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Inhaltsverzeichnis

Frontmatter

Chapter 1. Introduction

Abstract
These notes draw from the Theory of Cointegration and use it in order to test the monetary model of exchange rate determination. The analysis is empirical, that is, we take a theoretical model of exchange rate determination and asses its empirical performance. We have also addressed several issues concerning to the Theory of Cointegration.
Javier Gardeazabal, Marta Regúlez

Chapter 2. The Monetary Model of Exchange Rate Determination

Abstract
Monetary models of exchange rate determination were developed after the collapse of the fixed exchange rate system in the early 70’s. They are descendants of the Mundell-Fleming type of models. Several versions have been put forward giving rise to three main types of models. These are the flexible price monetary model due to Frenkel (1976) and Bilson (1978), the sticky price / real interest rate differential of Dornbusch (1976) and Frankel (1979) and the sticky price-asset monetary model of Hooper and Morton (1982). The modeling strategy is similar in all cases. Ad hoc aggregate macroeconomic relationships are used to obtain a semi-reduced form equation that specifies the level of the exchange rate as a linear function of fundamentals1.
Javier Gardeazabal, Marta Regúlez

Chapter 3. Long run Exchange Rate Determination I

Abstract
International Monetary Theory postulates a number of relationships among macroeconomic variables of different countries. Examples are, absolute and relative Purchasing Power Parity (PPP), Real Interest rate Parity (RIP), Uncovered Interest Parity (UIP) and (forward) foreign exchange market efficiency. These international linkages are at the basis of the economic modeling of open economies, in particular, monetary models of exchange rate determination, despite the fact that many authors have found empirical evidence against them.
Javier Gardeazabal, Marta Regúlez

Chapter 4. Long Run Exchange Rate Determination II

Abstract
The work of Baillie and Selover (1987), Boothe and Glassman (1987) and the previous chapter takes into account the nonstationarity of some of the variables involved in the monetary models. In this context, the equations of exchange rate determination derived from the monetary models are thought of as long-run relationships. From this point of view, deviations of the exchange rate from a linear combination of its fundamentals are stationary, or in other words, they are cointegrated. The methodology used in those studies is that developed by Engle and Granger (1987). The results obtained in all three studies reject the specification of the monetary approach.
Javier Gardeazabal, Marta Regúlez

Chapter 5. Short Run Exchange Rate Determination

Abstract
In this chapter we study the short run dynamics of the exchange rate. In particular, we are interested in how the exchange rate reacts to transitory deviations from the long run equilibrium. By inspecting the ECM we can see that the loadings matrix a plays an extremely important role in this matter.
Javier Gardeazabal, Marta Regúlez

Chapter 6. Effect of Non-Normal Disturbances on Likelihood Ratio Tests

Abstract
Since Granger (1981) first introduced the concept of cointegration the field has experienced a great development. There are by now several methods of estimating cointegrating vectors: Ordinary Least Squares (Engle and Granger (1987)), Non-linear Least Squares (Stock (1987)), Principal Components (Stock and Watson (1988)), Canonical Correlations (Bossaerts (1988)) and full information maximum likelihood in a Gaussian system (Johansen (1988b, 1991a)). All these methods of estimation are fairly simple to implement and this is probably why empirical applications grow in number very quickly. Inference, on the other hand, is more difficult to carry out. All known hypotheses tests on the number of cointegrating vectors have non standard asymptotic distributions. In addition, only the ML procedure1 allows the user to carry out inference on the cointegrating vectors and loading matrix based on standard χ2 tests.
Javier Gardeazabal, Marta Regúlez

Chapter 7. Estimation of The Time Series Model

Abstract
In this chapter we describe several methods of estimation under different restrictions on the parameters of the model. Johansen’s estimation procedure is just one of the methods analyzed, corresponding to the case when only the long run parameters α and β are restricted. In addition, we also study other types of restrictions, namely, zero restrictions on the short run parameters of the ECM.
Javier Gardeazabal, Marta Regúlez

Chapter 8. Prediction in Cointegrated Systems

Abstract
A wide range of macroeconomic magnitudes can be characterized “as non-stationary processes that have no tendency to return to a deterministic path”. This was reported by Nelson and Plosser (1982), but there is still a controversy about whether the nonstationarity of those variables can be captured by a deterministic or stochastic trend.
Javier Gardeazabal, Marta Regúlez

Chapter 9. Nominal Exchange Rate Prediction

Abstract
Nominal exchange rate prediction interests many. Economists can use exchange rate prediction exercises as a way of validating structural models of exchange rate determination. Businessmen are interested in forecasting rates to the extent that this will allow them to better hedge against foreign exchange risk. Finally, governments will conduct their domestic economic policy guided by a better knowledge if they have accurate rate forecasts at their disposal.
Javier Gardeazabal, Marta Regúlez

Chapter 10. A Simulation Exercise

Abstract
Engle and Yoo (1987) use a small simulation exercise to compare the forecasting ability of a bivariate unrestricted VAR including just one lag with that of an ECM estimated by the two-step procedure proposed by Engle and Granger (1987). The restricted ECM outperforms, in terms of mean squared error, its unrestricted opponent if the number of steps ahead predicted is six or greater. They argue that the better performance of the unrestricted VAR in the short run might be due to the long run character of the constraints. Hence, according to their argument, the restricted ECM would be misspecified in the short run. Whereas, it would be correctly specified once the forecasting horizon were such that the cointegrating restrictions became true.
Javier Gardeazabal, Marta Regúlez

Chapter 11. Conclusions

Abstract
The empirical evidence presented in this monograph is an attempt to revive the monetary model of exchange rate determination as a long run relationship. The interesting feature of this interpretation of the monetary model is that it allows for short run deviations of the exchange rate from its fundamentals.
Javier Gardeazabal, Marta Regúlez

Backmatter

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