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The contribution of economic fundamentals to movements in exchange rates

Author

Listed:
  • Balke, Nathan S.
  • Ma, Jun
  • Wohar, Mark E.

Abstract

Starting from the asset pricing approach of Engel and West, we examine the degree to which fundamentals can explain exchange rate fluctuations. We show that it is not possible to obtain sharp inferences about the relative contribution of fundamentals using only data on observed monetary fundamentals—money minus output differentials across countries—and exchange rates. We use additional data on interest rate and price differentials along with the implications of the monetary model of exchange rates to decompose exchange rate fluctuations. In general, we find that money demand shifts, along with observed monetary fundamentals, are an important contributor to exchange rate fluctuations.

Suggested Citation

  • Balke, Nathan S. & Ma, Jun & Wohar, Mark E., 2013. "The contribution of economic fundamentals to movements in exchange rates," Journal of International Economics, Elsevier, vol. 90(1), pages 1-16.
  • Handle: RePEc:eee:inecon:v:90:y:2013:i:1:p:1-16
    DOI: 10.1016/j.jinteco.2012.10.003
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    More about this item

    Keywords

    Bayesian analysis; Exchange rate decomposition; Monetary model; State-space model;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General

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