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Macroeconomic fundamentals and the exchange rate dynamics: A no-arbitrage macro-finance approach

  • Yin, Weiwei
  • Li, Junye
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    In this paper, we propose an arbitrage-free international macro-finance model that links the exchange rate dynamics to macroeconomic fundamentals. Jointly using data on exchange rates, yields of zero-coupon bonds, and macroeconomic variables of the US and the Euro area, we find a close link between macroeconomic fundamentals and the exchange rate dynamics. The model-implied monthly exchange rate changes can explain about 57% variation of the observed data. The macroeconomic innovations can help capture large variation of exchange rate changes. Robustness checks show that the results also hold for other major exchange rates.

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    Article provided by Elsevier in its journal Journal of International Money and Finance.

    Volume (Year): 41 (2014)
    Issue (Month): C ()
    Pages: 46-64

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    Handle: RePEc:eee:jimfin:v:41:y:2014:i:c:p:46-64
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