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The Equilibrium Exchange Rate in a Bayesian State-Space Model: An Application to Australia


  • Martin Melecky

    (School of Economics, University of New South Wales)


The equilibrium exchange rate is a closely scrutinized variable in international finance and monetary economics. A model to estimate an equilibrium exchange rate is proposed in this paper. It consists of several building blocks: a state-space structure, uncovered interest parity and the equilibrium exchange rate determinants. Prior information about the impact of the determinants is used when Bayesian estimation of the model is carried out. The estimates reveal that on average the Australian dollar was overvalued by about 3 percent during the period 1984-2004. The major overvaluations of the AUD/USD exchange rate took place during the period 1986-1988, and around the years 1990, and 2003. The information content of the acquired estimates of exchange rate misalignments appears to be superior to the purchasing parity equivalent.

Suggested Citation

  • Martin Melecky, 2005. "The Equilibrium Exchange Rate in a Bayesian State-Space Model: An Application to Australia," International Finance 0505005, University Library of Munich, Germany.
  • Handle: RePEc:wpa:wuwpif:0505005
    Note: Type of Document - pdf; pages: 25

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    More about this item


    Exchange-Rate Modeling; Equilibrium Exchange Rate; State-Space Model; Bayesian Estimation and Inference; Australian Dollar;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General


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