Accounting for exchange rate variability in present-value models when the discount factor is near one
By: Charles Engel, Kenneth D. West.
Contributors: West, Kenneth D.; National Bureau of Economic Research.
Series: NBER working paper series ;; working paper 10267; Working paper series (National Bureau of Economic Research : Online) ;; working paper no. 10267.
Publisher: National Bureau of Economic Research
Published: 2004
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Description: "Nominal exchange rates in low-inflation advanced countries are nearly random walks.  Engel and West (2003a) offer an explanation for this in the context of models in which the exchange rate is determined as the discounted sum of current and expected future fundamentals.  Engel and West show that if the fundamentals are I(1), then as the discount factor approaches one, the exchange rate becomes indistinguishable from a random walk.  An alternative explanation for the random-walk behavior of exchange rates is that there are some unobserved variables that drive exchange rates that follow near random walks.  This paper takes the approach that both explanations are possible.  We are able to measure how much of exchange-rate variation could be accounted for by the Engel-West explanation, despite the fact that we do not observe the information set of financial markets.  We find that the observable fundamentals (money, income, prices, interest rates) may account for about 40 percent of the variance of changes in exchange rates under the assumption of discount factors near unity"--National Bureau of Economic Research web site.
Notes: Also available in print.
Includes bibliographical references.
Title from PDF file as viewed on 1/24/2005.
System requirements: Adobe Acrobat Reader.
Mode of access: World Wide Web.