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Why Does the Australian Dollar Move so Closely with the Terms of Trade?

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Author Info

  • David Gruen

    (Reserve Bank of Australia)

  • Tro Kortian

    (Reserve Bank of Australia)

Abstract

The paper is motivated by two empirical results. Australia’s terms of trade exhibit temporary fluctuations around a slowly declining trend, and movements in Australia’s real exchange rate tend to follow those in the terms of trade. Together these results imply predictability in Australia’s real exchange rate as well as the presence of predictable excess returns that are sometimes quite large. Using a simple econometric model, with the terms of trade as the sole explanator, the paper demonstrates the forecastability of Australia’s real exchange rate over horizons ranging from one to two years. It then quantifies the magnitude of the predictable excess returns to holding Australian dollar denominated assets over such horizons, finding them to be highly variable and sometimes quite large in magnitude. The results suggest a relative scarcity of forward-looking foreign exchange market participants with an investment horizon of a year or more.

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File URL: http://www.rba.gov.au/publications/rdp/1996/pdf/rdp9601.pdf
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Bibliographic Info

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp9601.

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Date of creation: May 1996
Date of revision:
Handle: RePEc:rba:rbardp:rdp9601

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Cited by:
  1. Y.Chen & K. Rogoff, 2003. "Commodity Currencies and Empirical Exchange Rate Puzzles," DNB Staff Reports (discontinued) 76, Netherlands Central Bank.
  2. Tiffany Hutcheson, 2000. "Trading in the Australian Foreign Exchange Market," Working Paper Series 107, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  3. Valadkhani, Abbas & Layton, Allan P. & Karunaratne, Neil D., 2005. "Export Price Volatility in Australia: An Application of ARCH and GARCH Models," Economics Working Papers wp05-11, School of Economics, University of Wollongong, NSW, Australia.
  4. Kenneth W. Clements & Renee Fry, 2006. "Commodity Currencies and Currency Commodities," Economics Discussion / Working Papers 06-17, The University of Western Australia, Department of Economics.
  5. Chowdhury, Khorshed, 2007. "Are The Real Exchange Rate Indices of Australia Non-Stationary in the Presence of Structural Break?," Economics Working Papers wp07-05, School of Economics, University of Wollongong, NSW, Australia.
  6. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings, Federal Reserve Bank of Kansas City, pages 329-368.
  7. Balázs Égert, 2012. "Nominal and Real Exchange Rate Models in South Africa: How Robust Are They?," EconomiX Working Papers 2012-18, University of Paris West - Nanterre la Défense, EconomiX.
  8. Balazs Egert, 2009. "The Impact of Monetary and Commodity Fundamentals, Macro News and Central Bank Communication on the Exchange Rate: Evidence from South Africa," CESifo Working Paper Series 2612, CESifo Group Munich.
  9. Yu-chin Chen & Kenneth Rogoff, 2006. "Are the Commodity Currencies an Exception to the Rule?," Working Papers UWEC-2006-28, University of Washington, Department of Economics, revised Mar 2012.
  10. Khorshed Chowdhury, 2011. "Dynamics, Structural Breaks and the Determinants of the Real Exchange Rate of Australia," Economics Working Papers wp11-11, School of Economics, University of Wollongong, NSW, Australia.

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