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Strong comovements of exchange rates: Theoretical and empirical cases when currencies become the same asset

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  • Kühl, Michael

Abstract

The aim of this paper is to detect periods in which two currencies can be classified as being the”same” asset. Two currencies can be treated as the same asset if their exchange rates vis-à-vis the same base currency are cointegrated with a cointegration vector that is consistent with the triangular arbitrage condition. In a first step, it is theoretically derived under which conditions,with respect to the process of the fundamentals, the exchange rates are cointegrated. The empirical results yield that periods of strong comovements of the US dollar and Pound sterling based upon the Euro prevail during the 1990s and periods of comovements of Euro and Pound sterling denominated in US dollar prevail since the introduction of the Euro. Furthermore, no long-run relationships canbe discovered. This paper gives four major innovations to the literature. It first shows under which conditions exchange rates can be bivariately cointegrated. Secondly, it uses the cross-rate identity to test forcointegration, i.e. deducing recursively. Thirdly, it applies the cointegration methodology within atriangular framework by detecting cointegration between exchange rates that are not only denominated in U.S. dollars. And lastly, it shows that comovements between two exchange rates exist ina narrower sense but only in short periods, whereas the economic variables which have caused therelationship are explored. --

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Bibliographic Info

Paper provided by University of Goettingen, Department of Economics in its series Center for European, Governance and Economic Development Research Discussion Papers with number 76.

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Date of creation: 2008
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Handle: RePEc:zbw:cegedp:76

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Related research

Keywords: Foreign Exchange Market; Comovements; Cointegration; Long-Memory;

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  1. Carlo Altavilla & Paul De Grauwe, 2010. "Non-linearities in the relation between the exchange rate and its fundamentals," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(1), pages 1-21.
  2. Sephton, Peter S. & Larsen, Hans K., 1991. "Tests of exchange market efficiency: fragile evidence from cointegration tests," Journal of International Money and Finance, Elsevier, vol. 10(4), pages 561-570, December.
  3. Norrbin, S.C., 1993. "Bivariate Cointegration Among European Monetary System Exchange Rates," Working Papers 1993_07_06, Department of Economics, Florida State University.
  4. P J Perez & D R Osborn & M Artis, 2003. "The International Business Cycle in a Changing World: Volatility and the Propagation of Shocks," Centre for Growth and Business Cycle Research Discussion Paper Series 37, Economics, The Univeristy of Manchester.
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  7. Paloviita , Maritta, 2002. "Inflation dynamics in the euro area and the role of expectations," Research Discussion Papers 20/2002, Bank of Finland.
  8. Copeland, Laurence S, 1991. "Cointegration Tests with Daily Exchange Rate Data," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 53(2), pages 185-98, May.
  9. Jeon, Bang Nam & Seo, Byeongseon, 2003. "The impact of the Asian financial crisis on foreign exchange market efficiency: The case of East Asian countries," Pacific-Basin Finance Journal, Elsevier, vol. 11(4), pages 509-525, September.
  10. John T. Barkoulas & Christopher F. Baum & Mustafa Caglayan & Atreya Chakraborty, 1998. "Persistent Dependence in Foreign Exchange Rates? A Reexamination," Boston College Working Papers in Economics 377, Boston College Department of Economics, revised 21 Apr 2000.
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