Determinants of foreign exchange rate case of vietnamese dong and japanese yen

The main research question identifies 1 WhichVietnamese and Japanese macroeconomics variables determine the VND/JPYexchange rate; 2 What the role of the Japanese Yen plays in the economi

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT

ECONOMICS

DETERMINANTS OF FOREIGN EXCHANGE RATE: CASE OF VIETNAMESE DONG AND

JAPANESE YEN

A thesis submitted in partial fulfilment of the requirements for the

degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

Mr TRAN VUONG TU

Academic Supervisor:

PhD NGUYEN HOANG BAO

HO CHI MINH CITY, MAY 2013

This thesis was written at the University of Economics Ho Chi Minh City Inaddition, it was completed in October 2013 During the process of writing, thepaper has gained a lot of experience in writing a thesis and in the area of foreignexchange rate analysis During the three months of writing this thesis, severalpersons have contributed in the different ways to the quality of this thesis andthe paper would like to take this opportunity to thank them

Firstly, the paper would like to thank our supervisor PhD Nguyen Hoang Baofor all the help, guidance, and support The paper would also like to expressgratitude to all professors of the Vietnam-Netherlands Program for the Master

in Development Economics and the classmates who offer to us some usefulsuggestions Finally, we express special thank to our families and partners fortheir love and support

Exchange rate not only plays a very important role in the economic policy of thegovernment of Vietnam in the process of integration into the world economy, butalso effects many exporters, importers, foreign investors, and commercialbanks in the international transaction

Japanese economy plays as important as having mainly economic relations withVietnamese economy in the export-import trade, foreign direct investment (FDI)capital, official development assistance (ODA), etc However, Vietnam governmentapplies the floating exchange rate policy between Vietnamese Dong and theJapanese Yen Therefore, the fluctuations of Vietnamese-Japanese exchange ratemight great impact on the trade and investment The exporters and importers of twocountries, Japanese investors, the commercial bankers that having internationalsettlement with Japanese Yen, are in need of defending the exchange rate riskvolatility of the exchange rate pairs

Our study enhance on analyzing and predicting the fluctuations of Japanese exchange rate The main research question identifies (1) WhichVietnamese and Japanese macroeconomics variables determine the VND/JPYexchange rate; (2) What the role of the Japanese Yen plays in the economicrelationship between Vietnam and Japan and (3) Which performance of themultiple regression model and the auto- regressive integrated moving averagemodel are in predicting the VND/JPY exchange rate Methodology focuses on themultiple regression model to define the determinants Moreover, our study test thereliability in the prediction between multiple regression model and auto-regressiveintegrated moving average model to examine the VND/JPY exchange rate data.Hence, auto-regressive integrated moving average model plays better forecastingperformance

Vietnamese-Key Words: VND/JPY exchange rate, multiple regression model, auto-regressive integrated moving average (ARIMA), Vietnamese Dong, Japanese Yen, Vietnam, Japan

TABLE OF CONTENTS

Table of contents 1

List of tables 3

List of figures 3

List of abbreviations 4

1 Chapter one: Introduction 5

1.1Background of study 5

1.2 Research question 7

1.3Research objective 8

1.4The outline of paper 8

2 Chapter two: Literature review 9

2.1Theoretical framework 9

2.2Empirical Studies 14

3 Chapter three: Methodology 17

3.1Data 17

3.2 The fundamental regression model 18

3.3Box-Jenkins’ auto-regressive integrated moving average model (ARIMA) 19

4 Chapter four: The impact of the Japanese Yen in the economic relationship between Vietnam and Japan 23

4.1Overview of the Vietnamese foreign exchange policy 23

4.2Overview of the Japanese foreign exchange policy 25

4.3The impact of the Japanese Yen in the trade, investment, and finance between Japan and Vietnam 27

5 Chapter five: Results: Descriptive data, multiple regression and ARIMA 32

5.1Descriptive statistics 32

5.2 The results and summary of findings 34

5.3Forecasting performance 38

6 Chapter six: Conclusions 41

6.1Summary of study 41

6.2Policy implication 42

6.3Limitation of our study and suggestion for further research 42

References 44

A ppend ix A 50

A ppend ix B 52

A ppend ix C 60

A ppend ix D 70

LIST OF TABLES

Tables 2.1 Description of economic indicators 12

Tables 2.2 Empirical Studies 14

Tables 3.1 Variable sources 17

Tables 3.2 List of variables 18

Tables 3.3 The autocorrelation function (ACF) and the partial autocorrelation function (PACF) patterns summary 20

Tables 4.1 Global foreign exchange reserves 26

Tables 4.2 History of the Japan's interventions in the foreign exchange rate 26

Tables 5.1 Description of the variables 32

Tables 5.2 Correlation test and Anova F-test 33

Tables 5.3 The result regression model 34

Tables 5.4 Wald Test 35

Tables 5.5 Unit Root Test 36

Tables 5.6 ARIMA statistical results 37

Tables 5.7 The VND/JPY forecasting performance 38

Tables 5.8 Testing of forecasting ARIMA 39

Tables 5.9 The advantages and disadvantages in the multiple regression and Auto- regressive integrated moving average model (ARIMA) 40

LIST OF FIGURES Figure 3.1 Box Jenkins Methodology for ARIMA modeling 19

Figure 4.1 Value of trade balance Vietnam-Japan 28

Figure 5.1 The plot of the monthly VND/JPY exchange rate 36

LIST OF ABBREVIATIONS

S.No abbreviation Description

2 ARIMA Auto-regressive integrated moving average

5 CIEM Central institute for economic management

9 GSO General statistics office of Vietnam

10 IFE International Fisher effect

11 IPI industrial production index

13 JVEPA Japan-Vietnam economic partnership agreements

14 LCO (WTI oil) Light crude oil (West Texas intermediate oil)

15 MFAJ Ministry of Foreign Affairs of Japan

16 MFJ Ministry of Financial of Japan

17 MPIV Ministry of Planning and Investment of Vietnam

19 NAEC National Assembly's economic Committee

20 ODA Official development assistance

21 PAF Partial autocorrelation function

27 VGDC Vietnam general department of customs

29 Vietcombank Joint stock commercial bank for foreign trade of Vietnam

CHAPTER ONE: INTRODUCTION

This paper presents the research projects including studies of users, targetresearch to identify the factors that influence the exchange rate between theVietnamese Dong and Japanese Yen Accordingly, fluctuations in foreignexchange rate have great impact on Vietnamese government, the exporters,importers, commercial banks, and Japanese investors In addition, they have aneed for the research prediction on foreign exchange rate Therefore, ourresearch focuses on analyzing and predicting the fluctuations in VND/JPYexchange rate by multiple regression and auto-regressive integrated movingaverage (ARIMA) Our finding is what determinants of VND/JPY exchange rate inVietnam

1.1Background of study

Vietnam economy increasingly integrated into the world economy in term oftrade and investment Therefore, exchange rate plays a very important role in theeconomic policy of the Vietnamese government Moreover, many exporters,importers, foreign investors, and commercial banks, that make theinternational transactions, are impacted by the fluctuations in foreign exchangerate Indeed, many countries fall into economic hardship due to unstableexchange rate, such as trade deficit, high inflation, increasingly foreign debts, etc.Therefore, the exchange rate has attracted special attention to the economists,politicians for the study and research In addition, the exchange rate hasbecome an important topic, which is discussed and analyzed on over the world.Many researches have done in order to predict and analyze the fluctuations inforeign exchange rate

An opening economy is towards the integration with the world economy aswell as Vietnamese economy According to the report on April 2013, VietnameseMinistry of Planning and Investment, issued "Comprehensive evaluation ofVietnam’s socio- economic performance five years after the accession to theWorld trade organization"

report1 This report has identified the economic policy focused on foreign trade

of Vietnam is following the trend of multilateral development cooperation.The International trade of Vietnam and the rest of world become very exciting.However, the Vietnam’s exchange rate policy used to concentrate onimplementing the pegged exchange rate policy between Vietnamese Dong andU.S Dollar, and keep floating alongside most of other exchange rates It createssome difficult, risky factors for exporters, importers, commercial banks, andforeign investors during the international payment process for non-dollarcurrencies such as the Japanese Yen, Euro, and Australian Dollar etc.Indeed, the General statistics office of Vietnam on the international trade inVietnam in 2012 said that Vietnam has many international economies Besidethe United State of America as Vietnam’s largest trade partner with two-waytrade turnover reached US$ 27.6 billion, Vietnam still has many key tradingpartners such as Japan (approximately U.S Dollar 24.6 billion, 11.1% ofVietnamese total trade)2, South China (U.S Dollar 19.5 billion) and the Association

of Southeast Asian Nations (ASEAN)

Japan, in particular, is a country having highly economic relations withVietnam in many fields including export-import, foreign direct investmentcapital, Official development assistance, and etc According to theDepartment of Foreign Affairs under the Ministry of Planning and Investment,

in the years 2012-2013, Japan continues to be the largest donor of officialdevelopment assistance (ODA) for Vietnam with 40%3 of total officialdevelopment assistance (ODA) commitments to Vietnam According to theForeign investment agency under the Ministry of Planning and Investment, in

2012, Japan was the biggest foreign direct investment investor in Vietnam,accounted for 34.2%4 of total investment in Vietnam Thereby, indicating

1 ‘Comprehensive evaluation of Vietnam’s socio-economic performance five years after the accession to the World Trade Organization’ 2013, report 2013, Central institute for economic management,

Vietnamese Ministry of Planning and Investment

2 General statistics office of Vietnam 2013, Vietnam Export-Import report 2011-2012, Vietnam

3 Department of foreign affairs 2013, Official development assistance report 2011-2012, Ministry of

Planning and Investment in Vietnam

4 Foreign investment agency 2013, Foreign direct investment report 2011-2012, Ministry of Planning and Investment in Vietnam

the exchange rate fluctuations between the Vietnamese Dong and the JapaneseYen have great impact on Vietnam's economy in general and the exporters,importers, banks and Japanese investors in particular.

In studies related to the exchange rate between Vietnamese Dong and foreigncurrencies, normally only focused on fixed exchange rate policy betweenVietnamese Dong and the U.S Dollar There is virtually no study related to thepairs of floating exchange rate between Vietnamese Dong and the Japanese Yen

or Euro or Pound Considering the trade, economic relations, and investmentcooperation, the researches on the fluctuations in VND/JPY exchange rate plays

an important role in the trade policy between Vietnam and Japan, in the planningfor investment reception between Vietnam and Japan (official developmentassistance and foreign direct investment) It would be clearly explain in chapterfive In addition, the exporters, importers, Japanese investors, and commercialbanks have the international settlement with Japanese Yen They are in need ofdefending the exchange rate risk volatility of the exchange rate

Most of all, our study focuses on the analysis of determinants of foreignexchange rate Moreover, our study enhances for using the fundamental analysis

to define the determinants of the VND/JPY exchange rate by the multipleregression model and using the Auto-regressive integrated moving average toexamine the VND/JPY exchange rate Absolutely, our study investigates tofind out what determinants of VND/JPY exchange rate in Vietnam Besides that,our study further clarifies the role of the Japanese Yen in the economic relationshipbetween Vietnam and Japan

1.2 Research question

Hence, our study can suggest three-research questions as follows: (1) WhichVietnamese and Japanese macroeconomics variables determine the VND/JPYexchange rate; (2) What the role of the Japanese Yen plays in the economic

relationship between Vietnam and Japan and (3) Which performance of themultiple

regression model and the auto-regressive integrated moving average model are

in predicting the VND/JPY exchange rate

Our study enhances the multiple regression model and the auto-regressiveintegrated moving average model to econometric test the VND/JPY exchange rate.1.3Research objective

Our study identifies three objectives as follows: (1) to find out whichmacroeconomics variables determine the VND/JPY exchange rate; (2) to identifythe role of the Japanese Yen in the economic relationship between Japan-Vietnam and (3) To test forecasting performance of the multiple regressionmodel and the auto- regressive integrated moving average model in the VND/JPYexchange rate

The exporters, importers, Japanese investors, and commercial banks, that havethe international settlement with Japanese Yen, are our research objective Theyalways face to the exchange rate risk volatility of the exchange rate.Therefore, they are interested in which macroeconomics variables determine theVND/JPY exchange rate and how to use the econometric model in predicting theVND/JPY exchange rate

1.4The outline of paper

Our study is divided into five chapters as: chapter one briefs on the researchprojects including studies of users, target research to identify the factors Theyinfluence the exchange rate between the Japanese Yen and Vietnamese Dong.Chapter two presents many theories as the foundation for the study including theanalysis of the basic index of both countries (industrial index, consumer priceindex, interest rates, value of balance trade, prices of rice and prices of lightcrude oil) and auto-regressive integrated moving average model (ARIMA) Chapterthree presents research methods and research data Chapter four shows overviewthe foreign exchange rate policies of the two countries Vietnam and Japan.Moreover, it highlights the influence of the Japanese Yen in relation to

economic and trade between Vietnam and Japan Chapter five explains theresults of finding Finally, chapter six shows conclusion and further study.

CHAPTER TWO: LITERATURE REVIEW

Literature review is essentially an organized collection of theoretical frameworkand empirical studies Chapter two presents theories as the foundation for thestudy There is fundamental and technical analysis Fundamental analysisshows the multiple regression model to examine macroeconomic variables ofboth countries (industrial index, consumer price index, interest rates, value ofbalance trade, prices of rice, and prices of international crude oil) Technicalanalysis tests the VND/JPY exchange rate by auto-regressive integrated movingaverage (ARIMA)

2.1Theoretical framework

Two main theoretical frameworks will be discussed in this study: (1)Fundamental analysis is based on a thorough examination of macroeconomicvariables that have an impact on the currency; (2) Technical analysis is theopposite of fundamental analysis solely focuses on prices, and movements in thepast, ignoring the economic factors and policies Technical analysis focuses onprice action It is based on the history of the exchange rate It is expected that allthe essential information is already included in the price Our study enhancesthe Auto-regressive integrated moving average model in technical analysis.2.1.1Fundamental analysis on the multiple regression models

Faust, Rogers, and Wright (2003) emphasize that the exchange rates under afloating exchange rate depend on the demand and supply of a currency exchangerate If the delivery of the currency exceeded demand, the devaluation of thiscurrency and vice versa Depending on the asset market model shows "theexchange rate between two currencies represents the price that balances forshipments and demand for foreign currency denominated assets." theexpectations of the foreign exchange market and changes in the direction ofexpectations, changes in demand and supply of money and the exchange rate

They suggest two important theories: (1) purchasing power parity and (2)international Fisher effect.

The theory of purchasing power parity (PPP) initially formed by Cassel (1918),employs the long-term equilibrium exchange rate between the two currencies

to balance purchasing power in their home countries Therefore, the PPPexchange rate is the rate at which the two currencies are equal by removing thediscrepancies in the price levels between nations There are two versions ofpurchasing power parity theory: (1) the absolute version states that whenconverted into a common currency, the price levels in the world should beequal In other words, a unit of common currency at home should have thesame purchasing power worldwide; (2) the relative version says that depending

on the changes in the price levels between the two countries the exchangerate between home currency and foreign currency will be corrected to reflectthe changes in the price levels 5 The relative version can be presented asfollows:

et  e0 .(1  ih )

(1  i f)

(2.1)

where,

et is the spot foreign exchange rate in period t;

e0 is the foreign exchange rate at the beginning of the

period; ih is the inflation rate in the home nation; and,

if is the inflation rate in the foreign nation

The purchasing power parity is represented by the following approximation

(2.2)t

t

5 Shapiro, A.C Multinational Financial Management Seventh edition Wiley and Sons.

Rationally, purchasing power parity is that higher inflation may lead to a currencythat should depreciate against a country with low inflation6 Moreover, Zhangand Wu (2011) suggest that the price of good and products that the countryexports or imports are maybe affected the purchasing power Hence, purchasingpower parity suggests some economic variables that affect the change of theexchange rate such as the inflation, trade balance, the industrial, purchasingpower and the price of mainly export or import good.

The generalized version of impact international Fisher effect (IFE) said that aninterest rate higher than the share with a low inflation must withstand thecurrency with a high annual rate of inflation Differently, purchasing powerparity means that rates will move; match the changes in the differentialrates of inflation The combination of these two conditions is the effect ofinternational Fishermen International Fisher effect can be specified as:

(2.3)

where

rh is the interest rate in the home

country; rf is the interest rate abroad;

E(et ) is the expected foreign exchange rate at period t; and,

e0 is the foreign exchange rate at the beginning of the period t

Speculators will receive a positive return when they sell the currency ofeconomy X and buy the currency of economy Y, if the interest rate in theeconomy Y is lower than in economy X They expect the appreciation of thecurrency of economy Y This purchasing of currency of economy Y speculated orinvested in high-yielding assets The result is appreciation of the currency by theincreasing demand In the rational,

6 For example, if the rate of inflation in the country X is 15% and the inflation in country Y is 7%, the currency of country Y maybe appreciate roughly 8% compare of the currency of the country X.

the lower interest rate of a currency leads to a lower inflation rate It affectsthe price of currency Hence, the international Fisher effect said that interestrates have a significant effect on the exchange rate

Based on above theories, many economic indicators seem to be important toexplain movements in exchange rates Historically, Zhang and Wu (2011)suggested many indicators in examination of AUD/JPY exchange rate Theywere the gold price, oil price, Australian employment data, Australian consumerprice index (CPI), Australian gross domestic product (GDP), Australian tradebalance, Royal Bank of Australia (RBA) rate decisions, Japanese consumer priceindex (CPI), Japanese trade balance, Japanese industrial production index, andBank of Japan (BOJ) interest rate decisions Therefore, our study makes decisionfor applying some economic indicators to test the fluctuations in VND/JPYexchange rate as follows:

T ab l e 2.1: Description of economic indicators

There was a high percentage of total exports of commodity products

in account for Vietnam export, world prices may help explain the price movements of long-term exchange rate this product as the Vietnamese Dong.

Sometimes this means that entrepreneurship is Vietnamese Dong just like trading rice Vietnam is the second largest producer of rice and the Vietnamese Dong has generally a positive correlation with the price of rice, which in the case of an increase in the prices of rice, Vietnamese Dong

tends t o g r o w The price of

Index of Industrial Production (IPP) is basically the growth in industrial production of the country It has a close relation to the growth of Gross domestic product (GDP) to assess the economic development of an economy Accordingly, IIP may affect the exchange rate of the domestic currency against foreign currencies.

In Vietnam, it was published by the General Statistics Office of Vietnam.

is a net importer, meaning that Vietnam imports more goods than it exports Changing in the trade balance maybe affects the price of the Vietnamese Dong.

The State Bank of Vietnam (SBV) likely set the main interest rate which is based on three important factors: consumer price index, credit growth rate and money supply So the exchange rates, therefore, the interest rate policy emphasis the foreign exchange rate.

Dong Japanese

7 consumer price

index (CPI)

Japanese consumer price index (CPI) gauges the average change in retail prices for a fixed market basket of goods and services CPI helps the researchers and investors to measure the inflation in Japan.

8 Japanese

trade balance Japan plays as well as export country Therefore, the surplus of trade

balance has impact in the changing of the value of the Japanese Yen.

The Bank of Japan (BOJ) likely set the main interest rate, which is based

on three important factors: consumer price index, credit growth rate and money supply So the exchange rates, therefore, the interest rate policy emphasis the foreign exchange rate.

time series data The model uses no other independent variables but theprediction will come out from historical exchange rates Auto-regressiveintegrated moving average model requires large run of time series data andtechnical expertise on the part of forecaster.

The current values of a time series in terms of past values of itself (the regressive component) and past values of the error term (the moving averageterms) were represented by an auto-regressive integrated moving averagemodel The number of times a series, which were referred by the integratedcomponent, to must be differentiated to play stationary Auto-regressiveintegrated moving average model are agnostic in forecasting time series

They examine the forecasting performance

of standard macro-economic models of foreign exchange rates in real time, using the main economic indicators database of the organization for

calculated out of sample forecasts, as they would have been made at the time, and compares them to a random walk alternative.

He illustrated the use of four major exchange rates by a new bootstrap method It was for small-sample inference in long horizon regressions by analyzing the long horizon predictability.

In addition, the findings are reconciled with those of an earlier study.

The evidence is presented that ARIMA (2,1,2) plays the most

unemployment rate.

The resulting of time series testing indicates that standard macro- economic models have large effects

on exchange rate predictability.

The evidence is presented that the linear VEC model framework underlying the empirical study is likely to be mis- specified, and that the methodology for constructing bootstrap p-values for long- horizon

fundamentally awed.

After that checking the accuracy of the model in predicting performance

They issue that the study in a number

of time series and structural models, which was based on out of sample predicting accuracy.

He have used Box-Jenkins for making the predicting model.

ARIMA(0,1,1) is the most suitable model to be used for predicting the gold price.

As the result, they discovered that one

to twelve month horizons for the USD/DEM, USD/GBP, USD/JPY and trade-weighted dollar exchange rates was estimated by a random-walk model

They identified the ARIMA models - the Box Jenkins approach on forecast performance.

The objective of the research is to find

an appropriate ARIMA model for predicting oil palm price and wholesale price of oil palm of Thailand in the period from 2000 to 2004.

They suggested that the approach focus

on maximizing in-sample ‘goodness

of fit’ and minimizing out of sample forecast errors Thus, the approach followed is unashamedly one of

‘model mining’ with the aim of optimizing forecast performance.

The harmonized index of consumer prices (HICP) and some of its major sub- components play practical issues in ARIMA time series forecasting.

ARIMA (2,1,0) plays for predicting farm price of oil palm.

ARIMA (1,0,1) or ARMA(1,1) were suitable for predicting wholesale price

a regression model.

The prediction result of the ARIMA model is more accurate than those based on the fundamental regression model.

Source: Author’s collection from different sources

Summarily, the study finds that a topic relating to the analysis of exchange ratevolatility is not a new subject in the world Two main theoretical frameworkswill be discussed in this study: (1) Fundamental analysis is based on a thoroughexamination of macroeconomic variables and policies that have an impact on thecurrency Our study makes decision for applying some economic indicators forVND/JPY exchange rate They are the price of rice, the price of light crude oil

(West Texas Intermediate oil), Vietnamese industrial production index,Vietnamese consumer price Index (CPI), Vietnamese trade balance, State bank

of Vietnam (SBV) interest rate decisions for Vietnam Dong, Japanese industrialproduction index, Japanese consumer price

index (CPI), Japanese trade balance, and Bank of Japan (BOJ) interest ratedecisions for Japanese Yen (2) Technical analysis is Auto-regressiveintegrated moving average (ARIMA) model that can predict the future pricefrom historical data (time series data sets) Recently research, M Massarrat, M.and Khan, A., (2013), has made research and analysis related to gold priceprediction tools in Auto-regressive integrated moving average (ARIMA).Results suggest that ARIMA (0,1,1) is the most suitable model to be used forpredicting the gold price Ying Zhang and Hailun Wu (2011) use the auto-regressive integrated moving average (ARIMA) model and multiple regressionmodel to analysis Australia Dollar and Japanese Yen The prediction result ofthe auto-regressive integrated moving average model (ARIMA) is more accuratethan those based on the multiple regression model

CHAPER THREE: RESEARCH METHODOLOGY

Chapter three explains the number of observations and sources of databasethat applied for testing the multiple regression model and Auto-regressiveintegrated moving average model Our study also emphases the Box-Jenkinsmethodology in auto-regressive integrated moving average plays the modelidentification and model selection, parameter estimation and model checking, Itexamine the past value in time series, in order to make forecasts Moreover,the paper formulates a multiple regression model, which economicfundamentals influence the price movement of the VND/JPY exchange rate

3.1Source of the data sets

The data in this study is mainly based on the monthly from January 2007 (the

1st observation) to December 2012, which are includes 84 observations Sources

of data sets are follows:

Table 3.1: Variable sources

Light crude oil (West

price index (CPI)

Chicago board of trade Retrieved April 4, 2013 from

h

tt p :// gso.go v v n

Vietnamese trade balance Vietnam general

department of customs

Retrieved April 18, 2013 from h

bank for foreign trade

of Vietnam (Vietcombank)

Retrieved April 8, 2013 from http://www.vi e tcomb a nk.com.vn/ e xch a ng e r a tes/

The Japanese consumer

price index (CPI),

Japanese trade balance,

Japanese industrial

production index and

interest rate decision

of Japanese Yen

Sources: Author’s collection

Bank of Japan Retrieved April 4, 2013

from http://www.stat- search.boj.or.jp/index_en.html

3.2 The multiple regression model

In our study, the paper formulates a multiple regression model, which is used

to determine how much the economic fundamentals such as the price of acommodity, interest rates, and so on influence the price movement of theVND/JPY exchange rate The model is specified as:

Xratet = α1 + α2CPIjpt + α3CPIvnt + α4IIPjpt + α5IIPvnt + α6IRjpt + α7IRvnt +

α8∆tradejpt + α9∆tradevnt + α10∆ricet + α11∆oilt + ε t

The variables are defined in the below table:

T ab l e 3.2: List of variable

Expected Variable Description

Xrate t Value of VND/JPY rate over time t.

CPIjp t The consumer price index (CPI) index

is calculated as a percentage to reflect

the change in relative prices of

Japanese consumer goods over time t.

sign of the coefficients

-Theory at literature reviews

International Fisher Effect

CPIvn t The consumer price index (CPI) index

is calculated as a percentage to reflect

the

change in relative prices of Vietnam +

consumer goods over time t.

International Fisher Effect

IIPjp t Index-Industry Products referred to as

the IIP index is an indicator of

industrial

activity produced of Japan

IIPvn t

Inde x-

+

Industry Products referred to as the IIP

index is an indicator of industrial

activity produced by the General Statistics

-Office of Vietnam announced by time t

Purchasing Power Parity

Purchasing Power Parity

IRjp t The interest rate of Japanese Yen at

-∆tradejp t The percentage change in the Japanese

∆tradevn t This is the percentage change in the

Vietnam trade balance Since there is an

International Fisher Effect

Purchasing Power Parity

Purchasing Power Parity

adverse balance of trade, we use the first

difference divided by the absolute value of

the lagged trade balance at time t.

∆rice t The percentage change in the Vietnam

∆oil t The percentage change in the crude oil

* a considerations was unclear

3.3Box-Jenkins’ auto-regressive integrated moving average model (ARIMA)Meyler, Aidan and Kenny, Geoff and Quinn, Terry (1998) proposed the Box-Jenkinsmethodology for forecasting Irish inflation The Box-Jenkins methodology plays themodel identification and model selection, parameter estimation and Model checkingfor examining the past value in time series, in order to make forecasts It haspredictability in foreign exchange rate is accepted in many researchers andcountries They illustrates as follows:

Figure 3.1: Box Jenkins methodology for ARIMA modeling

-Sources: Meyler, Aidan and Kenny, Geoff and Quinn, Terry (1998)

Step 1 (Data collection and examination): Meyler, Aidan and Kenny, Geoff and Quinn, Terry (1998) recommended a lengthy time series of data (at least

50 observations) is required for univariate time series forecasting In study,the

VND/JPY monthly database shows 84 observations from January 2007 (the

1st observation) to December 2012 (the 84th observation)

Step 2 (Determine stationary of time series): Gujarati (2002) defined a stationarytime series is a series with constant mean, variance and auto-covariance atvarious lags He also introduced a rule of thumb to choice an appropriate laglength It is recommended to compute the autocorrelation function (ACF) up toone-third to one-quarter the length of the time series

Step 3 (Model identification and estimation): As mentioned above, d is order ofnon- seasonal differences to make time series stationary The next task is todetermine the value of p and q the paper use the graphical properties of theautocorrelation function (ACF) and the partial autocorrelation function (PACF).Gujarati, (2002) proposed theoretical patterns of the autocorrelation function(ACF) and the partial autocorrelation function (PACF), which are summarized infollows:

Table 3.3 The autocorrelation function (ACF) and the partial autocorrelation function (PACF) patterns summary

Type of Model Typical pattern of ACF Typical pattern of PACF

Decays exponentially or damped AR(p) Sine wave pattern or both Significant spikes through lags p

MA(q) Significant spikes through lags q Declines exponentially

Source: Gujarati, D N (2002) Basic Econometrics 4th edition

Step 4 (Diagnostic checking): In this step, model must be checked for adequacy

by considering the properties of the residuals whether the residuals from anARIMA model must has the normal distribution and should be random Anoverall check of model adequacy is provided by the Ljung-Box Q statistic Thetest statistics is to examine whether residual is a “white noise” or not If it is a

“white noise” then the model is accepted Otherwise, the procedure will bereset to the beginning Q- statistics and Normality test can be used in this step

Step 5 (Forecasting and forecast evaluation): Forecasts for one period or several periods into the future with the parameters for a tentative model have been

selected In

this research paper, the paper utilizes E-views 6 with “forecast” package buildand evaluate ARIMA model.

Meyler, Aidan and Kenny, Geoff and Quinn, Terry (1998) listed that some mainbenefits of using the auto-regressive integrated moving average as follows: First,they believe that it is useful if the time series have a big variables Second, theyemphasize that this reduced some error that occurs with multiple repressors.Third, the multiple models always require the huge and correlated variable in timeseries Forecasting by multiple models is highly dependent on the un-availablevariables and source of predicting, therefore, its result face uncertainty

However, Meyler, Aidan and Kenny, Geoff and Quinn, Terry (1998) synthesizesome limitations of auto-regressive integrated moving average (ARIMA);some of identification approaches plays as subjective Moreover, the talent andexperience of the forecasters can be depended by the reliability of the chosenmodel (although other modeling approaches are applied by this criticism as well)

It is not embedded within any underlying theoretical model or structuralrelationships It is not clear to the economic significance of the chosen model.Furthermore, unlike with structural models, it is not possible to run policysimulations with Auto-regressive integrated moving average models

Model for non-seasonal series are called autoregressive integrated movingaverage model, denoted by ARIMA (p,d,q) Here p indicates the order of theautoregressive part, d indicates the amount of differencing, and q indicates theorder of the moving average part If the original series is stationary, d= 0 andthe auto-regressive integrated moving average models reduce to the ARIMA(p,d,q) model

Summarily, based on theories that are showed in the literature review,methodology chapter undertook to build the multiple regression model fromselected variables in table 2.1 It is specified as: Xratet = α1 + α2CPIjpt +

α3CPIvnt + α4IIPjpt + α5IIPvnt

+ α6IRjpt + α7IRvnt + α8∆tradejpt + α9∆tradevnt + α10∆ricet + α11∆oilt + εt.Moreover, our study builds the steps to test the ARIMA model by the Box-Jenkinsmethodology with five steps: data collection and examination, determine stationary

of time series,

model identification and estimation, diagnostic checking, and forecasting and forecast evaluation.

CHAPTER FOUR: THE ROLE OF THE JAPANESE YEN IN THEECONOMIC RELATIONSHIP BETWEEN VIETNAM AND JAPAN

Chapter four presents the foreign exchange policy of Vietnam and Japan andemphasizes the impact of the Japanese Yen in the trade, investment andfinance between Japan and Vietnam The exporters, importers, investors andcommercial banks are interested in the fluctuations in VND/JPY exchange rate.Hence, it defines that the demand of analysis on the fluctuations in VND/JPYexchange rate plays an important role in defending the exchange rate riskvolatility of the exchange rate

4.1Overview of the Vietnam foreign exchange policy

Managing the exchange rate keeps the macroeconomic stability It helps to controlinflation It reduces the balance of payments deficit and improves theinternational trade balance It is more important than when Vietnam is stilltrying to overcome the 2007-2009 global economic crises Historically,Vietnam stopped the focusing central-planned economy in 1986 and playstowards to the foreign exchange rate policy However, the U.S Dollar is almostthe default currency pegs in Vietnam The State bank of Vietnam (SBV)announced the VND/USD exchange rate Based on international exchangerates between the U.S Dollar and other foreign currencies, the bank of commercewill establish the exchange rate between those currencies to U.S Dollar Theobjectives of the government’s foreign exchange policy are the control of foreignexchange market and narrow black market operations in foreign currencies.Moreover, when it is necessary, the government can intervene in the foreignexchange market In recent years, Vietnam makes great efforts to increaseexports It improves the balance of payments deficit It reduces the burden offoreign debt It tries to attract foreign investment Moreover, Vietnamesegovernment tries to improve the institutional, legal, financial system, andcommercial banks

The Vietnamese foreign exchange policy is divided in the last two stages8 (1)

in the period before 1996, the State bank of Vietnam managed the almost offoreign exchange activities, including inflows and outflows The exchange rate

is strong government intervention to keep rates steady (in 1991, the State bank ofVietnam had to intervene to keep the currency price before fever U.S Dollar;

in 1992, the State bank of Vietnam had to intervene to curb down against theappreciation of the USD against the dollar) (2) In the period from 1997 topresent, Vietnam plays the flexible exchange rate that in fixed by the regulatorymargin fluctuated between U.S Dollar and Vietnamese Dong In addition, theVietnamese foreign policy makes towards easing the current transaction.Therefore, the State bank of Vietnam allows the individual who can save theforeign currency in bank deposit without regarding to the origin of their foreigncurrency In addition, the savers play easy to drawn both capital and foreigncurrency Foreign currency credit is also extended to the borrowers

Recently, the Vietnamese foreign exchange market plays three markets(foreign exchange market inter-bank, foreign currency trading marketbetween financial institutions and free market) (1) The foreign exchange marketinter-bank is where the financial institutions dealing in foreign currency to satisfythe monetary needs of the customer, to balance its foreign status Here is wherethe State bank of Vietnam plays effective intervention in the exchange ratebetween Vietnamese Dong and U.S Dollars However, market activity is stillmany defects such as loss of balance between orders to buy and sell foreigncurrency at some transactions, the non- common using of derivative tools Theforeign exchange market inter-bank does not reflect market supply and demand offoreign currency in the economy Result creates conditions for the free markets tothrive Therefore, the market inter-banks currency often plays imbalances Incase of excess foreign exchange, market participants are always tried to put theselling order (in 1994-1995) Nobody sell in the scarcity condition of foreigncurrency (in 1997-1998) and (in 2008-2010) The State bank of

8 ‘Vietnam exchange rate 2000-2011 periods with decision factors, error level and impacts for export’

2012, The National Assembly's Economic Committee and the Vietnam United Nations Development Programm, Vietnam