Research On Interrelation Between RMB Spot Market And NDF Market

The RMB exchange rate plays an important role in China s economic, financial stabilityand development. In recent years, off-shore derivatives, with RMB Non-deliverable forwardsas a representive one, have gained a rapid development, which on one side provide tools forimporters, exporters and multinational corporation etc. to hedge exchange rate risk, on theother side exert a great impact on domestic foreign exchange markets. Both the spot andforward exchange markets are exchange rate pricing markets. However, due to its flexibleway of trading and lower cost, the forward exchange market often become the price discoverand guider, thus causing the concern that the spot maket will lose the pricing power of RMBexchange rate. Therefore, it is of great significance to research the interrelation between thespot market and NDF market. For regulators, this can help to make proper policies to makedomestic exchange markets develop healthily and constantly; for investors, this can help tohedge exchange risks and even earn profits with reasonable expectations.The interrelation between the spot market and NDF market mainly refers to the dynamicspillover of market information, including returns spillover effect and volatility spillovereffect, which repectively reflects the transmission of price and volatility between the twomarkets.Based on the theoretical analysis, the paper present the interaction mechanism andinfluencing factors of the spot and NDF markets. Then utilzing Granger causality andMA(1)-GARCH(1,1) model to extamine the interrelation between the two markets underdifferent economic situations and policies by four stages.The research shows that the exchange rate regime reform and financial controls greatlyinfluenced the interrelation between the two markets. From the aspect of returns spillovereffect, before the reform of exchange rate regime in2005, the spot maket was basically in theprice information center, but competed intensely with NDF market on the pricing power ofRMB. After the exchange rate reform, especially after the new round exchange rate reform in2010, the spot market has gradually achieved the RMB pricing power. From the aspect ofvolatility spillover effect, the spot market is the source of volatily and can significantly causepirce volatility in NDF market. The financial control policies can decrease the impact of NDFmarket to spot market. With financial deregulation, the spot market will be more vulnerable tothe volatility in NDF market, but regulators don t need to concen this too much. From theaspect of NDF contract duration, the shorter the NDF contract, the closer interrelationbetween the two markets. From the aspect of investors, participants of NDF short-termcontracts are mainly hedgers, while the long-term contracts participants are mainlyspeculators.In short, the empirical results show that after the new round exchange rate reform, thespot market has basically become the pricing center and volatility resource.