Abstract
Many studies have pointed out that the underlying relations and functions for the monetary model (e.g. the PPP relation, the money-demand function, monetary policy rule, etc.) have undergone parameter instabilities and that the relation between exchange rates and macro fundamentals is unstable due to the shift in the economic models in foreign exchange traders' views or the scapegoat effect in Bacchetta and van Wincoop (2009). Facing this, we consider a monetary model with time-varying cointegration coefficients in order to understand exchange rate movements. Weprovide statistical evidence against the standard monetary model with constant cointegration coefficients but find favorable evidence for the time-varying cointegration relationship between exchange rates and monetary fundamentals. Furthermore, we demonstrate that deviations between the exchange rate and fundamentals from the time-varying cointegration relation have strong predictive power for future changes in exchange rates through in-sample analysis, out-of-sample analysis, and directional accuracy tests.
Original language | English |
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Pages (from-to) | 394-410 |
Number of pages | 17 |
Journal | Journal of International Money and Finance |
Volume | 37 |
DOIs | |
Publication status | Published - 2013 |
Bibliographical note
Funding Information:We are grateful to an anonymous referee for valuable comments. We also thank seminar participants at Korea University and Kyung Hee University for helpful comments and discussions. Cheolbeom Park acknowledges that this work was supported by the National Research Foundation of Korea Grant funded by the Korean Government ( NRF-2012S1A5A8023577 ). However, all remaining errors are ours.
Keywords
- Exchange rate
- Monetary model
- Predictability
- Time-varying cointegration
ASJC Scopus subject areas
- Finance
- Economics and Econometrics