Twofish's Blog

September 21, 2007

Idea on how to revalue the RMB

Filed under: china, economics — twofish @ 8:37 am

Also about deliberately introducing volatility, I’m taking a page from derivatives pricing theory and portfolio theory. What the PBC wants to do is to keep people from doing arbitrage. From derivatives pricing theory, the only way you can do this is to introduce risk (beta) that corresponds to return (alpha).

So what the PBC could do is to figure out what alpha they want, and the figure out what the corresponding volatility should be, and then introduce some randomness into the system. Ideally, they could do so via a random number generator so that even *they* don’t know what the next days rates are going to be. A basket peg also does the same thing.

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4 Comments »

  1. Hi,

    I came here from Brad Setser->Michael Pettis-> your blog. I must say that some of your posts like the one on economic hitmen is some of the best internet writing I have seen on the net and I read a lot of good stuff on the net. Carry on.

    Comment by sa — September 21, 2007 @ 11:29 pm

  2. I wrote a few weeks ago on Brad Setser’s blog that historical volatility on USD/CNY had increased notably, still below USD/xxx one but on its way up.

    What puzzles me are the down spikes lasting a few days (when RMB is depreciating). PBC is likely controlling only up trend so my guess is that the more down phases we see the closer we are to a “market” equilibrium. Think brownian motion with trend floor curve, we just see the “blips” of the brownian over the floor.

    Comment by Laurent GUERBY — September 22, 2007 @ 7:54 pm

  3. One of the more bizarre papers I’ve seen is this one that purports to model PBC intervention in the currency markets as a frictional force

    http://en.wikiversity.org/wiki/Valuation_of_Renminbi_options_using_a_flucutation-dissipation_model

    From that model one would expect that as the PBC slows down its intervention that there is less “friction” and that the volatility of the RMB would increase.

    Comment by twofish — September 25, 2007 @ 1:00 am

  4. Not far from a volatility cap indeed (products which sells well in the mutual fund derivative market).

    Comment by Laurent GUERBY — September 27, 2007 @ 8:10 pm


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