An Exchange Rate Model with Market Pressures and a Contagion Effect

Wojciech Grabowski and Aleksander Welfe

Emerging Markets Finance and Trade, 2016, vol. 52, issue 12, 2706-2720

Abstract: The model we propose includes variables accounting for the behavioral aspects of decision-making in the currency markets, namely the contagion effect between countries in the same region. It combines the classical purchasing power parity (PPP) and uncovered interest rate parity (UIP) hypotheses with the effects of risk aversion in financial markets and of currency market pressures.The results based on the Polish data confirm that the currency market instabilities arise not only from fundamental factors such as economic activity and the country’s balance of payments, but also from the contagion effect brought about by investors’ tendency to view Poland and its neighbors, the Czech Republic and Hungary, as one group.

Date: 2016
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DOI: 10.1080/1540496X.2016.1216931

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