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http://hdl.handle.net/10419/53939
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| Title: | | What drives exchange rates? New evidence from a panel of US dollar bilateral exchange rates  |
| Authors: | | Cayen, Jean-Philippe Coletti, Donald Lalonde, René Maier, Philipp |
| Issue Date: | | 2010 |
| Series/Report no.: | | Bank of Canada Working Paper 2010,5 |
| Abstract: | | We use a novel approach to identify economic developments that drive exchange rates in the long run. Using a panel of six quarterly U.S. bilateral real exchange rates Australia, Canada, the euro, Japan, New Zealand and the United Kingdom over the 1980-2007 period, a dynamic factor model points to two common factors. The first factor is driven by U.S. shocks, and cointegration analysis points to a long-run statistical relationship with the U.S. debt-to-GDP ratio, relative to all other countries in our sample. The second common factor is driven by commodity prices. Incorporating these relationships directly into a state-space model, we find highly significant coefficients. Then, we decompose the historical variation of each exchange rate into U.S. shocks, commodities, and a domestic component. We find a strong role for economic fundamentals: Changes in the two common factors, which are driven by the (relative) U.S. debt-to-GDP ratio and commodity prices, can explain between 36 and 96 per cent of individual countries' exchange rates in our panel. |
| Subjects: | | Exchange rates Econometric and statistical methods |
| JEL: | | J31 |
| Document Type: | | Working Paper |
| Appears in Collections: | | Bank of Canada Working Papers
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