Exchange rates and fundamentals: A non-linear relationship?
AbstractWe test whether the relationship between changes in the nominal exchange rate and changes in its underlying fundamentals has non-linear features. In order to do so, we extend the Markov-switching model as proposed by McConnell and Perez Quiros (2000) and Dewachter (2001) and test it using a sample of low- and high-inflation countries. The empirical analysis shows that for the high-inflation countries the relationship between news in the fundamentals and the exchange rate changes is stable and significant. This is not the case, however, for the low-inflation Countries, where frequent regime switches occur.. We develop a non-linear model based on the existence of transactions costs that could explain our empirical findings. We find that this simple non-linear model is capable of replicating the empirical evidence uncovered in this paper. Copyright (c) 2007 John Wiley & Sons, Ltd.
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Bibliographic InfoPaper provided by Katholieke Universiteit Leuven in its series Open Access publications from Katholieke Universiteit Leuven with number urn:hdl:123456789/99801.
Date of creation: Jan 2007
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Publication status: Published in International journal of finance & economics (2007-01) v.12, p.37-54
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nominal exchange rate; non-linearities markov-switching model; purchasing power parity; long-run; real; equilibrium; perspective; models; market; float;
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