Parallel Currency Markets and the Monetary Exchange Rate Model: A VECM Application to Turkey Over 1987–1998

Evan Warshaw

Eastern European Economics, 2016, vol. 54, issue 6, 473-488

Abstract: This study takes a novel approach to testing the monetary model of exchange rate determination by allowing for distortions from the underground economy to be reflected via inclusion of the parallel exchange rate. Using a VECM methodology, an augmented model is tested and compared to a traditional flexible-price monetary model for Turkey over 1987–1998. While in-sample results are supportive of both models, out-of-sample analysis favors inclusion of the parallel exchange rate. Furthermore, the augmented model beats a random walk with and without drift over to mid-range forecast horizons. These results highlight the need to consider potential market distortions of exchange rate movements.

Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:mes:eaeuec:v:54:y:2016:i:6:p:473-488

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DOI: 10.1080/00128775.2016.1194215

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