Author: Isabel Ruiz (Ph. D.)

Publisher:

Published: 2006

Total Pages: 290

ISBN-13:

During the last decade, Latin American countries have moved towards becoming more open and financially integrated. At the same time, the region has appeared to adopt a "bipolar" position concerning exchange rate regimes. Most countries have moved towards more flexible exchange rates, while others have implemented hard pegs in the form of dollarization. This dissertation has two goals. First, to measure linkages and dynamics across Latin American foreign exchange markets. Second, to explore how exchange rate uncertainty impacts U.S. foreign direct investment (FDI) into Latin America. In order to study interactions among these markets, I focus on the level of the currency and a measure of its volatility. I test for first and second order common features: common stochastic trends and common volatility. Evidence of common features in the foreign exchange markets has substantial implications. From a macroeconomic perspective, they indicate movements toward financial integration. From the point of view of investors, it has implications in terms of the assessment of risk and the development of hedging strategies. The existence of common stochastic trends is analyzed across countries, trade areas, and over different periods of time using Johansen (1991, 1995) and Gregory and Hansen (1996) cointegration tests. The existence of a common volatility process is tested using a factor autoregressive heteroscedastic (ARCH) model and the Engle and Kozicki (1993) methodology. The evidence suggests that most countries' currencies are cointegrated with the Brazilian real. This finding implies that the Brazilian real displays useful information about the long-run path of other currencies in the region. In terms of volatility dynamics, while most currencies display evidence of time-varying variance, the volatility movements in the foreign exchange market seems to be mainly country specific. Finally, I analyze the impact of exchange rate changes and exchange rate uncertainty on U.S. FDI inflows into Latin America. Following Engle and Lee (1999), exchange rate uncertainty is decomposed into a transitory and a permanent component. While controlling for other foreign investment determinants, the results indicate that exchange rate uncertainty appears to be detrimental to FDI inflows.