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The Exchange Rate and Macroeconomic Determinants: Time-Varying Transitional Dynamics

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Abstract

In this paper, I consider modeling the effects of the macroeconomic determinants on the nominal exchange rate to be channeled through the transition probabilities in a Markovian process. The model posits that the deviation of the exchange rate from its fundamental value alters the market’s belief in the probability of the process staying in certain regime next period. This paper further takes into account the ARCH effects of the volatility of the exchange rate. Empirical results generally confirm that fundamentals can affect the evolution of the dynamics of the exchange rate in a nonlinear way through the transition probabilities. In addition, I find that the volatility of the exchange rate is associated with significant ARCH effects which are subject to regime change.

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Bibliographic Info

Paper provided by UMBC Department of Economics in its series UMBC Economics Department Working Papers with number 09-114.

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Length: 59 pages
Date of creation: 01 May 2008
Date of revision: 01 Nov 2009
Handle: RePEc:umb:econwp:09114

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Keywords: Exchange Rate; Macroeconomic Determinants; Markov-Switching; ARCH; and Time-Varying;

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Cited by:
  1. Lee, Chin & Law, Chee-Hong, 2013. "The Effects of Trade Openness on Malaysian Exchange Rate," MPRA Paper 45185, University Library of Munich, Germany.
  2. Yuan, Chunming, 2011. "Forecasting exchange rates: The multi-state Markov-switching model with smoothing," International Review of Economics & Finance, Elsevier, vol. 20(2), pages 342-362, April.

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