The Evaluation And Investigation Of Currency Basket Weight In RMB Exchange Rate

This paper examines our country’s formation mechanism of exchange rate and its arrangement after2005, considering the variation of exchange market itself as well as the relative change of currency basket weight implicitly in RMB. The basic model this study applied is the classical Frankel-Wei model, which is commonly used as the starting point for evaluating the implicit currency basket weight that home currency contains. By introducing the variable of Exchange Market Pressure (EMP), our study extends the initial model to differentiate the market’s volatility itself and intervention currency authorities implemented. Moreover, our study formats an optimal weight model of currency basket that aimed at stabilizing trade, combining with the EMP index, to estimate the possibility and extent of RMB’s undervaluation.Based on empirical analysis on RMB exchange rate, we find that the exchange rate of RMB is still softly pegged to US dollar, while other currencies’ influences to RMB are slowly showing. RMB’s dynamic trend is clear, and exchange rate’s elasticity and relative flexibility are significantly enhanced. Besides, RMB’s exchange rate is facing appreciation pressure according to EMP index, and the main sources of pressure stem from foreign reserves accumulation and strong appreciation expectation from exchange market itself. Followed the optimal weight model of currency basket, we reach a conclusion that there exists an undervaluation possibility of RMB.