Exchange Rates and Fundamentals

Charles Engel and Kenneth West ()

No 10723, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We show analytically that in a rational expectations present value model, an asset price manifests near random walk behavior if fundamentals are I(1) and the factor for discounting future fundamentals is near one. We argue that this result helps explain the well known puzzle that fundamental variables such as relative money supplies, outputs, inflation and interest rates provide little help in predicting changes in floating exchange rates. As well, we show that the data do exhibit a related link suggested by standard models - that the exchange rate helps predict these fundamentals. The implication is that exchange rates and fundamentals are linked in a way that is broadly consistent with asset pricing models of the exchange rate.

JEL-codes: F31 G12 (search for similar items in EconPapers)
Date: 2004-08
New Economics Papers: this item is included in nep-ifn
Note: EFG IFM ME AP
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Citations: View citations in EconPapers (12)

Published as Engel, Charles, and Kenneth D. West. "Exchange Rates and Fundamentals." Proceedings, Federal Reserve Bank of San Francisco, March 1, 2003
Published as Engel, Charles, and Kenneth D. West. "Exchange Rates and Fundamentals." Journal of Political Economy 113(3): 485-517, June 2005

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Journal Article: Exchange rates and fundamentals (2003)
Working Paper: Exchange rates and fundamentals (2003)
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