Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/224101
Authors: 
Huber, Florian
Kaufmann, Daniel
Year of Publication: 
2019
Series/Report no.: 
Working Papers in Economics No. 2019-04
Abstract: 
We estimate a multivariate unobserved components stochastic volatility model to explain the dynamics of a panel of six exchange rates against the US Dollar. The empirical model is based on the assumption that both countries' monetary policy strategies may be well described by Taylor rules with a time-varying inflation target, a time-varying natural rate of unemployment, and interest rate smoothing. Compared to the existing literature, our model simultaneously provides estimates of the latent components included in a typical Taylor rule specification and the model-based real exchange rate. Our estimates closely track major movements along with important time series properties of real and nominal exchange rates across all currencies considered, outperforming a benchmark model that does not account for changes in trend inflation and trend unemployment. More precisely, the proposed approach improves upon competing models in tracking the actual evolution of the real exchange rate in terms of simple correlations while it appreciably improves upon simpler competitors in terms of matching the persistence of the real exchange rate.
Subjects: 
exchange rate models
trend inflation
natural rate of unemployment
Taylor rule
unobserved components stochastic volatility model
JEL: 
F31
E52
F41
C5
E31
Document Type: 
Working Paper

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