The dynamic relationship between exchange rates and macroeconomic fundamentals: Evidence from Pacific Rim countries

Ming-Jen Chang and Che-Yi Su

Journal of International Financial Markets, Institutions and Money, 2014, vol. 30, issue C, 220-246

Abstract: This study explores the linkages between exchange rates and macroeconomic fundamentals to determine the long-run relationship, the short-run dynamic correction as well as the direction of causality for several Pacific Rim countries. The conventional cointegration tests fail to find the long-run equilibrium for any country-pairs except Taiwan, but cointegration tests with structural breaks demonstrate the long-run connections between exchange rates and fundamentals for some country-pairs. Evidence from the VECM with structural breaks reveals that exchange rates bear the burden of adjustment toward the long-run equilibrium in three countries during the floating exchange rate regime. The direction of causality between exchange rates and fundamentals appears to vary over time in the S. Korea–U.S. pair. However, there is a uni-directional causality in the Canada–U.S., Japan–U.S., and Thailand–U.S. country-pairs. That is, the Canadian dollar/dollar, yen/dollar, and baht/dollar exchange rates contain information about future changes in macroeconomic fundamentals which correspond to the implications of the asset-pricing model of exchange rates. Finally, this study determines the time-varying causality between both variables during several sub-periods using a bootstrap rolling window approach for the four country-pairs.

Keywords: Exchange rate; Macroeconomic fundamentals; Pacific Rim countries; Structural break; Time-varying (search for similar items in EconPapers)
JEL-codes: C32 F31 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:30:y:2014:i:c:p:220-246

DOI: 10.1016/j.intfin.2014.03.002

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