Why Does the Australian Dollar Move so Closely with the Terms of Trade?
AbstractThe 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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Bibliographic InfoPaper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp9601.
Date of creation: May 1996
Date of revision:
Find related papers by JEL classification:
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models &bull Diffusion Processes
- F31 - International Economics - - International Finance - - - Foreign Exchange
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