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Non-linearities in the relation between the exchange rate and its fundamentals

✍ Scribed by Carlo Altavilla; Paul De Grauwe

Publisher
John Wiley and Sons
Year
2008
Tongue
English
Weight
417 KB
Volume
15
Category
Article
ISSN
1076-9307

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✦ Synopsis

Abstract

We develop a simple theoretical model in which chartists and fundamentalists interact. The model predicts the existence of different regimes, and thus non‐linearities in the link between the exchange rate and its fundamentals. We test the model empirically by adopting a Markov‐switching vector error correction model. The results suggest the presence of non‐linear mean reversion in the nominal exchange rate process. The implications are that different sets of macroeconomic fundamentals act as driving forces of the exchange rates during different time periods. Copyright Β© 2008 John Wiley & Sons, Ltd.

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