de Grauwe, Paul 
ORCID: 0000-0001-5225-1301 and Vansteenkiste, Isabel
(2007)
Exchange rates and fundamentals: a non-linear relationship?
International Journal of Finance and Economics, 12 (1).
pp. 37-54.
ISSN 1076-9307
Abstract
We test whether the relationship between changes in the nominal exchange rate and changes in its underlying fundamentals has non-linear features. In order to do so, we extend the Markov-switching model as proposed by McConnell and Perez Quiros (2000) and Dewachter (2001) and test it using a sample of low- and high-inflation countries. The empirical analysis shows that for the high-inflation countries the relationship between news in the fundamentals and the exchange rate changes is stable and significant. This is not the case, however, for the low-inflation countries, where frequent regime switches occur. We develop a non-linear model based on the existence of transactions costs that could explain our empirical findings. We find that this simple non-linear model is capable of replicating the empirical evidence uncovered in this paper.
| Item Type: | Article |
|---|---|
| Official URL: | http://dx.doi.org/10.1002/ijfe.310 |
| Additional Information: | © 2007 John wiley & Sons |
| Divisions: | LSE |
| Subjects: | H Social Sciences > HB Economic Theory H Social Sciences > HG Finance |
| JEL classification: | F - International Economics > F3 - International Finance > F31 - Foreign Exchange F - International Economics > F3 - International Finance > F37 - International Finance Forecasting and Simulation |
| Date Deposited: | 05 Oct 2012 12:49 |
| Last Modified: | 11 Dec 2024 23:14 |
| URI: | http://eprints.lse.ac.uk/id/eprint/46591 |
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