Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/76405 
Year of Publication: 
2003
Series/Report no.: 
CESifo Working Paper No. 904
Publisher: 
Center for Economic Studies and ifo Institute (CESifo), Munich
Abstract: 
In this paper, we construct alternative theoretical models for exchange rates by introducing additional risk factors, based on the volatility of macroeconomic fundamentals. The modified flexible-price monetary model is used to characterize the long-run equilibrium of exchange rates, while the modified sticky-price model explains the adjustment towards the long run. Empirically, in a number of OECD countries we find cointegration relationships between the exchange rate and macroeconomic variables and also some evidence for the long-run equilibrium error correction. Macroeconomic uncertainty can significantly explain the variation of the exchange rate from its fundamental-based value. The results lead us to believe that macroeconomic sources of FOREX risk may be a missing factor in the exchange rate study.
Subjects: 
flexible-price and sluggish-price exchange rate models
expectation formations
macroeconomic risk
risk premium
asset pricing
Document Type: 
Working Paper
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