Cross-section dependence and the monetary exchange rate model – A panel analysis

Abstract

This paper tackles the issue of cross-section dependence for the monetary exchange rate model in the presence of unobserved common factors using panel data from 1973 until 2007 for 19 OECD countries. Applying a principal component analysis we distinguish between common factors and idiosyncratic components and determine whether non-stationarity stems from international or national stochastic trends. We find evidence for a cross-section cointegration relationship between the exchange rates and fundamentals which is driven by those common international trends. In addition, the estimated coefficients of income and money are in line with the suggestions of the monetary model. JEL-Classification: C32, C23, F31, F41

Causal relations between nominal exchange rates and monetary fundamentals in Central and Eastern European countries

“…Recently, Beckmann et al . () followed this line of reasoning and, after isolating common factors from idiosyncratic components, presented evidence for the existence of the international long‐run relationship between the common factors of exchange rates and monetary fundamentals. The slope homogeneity assumption, in turn, is equivalent to imposing a joint restriction on a whole panel, which is a very strong null hypothesis (Granger, ) and makes it impossible to capture country‐specific characteristics (Breitung, ).…”

“…An example of such an analysis is the study by Beckmann et al . (), which examined both short‐ and long‐term dynamics of exchange rates, although in advanced economies only. It would be useful to extend this line of research to the CEE countries.…”

Exchange Rate Interdependence in ASEAN Markets: A Wavelet Analysis

“…Understanding exchange rate interdependence and contagions is essentially important for assisting portfolio managers and investors in decision making. Since the advancement of financial integration and globalization, several studies (Baillie & Bollerslev, 1991; Beckmann et al, 2012; Beirne & Gieck, 2014; Chang, 2008; Dias & Embrechts, 2010; Hong, 2001; Huang & Yang, 2002; Inagaki, 2007; Kühl, 2010; Kumar et al, 2017; Lahmiri, 2017; Laopodis, 1998; Loaiza-Maya et al, 2015; Meng & Huang, 2019; Pérez-Rodríguez, 2006; Tamakoshi & Hamori, 2014; Tiwari & Albulescu, 2016; Yang et al, 2016) examine the exchange rate interdependency and volatility spillovers, suggesting strong substantiation of diversification benefits. This section reviews the relevant empirical literature with different techniques to understand interdependence and contagion of foreign exchange markets.…”

“…Principal component analysis 11 fragments the correlated exchange rates into a distinctive component and a common factor. Study of Beckmann et al (2012) reveals the existence of cross-member cointegration in OECD countries. The findings support that international trends drive the nonstationarity of exchange rates.…”

The monetary model of exchange rate behaviour: the case of South Africa.

“…This demonstrates the exchange rates' basic disconnect to macroeconomic fundamentals. However, recently a growing number of studies claimed some degree of success in modelling the exchange rate behaviour (see, for example, Beckmann et al 2012;Dabrowski et al 2014, among others). Xie and Chen (2019) challenge these findings on the basis that the differences in the findings are due to sophistication of the estimating methods.…”