Publications
Covered Interest Parity: A Forecasting Approach to Estimate the Neutral Band. Economic Modelling 2025. (Revised Manuscript).
(Bank for International Settlements (BIS) Working Paper 1206)
(Banco de México Working Papers. No. 2020-02 under the title: Covered Interest Parity: A Stochastic Volatility Approach to Estimate the Neutral Band.)
Abstract: This paper introduces a new approach to estimate the neutral band, where deviations from covered interest parity (CIP) are not considered profitable arbitrage opportunities. The approach fills a gap in the literature on international finance and is theoretically grounded. Using daily Pound Sterling-US Dollar data from 2000 to 2021, I illustrate that estimates based on the forecast distribution of CIP deviations with a time-varying variance component are superior to the mean-based estimates currently available. The results reveal that the estimated neutral band adapts to market dynamics, widening from 3 to 191 basis points as financial stress and volatility increase. The forecasting approach is further validated on G10 and emerging market currency pairs. Market participants can use these findings to set minimum profit targets in CIP trading, while policymakers can assess the liquidity of the foreign exchange market more effectively.
Income Elasticity of the Main Taxes in Mexico and Fiscal Loss during the COVID-19 Pandemic (joint with Brian Roque and Daniel Ventosa-Santaulària). Forthcoming in Economics Bulletin 2025. (Revised Manuscript).
Abstract: We estimate the income elasticity of Mexico's value-added, income and total taxes. Our findings reveal that the elasticity of these taxes is greater than one, indicating a tax system that is responsive to economic fluctuations. These results confirm the countercyclical role of the tax system and underscore the growing importance of non-oil tax revenue in maintaining fiscal stability. A counterfactual analysis to assess revenue losses attributable to the COVID-19 pandemic offers insights into the resilience of Mexico’s tax system to economic shocks.
Global Supply Chain inflationary pressures and monetary policy in Mexico (joint with Daniel Ventosa-Santaulària and J. Eduardo Valencia). Emerging Markets Review 2024. January. 58: 101089. (Revised Manuscript).
Abstract: In this paper, we examine the impact of stress in the global supply chains on inflation and monetary policy in Mexico, a representative emerging market economy. Using non-linear local projections, we estimate the degree of monetary policy tightening required in a high-stress supply chain environment and compare it to that in a low-stress environment. We instrument the monetary policy shocks with shocks to the federal funds rate. Results suggest that in a high-stress regime, the effect of an increase in the monetary policy interest rate on inflation over a one-year period is reduced considerably. We argue that this reduction is due to the slow response of inflation expectations to a monetary policy tightening in a high-stress regime. Furthermore, raising the interest rate has an effect on producer price inflation, a channel that is absent in a low-stress regime. This finding highlights the role of monetary policy in stabilizing inflation when facing supply shocks that are not necessarily permanent.
Capital Flows to Emerging Markets and Global Risk Aversion during the COVID-19 Pandemic (with Carlos Alba, Gabriel Cuadra and Raúl Ibarra). International Journal of Finance and Economics 2024. 29(3), 2804–2836. Banco de México Working Papers. No. 2021-17.
Abstract: This paper analyses recent changes in the relative importance of the determinants of capital flows to emerging market economies. For this purpose, we estimate vector autoregressive (VAR) models for the period 2009-2021. Based on these models, we estimate the effects on debt flows from shocks to their determinants. Then, we quantify the contribution of each of the variables included in the model to explain the evolution of these flows in each month of the sample through a historical decomposition analysis. The main results indicate that the contribution of global risk aversion to explain the evolution of debt flows increased during March 2020 compared to the past, although its relative importance has decreased since, particularly as central banks in systemically important economies restored liquidity and the performance of financial markets improved.
Explaining Apparent deviations from Covered Interest Parity: Evidence from Mexico. Revista Mexicana de Economía y Finanzas. January - March 2023. (Previously Circulated as: Peso-Dollar Forward Market Analysis: Explaining Arbitrage Opportunities during the Financial Crisis. Banco de México Working Papers. No. 2014-09.)
Abstract: This paper tests and quantifies the effects of reduced funding liquidity conditions on the covered interest parity (CIP) relating the U.S. Dollar-Mexican Peso market. To this end, a vector error-correction model is estimated. Results suggest, first, that apparent deviations from the CIP disappear when measures of funding liquidity for market participants are considered. Second, the exchange rate forward premium and the U.S. interest rate adjust towards the CIP cointegrating relationship. Finally, a structural analysis shows that deviations from CIP are mostly determined by shocks on the funding liquidity in the U.S. while funding liquidity conditions in Europe also have a non-negligible role. From the policy perspective, the paper underlies the relevance of funding liquidity measures when assessing whether the foreign exchange market works efficiently. As ever, there are some caveats in the analysis to consider. First, funding liquidity measures may shift from non- to stationary regimes. Second, market participants may not able to fund their liquidity at reference rates. The financial series present considerable ARCH-like behaviour, this may be a source of information to explore in further work.
Identifying Dornbusch's Exchange Rate Overshooting with Structural VECs: Evidence from Mexico (with Carlos Capistrán and Daniel Chiquiar). International Journal of Central Banking. December 2019. (Banco de México Working Papers version)
Abstract: In this paper we use data from Mexico to identify Dornbusch's (1976) exchange rate overshooting hypothesis. We specify and estimate a structural cointegrated VAR that considers explicitly the presence of a set of long-run theoretical relations on macroeconomic variables (a purchasing power parity, an uncovered interest parity, a money demand, and a relation between domestic and U.S. output levels). We then impose a recursiveness assumption to identify the response of domestic variables to a monetary policy shock. The long-run restrictions embedded in the model are themselves identified, estimated, and tested using an ARDL methodology that is robust to the degree of persistence of the time series and, in particular, to whether they are trend- or first-difference stationary. With this approach, we are able to find that the response of the exchange rate to monetary policy shocks is consistent with Dornbusch's model.
Working Papers
MonetaryPolicy in Emerging Markets under Global Uncertainty (joint with Mateo Hoyos and Daniel Ventosa-Santaulària). CIDE Working Papers. 2024.
Abstract: The neutral band is the interval where deviations from Covered Interest Parity (CIP) are not considered meaningful arbitrage opportunities. The band is determined by transaction costs and risk associated to arbitrage. Seemingly large deviations from CIP in the foreign exchange markets for the US Dollar crosses with Sterling, Euro and Mexican Peso have been the norm since the Global Financial Crisis. The topic has attracted a lot of attention in the literature. There are no estimates of the neutral band to assess whether deviations from CIP reflect actual arbitrage opportunities, however. This paper proposes an estimate of the neutral band based on the one-step-ahead density forecast obtained from a stochastic volatility model. Comparison across models is made using the log-score statistic and the probability integral transformation. The stochastic volatility models have the best fit and forecasting performance, hence superior neutral band estimates.
Robust Inference with Missing Observations (with Deepa Dhume Datta and Wenxin Du). June 2023.
Abstract: The Newey-West (1987) and Andrews (1991) estimators have become the standard way to estimate a heteroskedasticity- and autocorrelation-robust (HAR) inference, but it does not immediately apply to time series with missing observations. We propose two simple modified HAR estimators for time series with missing data. First, our Amplitude Modulated estimator treats the missing observations as non-serially correlated. Second, our Equal Spacing applies to the series formed by treating the data as equally spaced. We show asymptotic consistency of both estimators and show that if missing data is ignored, usual HAR esitmators are under estimated, thus leading to under rejection. We discuss the finite sample and performance of the estimators when conducting inference using Monte Carlo simulations.
Unit Root Testing in ARMA Models: A Likelihood Ratio Approach. Banco de México Working Papers. No. 2016-03.
Abstract: This paper proposes a Likelihood Ratio test for a unit root (LR) with a local-to-unity autoregressive parameter embedded in ARMA(1,1) models. By dealing explicitly with dependence in a time series through the Moving Average, as opposed to the long Autorregresive lag approximation, the test shows gains in power and has good small-sample properties. The asymptotic distribution of the test is shown to be independent of the short-run parameters. The Monte Carlo experiments show that the LR test has higher power than the Augmented Dickey Fuller test for several sample sizes and true values of the Moving Average parameter. The exception is the case when this parameter is very close to -1 with a considerably small sample size.
Work in Progress
Gaussian Likelihood Tests for a Unit Root in a Near-Integrated ARMA Model (with Marcus Chambers)
The Difference-in-Variance Test for Asymmetry (with Daniel Ventosa-Santaulària A. E. Sanchez-Urbina and Eduardo Vera-Valdés)