shah, Zeileis and Patnaik (2005) found similar results in their study of the chinese yuan regime. In our study, in the three months post the switch, there is clear evidence of a tight USD peg as the regression renders all other co-efficients insignificant.
Breaks have been identified four times since 2007, with the latest in effect since 12 November 2010. An interesting development has been the broadening of the basket since its inception; accounting for currencies of countries that are Kuwait’s trading partners. The basket composition thus derived is: USD 73.46%, EUR 11.55%, JPY 3.3%, CNY 6.42%, INR 1.98%.
To monitor for future structural breaks as suggested by Shah et al (2005), it becomes imperative to be able to forecast the movement of KWD along with its basket components. Finally, robustness checks are of paramount importance in order to determine the accuracy of the models via back-testing.
Bai, J., Perron, P., 1998. Estimating and Testing Linear Models with Multiple Structural Changes. Econometrica, 22(1), pp. 47-78.
Frankel, J.A., Wei, S-J., 2008. Estimation of De Facto Exchange Rate Regimes: Synthesis of the Techniques for Inferring Flexibility and Basket Weights. National Bureau of Economic Research (Working Paper 14016).
Shah, A., Zeileis, A., Patnaik, I. 2005. What is the New Chinese Currency Regime?. Research Report Series / Department of Statistics and Mathematics, 23.
Kuwaiti Dinar history <www.cbk.gov.kw>
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