Understanding the sources of the exchange rate disconnect puzzle: A variance decomposition approach

Yu-Hsi Chou

International Review of Economics & Finance, 2018, vol. 56, issue C, 267-287

Abstract: In this paper, we apply the monetary model to examine the degree to which economic fundamentals can explain large and persistent fluctuations in the spread between the nominal exchange rate and monetary fundamentals i.e. the so-called “exchange rate disconnect puzzle.” We show that deviations from purchasing power parity account for the bulk of the variation in the deviations of the nominal exchange rate from observed monetary fundamentals, whereas the importance of the risk premium becomes more pronounced after the establishment of the European Economic and Monetary Union.

Keywords: Monetary fundamentals; Exchange rate disconnect puzzle; Variance decomposition (search for similar items in EconPapers)
JEL-codes: C5 F31 F47 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:56:y:2018:i:c:p:267-287

DOI: 10.1016/j.iref.2017.10.029

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