Exchange Rates and Fundamentals

48 Pages Posted: 17 Sep 2004

See all articles by Charles M. Engel

Charles M. Engel

University of Wisconsin - Madison - Department of Economics; National Bureau of Economic Research (NBER); University of Washington - Department of Economics

Kenneth D. West

University of Wisconsin - Madison - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: August 2004

Abstract

We show analytically that in a rational expectations present value model, an asset price manifests near random walk behavior if fundamentals are I(1) and the factor for discounting future fundamentals is near one. We argue that this result helps explain the well known puzzle that fundamental variables such as relative money supplies, outputs, inflation and interest rates provide little help in predicting changes in floating exchange rates. As well, we show that the data do exhibit a related link suggested by standard models - that the exchange rate helps predict these fundamentals. The implication is that exchange rates and fundamentals are linked in a way that is broadly consistent with asset pricing models of the exchange rate.

Suggested Citation

Engel, Charles M. and West, Kenneth D., Exchange Rates and Fundamentals (August 2004). NBER Working Paper No. w10723. Available at SSRN: https://ssrn.com/abstract=589008

Charles M. Engel (Contact Author)

University of Wisconsin - Madison - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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University of Washington - Department of Economics ( email )

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Kenneth D. West

University of Wisconsin - Madison - Department of Economics ( email )

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Madison, WI 53706
United States
608-262-0033 (Phone)
608-262-2033 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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