Do fundamentals matter for the D-Mark/Euro-Dollar? A regime switching approach

Frömmel, M., Macdonald, R. and Menkhoff, L. (2005) Do fundamentals matter for the D-Mark/Euro-Dollar? A regime switching approach. Global Finance Journal, 15(3), pp. 321-335. (doi:10.1016/j.gfj.2004.09.001)

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In this paper, we demonstrate that there is evidence of an unstable and nonlinear relationship between fundamentals and exchange rates. Modeling this time-varying nature of the importance of fundamentals in a Markov switching framework substantially improves the fit of the real interest rate differential model and leads to parameter estimates, which in one regime are in line with theoretical expectations and allow us to draw reasonable conclusions on the influence of fundamentals on exchange rate dynamics. Factors that prove to be closely related to regime switches are short-term interest rate, inflation differentials and differences in economic growth. Therefore, fundamentals do not only matter for the exchange rate within each regime, but are also related to the switches between the regimes.

Item Type:Articles
Glasgow Author(s) Enlighten ID:MacDonald, Professor Ronald
Authors: Frömmel, M., Macdonald, R., and Menkhoff, L.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:Global Finance Journal
ISSN (Online):1873-5665
Published Online:13 December 2004

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