Abstract

Financial liquidity is one of the most important factors that affects China’s currency market along with other macroeconomic factors. Shanghai Interbank Offered Rate (Shibor) is the quantitative indicator of the financial liquidity of China’s capital market. China has been continuously promoting the marketization of interest rates. The interbank market, as a resource of money supply, is significantly affected by this process. This paper empirically investigates the relationship between Shibor and the onshore renminbi-dollar exchange rate utilizing data from October 2006 to January 2015. Furthermore, in addition to Shibor, inflation rate difference, benchmark interest rate difference, GDP growth rate difference, and trade balance are all included as control variables. First, preliminary tests such as the ADF test and Granger causality test were conducted for selecting the most appropriate regression method. A VAR test, impulse response, and variance decomposition were then conducted. Empirical results show that Shibor has a significant impact on the onshore renminbi-dollar exchange rate, exhibiting a one-way causal relationship with an inverse direction. Furthermore, other control variables also show a different relationship to the onshore renminbi-dollar exchange rate to some extent. The finding is consistent with classical theory and practical judgment. This paper contributes to existing literature on classical theory testing of the exchange rate and provides new evidence on the influencing factors of the exchange rate.

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