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Exchange Rate Determination: Mixed Microstructural and Macroeconomic Approach

Ali Trabelsi Karoui and Aida Kammoun
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Ali Trabelsi Karoui: University of Sfax. Sfax, Tunisia.

International Journal of Economics and Financial Issues, 2021, vol. 11, issue 3, 89-106

Abstract: This paper represents a new approach in the exchange rate determination by using microstructural and macroeconomic variables. We test a combination of fundamentals and microstructure variables in cointegrated relationship of the USD/JPY and USD/GBP currencies’ pairs. The ‘twofold’ model includes interest rate, money supply and net foreign assets as fundamentals, and spread and high-low spread as a microstructure variable. Then we compare the different models of macroeconomic and twofold model with the random walk using an error-correction method. We find that the twofold model outperforms the random structural model in out-of-sample and in-sample forecast test for both exchange rates. Twofold model outperforms in out-of-sample forecast the random walk test for the USD/JPY.

Keywords: exchange rate; spreads; interest rate; money supply; net foreign assets; twofold model; cointegration (search for similar items in EconPapers)
JEL-codes: F31 F62 G15 G17 G18 (search for similar items in EconPapers)
Date: 2021
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