Investigation on transition of RMB forward exchange rate pricing mechanism based on error correction model with structural mutation

Abstract

The offshore RMB market has been showing a momentum of rapid development. However, the impact of this market on the RMB exchange rate has been less studied. This paper constructs an error correction model with structural mutations and focuses on the turning point for RMB Forward Rate, during the time before and after September 2011. The model is constructed considering the micro-institutional differences between domestic and offshore RMB forward exchange rates, the impact of spreads, the impact of spot exchange rates and international financial market shocks such as the VIX index of the US dollar index. We also apply the error correction model with abrupt changes method to select the model which is innovative. According to the results of the model, the domestic RMB foreign exchange derivatives market and the offshore RMB foreign exchange derivatives market jointly played a leading role in price discovery in the determination of both short-term and long-term RMB forward exchange rates, and we also found September 2011 was an important structural change point for the RMB forward curves both domestic and abroad. Before that period, interest rate parity did not play a positive role and the NDF exchange rate occupied the dominant role in price discovery; the domestic RMB forward exchange rate and the overseas NDF exchange rate were both driven by speculative factors.