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China seeks to internationalize its currency, especially by promoting an offshore market dedicated to international transactions with the rest of the world, while maintaining close control over its onshore currency, primarily dedicated to domestic transactions. The offshore exchange rate with the USD is sup-posed to be driven by market forces, while the onshore exchange rate continue to be managed by Chinese monetary authorities. Consequently, the two currencies are subject to frequent deviations reflecting these distinct market structures and investor behaviors.
In this paper, we aim to investigate whether these deviations are persistent and, if so, to what extent. Our methods rely on a fractional cointegration approach that allows us to assess whether the two exchange rates are co-persistent in nature and whether the deviations from their long-run equilibrium are weakly persistent, strongly persistent, or stationary. We also explore whether the persistence of these deviations varies over time and are driven by China's monetary and exchange rate policy uncertainty.
Our main results indicate a declining in the persistence of deviations especially after 2016. We also find a significant relationship between theses deviations and exchange rate and monetary policy uncertainty, especially when the CNH is weaker than the CNY.
