A Test of Monetary and Portfolio Balance Models of Exchange Rate Determination
37 Pages Posted: 15 Feb 2006
Date Written: October 2, 1986
Abstract
This paper tests whether the volatility in the fundamentals that ought to determine exchange rates is large enough to produce the observed volatility in exchange rates. The results show that monetary and portfolio balance considerations cannot explain the observed variability in the exchange rate of the deutsche mark vis-a-vis the U.S. dollar Japanese yen and Swiss franc. However monetary and portfolio balance considerations can explain the observed variability of the deutsche mark vis-a-vis other EMS currencies. This suggests that the EMS has been successful in reducing the exchange rate volatility to the minimum compatible with the volatility in the fundamentals.
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