Three essays on the empirical aspects of models of exchange rate determination
Abstract
This investigation examines various aspects of the so called monetary models of exchange rate determination. The thread which connects all three essays is the econometric modeling of nonstationary variables. Essay one examines the validity of the imposition of purchasing power parity (PPP) as a long run equilibrium condition that is found in monetary models of exchange rate determination. Tests for the cointegration of prices indices and exchange rates are conducted. However, unlike previous cointegration tests of PPP, this essay uses precise data pretests and does not impose a priori restrictions upon the cointegrating vector. Using Swiss exchange rate data, this essay finds evidence that PPP holds as a long run equilibrium. Essay two investigates the conclusions found in many monetary models of exchange rate determination that the exchange rate will 'overshoot' its long run equilibrium in reaction to an unanticipated permanent monetary shock. This proposition is examined by the estimation and simulation of the vector error correction models implied by the cointegration results found in the first essay. Again using Swiss exchange rate data, unanticipated monetary shocks lead to simulated exchange rate dynamics which are in many cases broadly consistent with the monetary overshooting of the exchange rate implied by the monetary models. The third essay tests the causal relationships implied by the monetary models as well as the efficient market models of exchange rate determination. These tests are conducted by applying multiple time series Granger causality tests to the vector error correction models built in the previous essay. This essay finds that lagged price indices Granger cause the nominal exchange rate and lagged and contemporaneous monetary variables do not Granger cause the nominal exchange rate thus finding evidence contrary to both the monetary and efficient market models of exchange rate determination.
Degree
Ph.D.
Advisors
Carlson, Purdue University.
Subject Area
Economics
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