Exchange rate behavior in developing economies: A theoretical and empirical investigation

Vijay Bhawnani, Purdue University

Abstract

This dissertation is organized into two parts. The overall intent is to examine exchange rate behavior in developing economies. In the first part (chapter 2), we extend the literature on speculative attacks and balance of payments crises to model developing economies with dual exchange rate regimes. We show the effects of the degree of currency convertibility on the parallel market and on the probability of devaluation. The model implies that exchange rates and the forcing variables will be cointegrated. Tests with data from Mexico support this implication. Exchange rate forecasts conditional on devaluation are also close to actual exchange rates set by the Bank of Mexico in the years 1982-1991. In the second part (chapter 3), we investigate the ability of a variety of exchange rate models to forecast parallel exchange rates for developing economies. In contrast to earlier studies, which use actual values of the exogenous variables, we employ time series forecasts of the exogenous variables. An error-correction version of a monetary model proposed by us, that incorporates the dynamics of both short run and long run adjustment processes, outperforms all other estimated models that have been suggested earlier.

Degree

Ph.D.

Advisors

Kadiyala, Purdue University.

Subject Area

Economics|Economic theory

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