Mt AtMti and Nt A

Where (At, A) are exogenous random gross rates of change in M and N. If the domestic household received transfers only of M, it faces foreign purchasing-power risk because it it also needs N to buy y-goods. Introducing the second currency creates a new country-specific risk that households will want to hedge. The complete markets paradigm allows markets to develop whenever there is a demand for a product. The products that individuals desire are claims to future dollar and euro transfers.5 So...

Long Run Analyses of Real Exchange Rates

Empirical research into the long-run behavior of real exchange rates has employed econometric analyses of nonstationary time series and is aimed at testing the hypothesis that the real exchange rate has a unit root. This research can potentially provide evidence to distinguish between the Casselian and the Balassa-Samuelson views of the world. Univariate Tests of PPP Over the Float To test whether PPP holds in the long run, you can use the augmented Dickey-Fuller test (chapter 2.4) to test the...

T FoVt tj FoVtj Cj etj Cj FoVtj FjVtj

13They are only identifying restrictions, however, and cannot be tested. 14Cointegration is discussed in Chapter2.6. Fj CjFo for all j F(1) C(1)Fo. (8.47) Given the Cj, which you get from unrestricted VAR accounting, (8.47) says you only need to determine Fo after which the remaining Fj follow. In our 3-dimensional system, Fo is a 3 X 3 matrix with 9 unique elements. To identify Fo, you need 9 pieces of information. Start with, E G'G E(etet) FoE(vtvt)Fo FoFo where G is the unique upper...