An Approach for Determining Exchange Rates: The Mixture of the Purchasing Power Parity Model and the Chartist Model

Abstract

In the medium- and long-run, prices rather than interest rates are thought to have an effect on exchange rates, and the purchasing power parity (PPP) theory, which posits as a determining factor in exchange rates, has been used not only in academic fields but also in practice. This study considers that exchange rates are determined by the mixture of past exchange rates and the PPP theory. On the other hand, it is often pointed out that the actual exchange rate diverges significantly from the exchange rate derived from the PPP theory. Moreover, this study hypothesizes that when the deviation becomes large, there will be a movement to correct the deviation. The empirical estimations show that when the deviation is large, such movement cannot be found and when the deviation is small, there is a movement toward correction.