the monetary approach to exchange rate determination under rational expectations the dollar deutschmark rate abstract this paper reformulates the monetary approach after ascertaining that a money demand function with a partial adjustment mechanism had more empirical support than a money demand function which assumed instantaneous stock adjustment the resulting exchange rate equation is estimated by two rational expectations techniques the parameter estimates are reasonable and are robust to the estimation technique used to different specifications of the driving processes and to changes in the estimation period the structural model outperforms the random walk model and its own unconstrained equivalent a pure time series equation in outof sample forecasts

evaluating the predictability of exchange rates using long horizon regressions mind your p s and q s since the breakdown of the bretton woods agreement researchers have used a wide variety of structural models to try to predict exchange rate movements unfortunately finding consistent evidence that these models outperform a random walk has proven elusive in this paper we investigate the impact different methods of inference may have had on these conclusions using p values based on recently developed tests of forecast accuracy and encompassing as well as q values designed to mitigate multiple testing problems we provide stronger evidence consistent with these models having superior predictive ability our results suggest that previous studies inability to detect predictive ability may have been influenced by the statistics used and the manner in which they were employed

factor models and time varying parameter framework for forecasting exchange rates and inflation a survey a survey of models used for forecasting exchange rates and inflation reveals that the factor based and time varying parameter or state space models generate superior forecasts relative to all other models this survey also finds that models based on taylor rule and portfolio balance theory have moderate predictive power for forecasting exchange rates the evidence on the use of bayesian model averaging approach in forecasting exchange rates reveals limited predictive power but strong support for forecasting inflation overall the evidence overwhelmingly points to the context of the forecasts relevance of the historical data data transformation choice of the benchmark selected time horizons sample period and forecast evaluation methods as the crucial elements in selecting forecasting models for exchange rate and inflation

a new technique for postsample model selection and validation abstract the model selection and granger causality literatures have focused on insample rather than postsample hypothesis testing this is because postsample model validation periods are usually short whereas the correlations in typical postsample forecast errors require large sample methods a resampling based postsample inference procedure is described which explicitly estimates the uncertainty which its large sample approximation induces in the inference significance levels it produces the procedure is applied to postsample forecasting errors from the ashley et al 1980 study examining granger causation between us consumption and advertising expenditures postsample model validation is apparently feasible but requires longer postsample periods than past studies have allocated

testing ppp hypothesis under temporary structural breaks and asymmetric dynamic adjustments we test the empirical validity of the ppp proposition under temporary structural breaks and dynamic nonlinear adjustments although several testing procedures have recently been proposed in the exi

tests for symmetric and asymmetric nonlinear mean reversion in real exchange rates new tests based on smooth transition autoregressive models for mean reversion in time series of real exchange rates are proposed one test forces mean reversion to be symmetric about the integrated process central case while the other permits asymmetry the tests are applied to monthly series of seventeen real exchange rates against the u s dollar and fourteen against the deutsche mark they reveal stronger evidence against the unit root null hypothesis than does the usual dickey fuller test

regime linkages in the us uk real exchange rate real interest differential relation abstract using a multivariate regime switching framework and focusing on the period 1921 2002 which is characterized by different nominal exchange rate regimes and monetary regimes we find supportive evidence of the us uk real exchange rate real interest differential relation in terms of volatility regime dependence the two variables are jointly characterized by high volatility during periods of floating exchange rates and by low volatility during periods of fixed exchange rates thereby suggesting that the nominal exchange rate regime is the driving force behind the volatility regime switching thus allowing for regime switching in the real exchange rate real interest differential relation bridges the gap between popular theories of real exchange rate determination which predict such a relation and previous empirical studies which failed to uncover such a relation for the us uk real exchange rate

currency fluctuations in the post bretton woods era the international monetary landscape that has emerged since the felling of bretton woods is characterized by a hybrid exchange rate system that lies somewhere between the textbook polar cases of a gold standard and a pure float this system has relatively flexible exchange rates between major countries active central bank intervention in the market for the major currencies and predominantly fixed exchange rates relative to the dollar or to some basket of currencies for less developed countries and newly industrializing nations the majority of research on currency markets since the early 1970s has focused on the characteristics of flexible exchange rates under this hybrid regime my thesis is that this research has been unsuccessful the proportion of monthly or quarterly exchange rate changes that current models can explain is essentially zero even after the fact forecasts that use actual values instead of forecasted values of the explanatory variables cannot explain major currency movements over the post bretton woods era this result is quite surprising since exchange rate changes would be entirely unpredictable only in very special cases of the theoretical models discussed as the discussion below will argue it is not a general implication of market efficiency that exchange rates follow a random walk process 1

real exchange rate adjustment in european transition countries abstract in single equation tests real exchange rates show mean reversion for nine of 10 central and eastern european transition countries for the period january 1993 to december 2005 because of the shift from controlled to market economies and accompanying crises failed policy regimes and changes in exchange rate regimes unit root tests for transition countries often require allowance for structural changes accounting for structural breaks gives substantially faster mean reversion speeds than those found for major industrialized countries these fast adjustment speeds are plausible transition countries had perhaps 10 years to make unprecedented adjustments required for accession to the european union a number of papers have applied non linear models to the central and eastern european countries this paper investigates four non linear models and compares them with piece wise linear break models the break models appear superior in detecting mean reversion for the central and eastern european transition countries

a re assessment of the relationship between real exchange rates and real interest rates 1974 1990 abstract this paper uses cointegration techniques and error correction models to re examine the link between real exchange rates and real interest rate differentials the results show that real exchange rates and real interest rates are nonstationary however they are not cointegrated with each other on the other hand the dynamic models indicate that there might be a long run relationship between these variables but this cannot be verified the final conclusion is that there is little empirical evidence in support of a systematic relationship and this result is robust across exchange rates time periods and measures of expected inflation

a note on the determinants of unexpected exchange rate movements abstract in this paper we study the relative importance of surprises in fundamentals in explaining unexpected exchange rate movements employing a unique survey dataset that contains matched exchange rate and interest rate expectations we are able to derive a number of interesting conclusions a variance decomposition of unexpected exchange rate movements into various components reveals that interest rate news is relatively unimportant but that changes in perceptions about risk premia and more importantly revisions of expectations with regard to future exchange rate levels are crucial in explaining unexpected exchange rate movements

testing long horizon predictive ability with high persistence and the meese rogoff puzzle a well known puzzle in the international finance literature is that a random walk predicts exchange rates better than economic models meese and rogoff 1983a b and 1988 this paper offers a potential explanation for this finding when exchange rates and fundamentals are highly persistent long horizon forecasts of economic models are asymptotically biased by the estimation error in the parameter that measures the persistence when this bias outweighs the benefits from exploiting economic information the random walk model will forecast better this happens even if the economic model is the true data generating process the reason is that a random walk model imposes a unit root rather than estimates it the paper thus proposes a test for equal predictive ability in the presence of highly persistent variables when applied to the meese rogoff exercise this test shows that the poor forecasting ability of economic models does not imply that the models are not a good description of the data

was it real the exchange rate interest differential relation over the modern floating rate period in this paper we explore the relationship between real exchange rates and real interest rate differentials in the united states germany japan and the united kingdom contrary to theories based on the joint hypothesis that domestic prices are sticky and monetary disturbances are predominant we find little evidence of a stable relationship between real interest rates and real exchange rates we consider both in sample and out of sample tests one hypothesis that is consistent with our findings is that real disturbances such as productivity shocks may be a major source of exchange rate volatility this paper investigates the empirical relationship between major currency real exchange rates and real interest rates over the modern post march 1973 flexible rate experience the exchange rates examined here include the dollar mark dollar yen and dollar pound rates our two major findings are as follows first the data do not indicate a strong correspondence between real interest rate differentials short term or long term and real exchange rates this finding appears to conflict with the predictions of most monetary and portfolio balance models of exchange rate determination though the conflict can be substantially reconciled if aggregate disturbances are primarily real in nature i e changes in productivity tastes etc it is true that in many cases the sign of the estimated exchange rate interest rate differential relationship is consistent with the possible predominance of financial market disturbances but the relationship is not stable enough to be statistically significant second although one does find some evidence of a unit root in both real exchange rates and long term but not shortterm real interest differentials these two series do not appear to be linearly cointegrated hence the nonstationarity or near nonstationarity in the two series cannot be attributed to the same factor in section i we briefly describe a class of small scale monetary models of exchange rate determination the importance of this class of models for empirical work derives from its strong predictions about how the exchange rate will move

is there a j curve abstract if the response of the value of the trade balance to movements in the real exchange rate is described by a j curve then a real depreciation initially worsens a balance of trade deficit only improving it over time this paper investigates whether a j curve can be detected in the last twenty five years of american data no statistically reliable evidence of a stable j curve is detected the model is checked extensively to support this finding

sources of fluctuations in real and nominal exchange rates this paper attempts to distinguish empirically real versus nominal sources of fluctuations in real and nominal exchange rates the distinction is obtained by imposing the following restriction on the bivariate vector autoregression of real and nominal exchange rates over the current flexible rate period nominal shocks are required to have no permanent effect on the level of the real exchange rate given this identification scheme the author analyzes the dynamic effects and relative importance of real and nominal shocks with regards to exchange rates the findings indicate that real shocks dominate nominal shocks for both exchange rate series over short and long frequencies copyright 1992 by mit press

real exchange rates and real interest rates once again a multivariate panel cointegration analysis this paper employs multivariate panel cointegration techniques to re examine the empirical relationship between bilateral real exchange rates and real interest rates the results from a panel of 1470 quarterly observations on canada france germany italy japan uk and usa over the period 1977 to 1994 indicate the absence of any long run relationship between the two variables

ruling out divergent speculative bubbles abstract the growth in the empirical literature on testing for divergent in mean speculative bubbles indicates that existing theoretical arguments for ruling out such price paths are not sufficiently compelling here we strengthen the case for ruling out explosive or implosive bubbles a priori by filling in two gaps first we demonstrate why divergent stochastic bubbles arising from purely extrinsic uncertainty as in blanchard 1979 cannot be equilibria in a monetary optimizing model second we show why existing arguments for ruling out implosive price bubbles are insufficient in some cases and we provide stronger arguments

nonlinearities in real exchange rate determination do african exchange rates follow a random walk in this article we aim at modelling the long run behaviour of the real effective exchange rates reer for a pool of african countries not much attention has been paid to this group of countries in particular to the existence of nonlinearities in the long run path of such a variable controlling for two sources of nonlinearities i e asymmetric adjustment to equilibrium and nonlinear deterministic trends allows us to gain some insight about the behaviour of the african reer we find that these sources of nonlinearities help us to explain the apparent unit root behaviour found applying linear unit root tests for most of the countries

testing for bubbles in exchange markets a case of sparkling rates this paper investigates the possibility that the observed deviations of major bilateral exchange rates from values implied by market fundamentals are a consequence of rational asset market bubbles when a new econometric methodology for detecting asset market bubbles is used the joint hypothesis of no bubbles and stable autoregressive processes for relative money supplies and real incomes is rejected for the dollar deutsche mark and dollar pound ratesusing monthly data over the period 1973 82 additional tests for coefficient stability and for lack of cointegration between exchange rates and market fundamentals suggest that the bubble findings must be interpreted with care

exchange rate predictability the main goal of this article is to provide an answer to the question does anything forecast exchange rates and if so which variables it is well known that exchange rate fluctuations are very difficult to predict using economic models and that a random walk forecasts exchange rates better than any economic model the meese and rogoff puzzle however the recent literature has identified a series of fundamentals methodologies that claim to have resolved the puzzle this article provides a critical review of the recent literature on exchange rate forecasting and illustrates the new methodologies and fundamentals that have been recently proposed in an up to date thorough empirical analysis overall our analysis of the literature and the data suggests that the answer to the question are exchange rates predictable is it depends on the choice of predictor forecast horizon sample period model and forecast evaluation method predictability is most apparent when one or more of the following hold the predictors are taylor rule or net foreign assets the model is linear and a small number of parameters are estimated the toughest benchmark is the random walk without drift

terms of trade and real exchange rates the canadian evidence abstract this paper presents empirical evidence linking the canada us real exchange rate with the terms of trade using recently developed econometric methods for nondashstationary data we find that the real exchange rate is cointegrated with terms of trade variables and that causality runs from the terms of trade to the exchange rate we then construct a simple exchange rate equation that satisfies several specification tests and performs better than a random walk in post sample forecasting experiments the results suggest that much of the variation in the real exchange rate is attributable to movements in the terms of trade and that the influence of monetary factors is secondary

cost pass through in the u s automobile market we study cost pass through in the u s automobile market using a framework that incorporates the effects of cost changes on input decisions we find that accounting for firms factor market decisions significantly increases measured cost pass through although we reject the hypothesis of full cost pass through and constant markups in addition our evidence suggests that cost shocks common to all manufacturers have a greater effect on prices than do model specific cost shocks finally we examine how pass through varies with manufacturer nationality finding that u s firm cost pass through exceeds that of european and asian firms

an empirical analysis of ex ante profits from forward speculation in foreign exchange markets this paper constructs a time series band for ex ante profits from forward speculation and examines the permanent component of the median of the band for six different exchange markets the unpredictability of ex ante profits is rejected using nonparametric tests deviations of ex ante profits from forward premia are attributed to deviations of nominal exchange rates from martingale processes it is shown that movements in the terms of trade are responsible for most of the variability and serial correlation properties of ex ante profits t is by now widely recognized that the forward rate is not an unbiased predictor of future spot rates and that realized nominal profits from spec ulating in the forward market are nonnegligible and highly volatile see e g hodrick 1987 frankel and meese 1987 however the nature of these profits is as of yet undetermined this paper attempts to shed light on this issue by examining the time series properties of ex ante profits from forward speculations in six foreign exchange markets i focus on three aspects of the problem first i provide a measure of the range and the variability of ex ante profits two issues with contradictory evidence in the literature see hodrick 1987 and frankel 1988 for refer ences second i relate deviations from uncov ered interest parity to risk and to deviations of nominal spot rates from martingale processes third i link the time series properties of ex ante profits to the behavior of the real exchange rate since ex ante profits are not observable the empirical analysis requires the construction of a time series for the expected future spot rate frankel and froot 1987 ito 1988 cumby 1988 and diebold and nason 1990 have all suggested ways of computing this series here i provide an alternative method for constructing a time series for expected future spot rates and for statistically assessing the properties of ex ante profits expected future spot rates are measured as a 90 confidence band obtained from the simulated recursive distribution for the linear predictor of the series i simulate the distribution of the linear predictor rather than use simple point forecasts in order to reduce the forecast error due to parameter uncertainty an addi tional measure for expected future spot rates considered is a point estimate of the permanent component of the median of the band i use nonparametric tests to examine the rela tionship between ex ante profits and other series nonparametric tests are employed here for two reasons first i am interested in the entire popu lation properties of the data existing results are derived by examining only the first and second moments of the data second efficiency tests are generally based on linear parametric functional forms pagan and ullah 1988 have pointed out problems with these tests when the conditional mean of the data is nonlinear nonparametric tests overcome these problems the results indicate that nominal and real rates do not follow martingale processes that a risk premium rarely explains the behavior of the ex ante profits and that variations in expected terms of trade account for the time series proper ties of ex ante profits

an empirical inquiry into the nature of the forward exchange rate bias abstract this paper tests whether anticipated real exchange rate movements fully account for the systematic time varying discrepancies between forward and future spot exchange rates the data do not reject this hypothesis the results demonstrate that 1 real exchange rate changes are predictable 2 anticipated real exchange rate changes are reflected in the forward bias and 3 information available at the signing of the forward contract is useless in forecasting differences between forward and future spot prices beyond the information s ability to predict real exchange rate changes the results emphasize the importance of real exchange rates in international asset pricing

talent and publicity as determinants of superstar incomes empirical evidence from the motion picture industry by drawing on the two prevailing economic stardom theories the paper investigates the sources of superstardom in the us movie industry for the econometric analysis we use income and popularity d

real exchange rates under the gold standard purchasing power parity is one of the most important equilibrium conditions in international macroeconomics empirically it is also one of the most hotly contested numerous recent studies for example have sought to determine the validity of purchasing power parity using data from the post bretton woods float and have reached different conclusions we assert that most such studies are flawed for two reasons first the post 1973 data contain by definition only a very limited amount of the low frequency information relevant for examination of long run parity second the dynamic econometric techniques used to model deviations from parity are typically quite crude with respect to admissible low frequency dynamics both deficiencies are rectified in the present paper with dramatic results we construct a new data set of 16 real exchange rates covering more than a century of the classic gold standard period and we study deviations from parity using long memory models that allow for subtle forms of mean

stochastic trends and economic fluctuations in a large open economy abstract this study examines the role of stochastic trends in real exchange rates and foreign output in explaining economic fluctuations in the united states while many of the results are consistent with recent closed economy studies the evidence shows that external shocks have significant short run effects on economic fluctuations even in a large country a real appreciation of the dollar leads to permanent decreases in net exports and temporary decreases in output permanent shocks to real exchange rates have surprisingly large effects on output over the course of the normal business cycle

the exchange rate interest differential relationship in six east asian countries abstract this study shows that the real exchange rate real interest differential relation in six east asian economies changes with the nominal regime positive time varying correlations characterize the relation during pegged regimes correlations are negative during freely falling regimes

exchange rate volatility and deviations from unbiasedness in a cash in advance model abstract this paper examines time series properties of exchange rate changes the forward premium and the forward bias in the context of a variant of svensson s cash in advance model the model is solved and simulated using realistic forcing processes whose law of motion is estimated from u s japan data and then approximated by a markov chain although method of moments estimation shows that the over identifying restrictions implied by the model are not rejected it fails dramatically in producing a sufficiently variable risk premium on forward market speculation this result is robust to various pertubations to the model s parameters forcing processes and preference structure the model also fails to match exchange rate and forward premium volatility simultaneously

towards a loanable funds amended liquidity preference theory of the exchange rate and interest rate abstract the objective is to develop a unified theory of the exchange rate and interest rate using a loanable funds amended liquidity preference approach in order to provide a new perspective on many puzzling facts associated with the post bretton woods international economy it is shown that i a monetary expansion can initially raise the interest rate but depreciate the home currency ii real demand shocks can cause interest rate and exchange rate overshooting iii an infinite interest elasticity for capital flows cannot cause exchange rate overshooting if an extended marshall lerner condition holds iv the home currency can appreciate when the current account is negative if the extended marshall lerner condition is not satisfied and v changes in the disequilibrium regime will cause instability in the estimates of reduced form coefficients

three regime asymmetric star modeling and exchange rate reversion the breakdown of the bretton woods system and the adoption of generalized floating exchange rates ushered in a new era of exchange rate volatility and uncertainty this increased volatility leads economists to search for economic models able to describe observed exchange rate behavior in the present paper we propose more general star transition functions that encompass both threshold nonlinearity and asymmetric effects our framework allows for a gradual adjustment from one regime to another and considers threshold effects by encompassing other existing models such as tar models we apply our methodology to three different exchange rate data sets one for developing countries and official nominal exchange rates the second for emerging market economies using black market exchange rates and the third for oecd economies

some linear and nonlinear thoughts on exchange rates abstract after discussing the inconclusive results of linear structural models as applied to exchange rates this paper assesses the possibilities of using a particular form of nonlinear estimation called alternating conditional expectations as i a diagnostic tool and ii a forecasting method it contrasts the forecast performance of various linear in levels in differences error correction and nonlinear in levels in differences specifications of a sticky price monetary model augmented by a relative wealth variable the diagnostic results are as follows the optimal transformations are almost always nonlinear and often nonmonotonic forecasting results in sample and out of sample nonlinear forecasts yield substantial improvements over a random walk however in exercises with forecasts from rolling regressions the random walk specification still dominates over one quarter forecast horizons albeit only marginally and insignificantly so nonlinear specifications do slightly better than linear competitors at four quarter horizons

fed intervention dollar appreciation and systematic risk abstract in a four factor asset pricing model estimated on daily data fed intervention significantly affects betas of surprises in the market return expected inflation rate yield curve and corporate bond risk premium fed foreign currency sales cause economically and statistically significant increases in the systematic risk premium in appreciation and thus in the dollar s expected appreciation rate the direction the fed desires and consistent with the signaling but not the portfolio balance channel intervention s effects on actual appreciation are less reliable they depend on unpredictable risk factor realizations even successful intervention to strengthen the dollar may be costly by increasing the dollar s systematic risk intervention reduces the attractiveness of u s relative to foreign investments further uncertainty about future fed interventions may induce resource misallocation ceteris paribus investors find it harder to estimate risk adjusted discount rates and forecast the home currency value of cash flows

real exchange rates and macroeconomics evidence and theory since the early 1980s a large body of research has thrown doubt on the relevance of macroeconomic models for understanding exchange rates the authors argue that a balanced reading of recent literature in exchange rate economics gives a more optimistic assessment many studies have established the pertinence of long run purchasing power parity ppp and the explanatory power of macroeconomic fundamentals in real exchange rate fluctuations a reasonably strong case can be made for a traditional macroeocnomic interpretation of real exchange rates which emphasizes short run price stickiness but long run ppp but a central new ingredient in this interpretation is the presence of international commodity market segmentation and persistent deviations from the law of one price an example is given of a dynamic general equilibrium model that can reproduce some of the observed features of real exchange rate fluctuations

cointegration and the long run forecast of exchange rates abstract multivariate cointegration is used to generate the long run forecast of the dollar dm exchange rate it is shown that while the random walk model outperforms the monetary structural models in the short run the latter based on the error correction model outperform the former in the long run

a re examination of the exchange rate interest differential relationship evidence from germany and japan abstract this paper presents empirical evidence which links the exchange rate interest differential relation over the recent floating rate period using johansen s cointegration test we find a long run relationship between real exchange rates and expected real interest differentials in addition empirical evidence is provided to show that our error correction framework leads to real exchange rate forecasts that are superior to those generated by a random walk forecasting model moreover this superiority in out of sample predictability is supported statistically by the test of diebold and mariano

evidence on the purchasing power parity in a panel of cities evidence is provided on the ppp hypothesis using a sample of 50 spanish cities for a long time period through the application of panel data unit root tests although results suggest non rejection of the ppp short run deviations as measured by half lives indicate that real factors might be causing a slow rate of convergence to a common price index even in highly integrated economies

dynamic laffer curves abstract in an endogenous growth model with human capital accumulation we discuss the possibility of welfare improving changes on the fiscal policy stance in some actual economies first we characterize the extent to which the initial fall in revenues produced by a permanent tax cut can be compensated by an increase in the tax base due to a dynamic laffer curve effect showing that there is in fact a non trivial margin for substituting debt for taxes on labor and capital income second we show that the largest feasible reduction in labor income tax rates may easily produce a higher welfare gain than the largest feasible reduction in capital income tax rates two qualifications a feasible tax cuts exist only for a relatively high elasticity of intertemporal substitution of consumption and b the preference for the largest feasible tax cut on labor income rather than that on capital income reverses for a low appreciation for leisure relative to consumption in the preferences of the representative agent