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Do Fundamentals Matter for the D-Mark/Euro-Dollar? A Regime Switching Approach

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  • Frömmel, Michael
  • MacDonald, Ronald
  • Menkhoff, Lukas

Abstract

In this paper we demonstrate that there is evidence of an unstable and nonlinear re-lationship between fundamentals and exchange rates. Modeling this time-varying nature of the importance of fundamentals in a Markov switching framework substan-tially improves the fit of the real interest rate differential model and leads to parame-ter estimates, which in one regime are in line with theoretical expectations and allow us to draw reasonable conclusions on the influence of fundamentals on exchange rate dynamics. Factors which prove to be closely related to regime switches are short term interest rate, inflation differentials and differences in economic growth. There-fore fundamentals do not only matter for the exchange rate within each regime, but are also related to the switches between the regimes.

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File URL: http://diskussionspapiere.wiwi.uni-hannover.de/pdf_bib/dp-289.pdf
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Bibliographic Info

Paper provided by Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät in its series Hannover Economic Papers (HEP) with number dp-289.

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Length: 21 pages
Date of creation: Dec 2003
Date of revision:
Handle: RePEc:han:dpaper:dp-289

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Keywords: exchange rates; real interest rate diffential model; Markov switching model;

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References

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Citations

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Cited by:
  1. Joscha Beckmann & Ansgar Belke & Frauke Dobnik, 2011. "Cross-Section Dependence and the Monetary Exchange Rate Model: A Panel Analysis," Discussion Papers of DIW Berlin 1119, DIW Berlin, German Institute for Economic Research.
  2. Joscha Beckmann & Ansgar Belke & Michael Kühl, 2011. "The dollar-euro exchange rate and macroeconomic fundamentals: a time-varying coefficient approach," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 147(1), pages 11-40, April.
  3. Joscha Beckmann, 2011. "Nonlinear Adjustment, Purchasing Power Parity and the Role of Nominal Exchange Rates and Prices," Ruhr Economic Papers 0272, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  4. Joscha Beckmann & Ansgar Belke & Michael Kühl, 2011. "Cointegration, structural breaks and monetary fundamentals of the Dollar/Yen Exchange," International Advances in Economic Research, Springer, vol. 17(4), pages 397-412, November.

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