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Measuring the dollar–euro permanent equilibrium exchange rate using the unobserved components model

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  • Chen, Xiaoshan
  • MacDonald, Ronald

Abstract

This paper employs an unobserved component model that incorporates a set of economic fundamentals to obtain the Euro–Dollar permanent equilibrium exchange rates (PEER) for the period 1975Q1 to 2008Q4. The results show that for most of the sample period, the Euro–Dollar exchange rate closely followed the values implied by the PEER. The only significant deviations from the PEER occurred in the years immediately before and after the introduction of the single European currency. The forecasting exercise shows that incorporating economic fundamentals provides a better long-run exchange rate forecasting performance than a random walk process.

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  • Chen, Xiaoshan & MacDonald, Ronald, 2015. "Measuring the dollar–euro permanent equilibrium exchange rate using the unobserved components model," Journal of International Money and Finance, Elsevier, vol. 53(C), pages 20-35.
    • Handle: RePEc:eee:jimfin:v:53:y:2015:i:c:p:20-35
    DOI: 10.1016/j.jimonfin.2014.12.008
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    More about this item

    Keywords

    Permanent equilibrium exchange rate; Unobserved components model; Exchange rate forecasting;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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