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Estimating exchange rate responsiveness to shocks

journal contribution
posted on 2008-12-01, 00:00 authored by Paresh Narayan
The goal of this paper is to examine the importance of permanent and transitory shocks using a more efficient trend-cycle decomposition of the real exchange rate series. Our main contribution is that in measuring the impact of shocks, we not only impose common trend restrictions but also common cycle restrictions. We later confirm, through a post sample forecasting exercise, the efficiency gains from imposing common cycle restrictions. Our results indicate that permanent shocks are responsible for the bulk of the real exchange rate variations for Japan, Italy, Germany, France, and the UK vis-à-vis the US dollar over short horizons. For Canada, however, transitory shocks are dominant over the short horizon. In sum, while for Japan, France, and Italy, around 15% of the variation in real exchange rate is due to transitory shocks, for Canada, Germany and the UK, over 25% of the variations over the short horizon are due to transitory shocks. Thus, we claim that the role of transitory shocks should not be ignored.

History

Journal

Review of financial economics

Volume

17

Issue

4

Pagination

338 - 351

Publisher

Elsevier Inc.

Location

Amsterdam, The Netherlands

ISSN

1058-3300

eISSN

1873-5924

Language

eng

Publication classification

C1 Refereed article in a scholarly journal

Copyright notice

2008, Elsevier Inc.

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