Driver Currencies and Triangular Cross-Border Effects

Almost all the models and empirical studies have been set up, implemented and curried out between pairs of currencies, usually the bilateral exchange rates between the US dollar and the currencies under investigation and, to a less extent, between the Deutsche mark and the currencies under investigation, the euro and the currencies under investigation, and so on. The influence of a “third” currency has not been considered. While the global foreign exchange market is a multi-currency regime, it can be embodied by a number of triangular sub-regimes, where the cross exchange rate between the foreign currency and the other foreign currency, the “third” currency, must satisfy the non-arbitrage conditions. Therefore, multilateral exchange rate relationships can be feasibly examined through the triangular framework, taking into account the influence of the “third” currency. This is particularly relevant for assessing the effect of the de facto peg of a large currency to another large currency, such as the US dollar, on exchange rates between the US dollar and other currencies and between other currency pairs. When the exchange rate arrangements between the three currencies are not uniform, the causal relationship, if exists, can be asymmetric, giving rise to the driver currency effect. Research has been carried out to take on these emerging issues recently, including Wang (2010), McKinnon and Schnabl (2012), Wang and Zhang (2014), and Ryan (2015).