Structural models of the exchange rate : theory and evidence

Smith, Peter Nigel (1987) Structural models of the exchange rate : theory and evidence. University of Southampton, Doctoral Thesis.

Abstract

In this thesis the negative views of much empirical work which has examined theoretical models of the exchange rate for the floating rate period is explained and questioned. Following presentation of two popular theoretical models, Chapter 1 shows why much empirical work is incorrect. However, even using correct techniques the conclusion on the simple form of these models is negative. In particular the existence of the rational expectations solution assumed in much previous work is questioned. Chapter 2 contains an examination of one particular model of the exchange rate and presents a new technique for assessing the causes of the failure of a model incorporating rational expectations. In Chapter 3 I use the information from the first two chapters in developing an empirical representation of the sticky-price exchange rate model which takes account of the theory whilst using dynamic specification to provide data coherent estimates of the structure of the model. Tests of misspecification and exogeneity are used to examine assumptions made in the theory. The dynamic properties of the model along with the existence of the rational expectations solution are examined in Chapter 4. Dynamic simulation of various forms of the model is used to provide information on the intrinsic and extrinsic dynamic structure of the model. Overshooting of the exchange rate when the model is subjected to monetary shocks is confirmed. Finally in Chapter 5 I consider a development of the sticky-price model to allow for the presence of wealth effects and imperfect substitutability of international capital. Some standard theoretical results are questioned and reversed in some of the cases that I consider. (D80610)

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