An Empirical Study Of The Volatility Of Chinese Yuan Forward Price In Foreign And Domestic Markets

Over the past ten years, two types of forward markets for Chinese Yuan (“CNY”) have emerged. One is the CNY forward market within China, the onshore forward market; the other is the forward market outside of China, the offshore forward market. The onshore forward market could be split into inter-bank and over-the-counter (“OTC”) forward markets. Inter-bank forward market serves domestic and foreign financial institutions while the OTC market meets the need of corporations that need to settle their businesses in foreign currencies. On the other hand, the offshore forward market is represented by Non-Delivery Forward (“NDF”) transactions taking places in Singapore, Hong Kong and etc. Typically, international financial institutions, multi-national corporations, import and export dealers and hedge funds are active in this sector.Since 21 July 2005, on principle of“initiative, controllability and gradualness”, the Chinese government has moved the its currency to a managed floating exchange rate based on market supply and demand with reference to a basket of foreign currencies. After the reform, volatility of CNY exchange rate increased significantly, which in turn boasts the demand by import and export dealers, multi-national corporations and financial institutions for due risk management.It is common to hedge foreign exchange risks in the forward markets. It is noted that prices of domestic CNY forward and NDF with the same underlying asset, the CNY spot exchange rate in a certain future time point, and term structure diverge in their respective prices, due to the presence of domestic capital projects and foreign exchange regulation. Based on experiences of domestic forward and foreign NDF rates of recent years, the former is less volatile, regardless of positive or negative premiums. In the long run, the two exhibits correlation with their difference contained within a certain range. The implied correlation indicates the dissimilar risk profiles and connection of the two markets. Quantitative analysis of the observed phenomenon can supply market players with decision-making references and theoretical support. In the mean time, the existence of offshore NDF markets suggests the imminent demand for CNY deregulation, and its impacts on the CNY forward rate should draw attention of our administration. In a word, study of the correlation mentioned above would help to develop the CNY derivative market.This article talks about the internal transmission mechanism of RMB onshore and offshore forward markets fluctuation and the causes of dramatic market fluctuation, from the multiple angles of quantitative characteristics, quantitative relations.