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The Role of Unobservable Fundamentals in Korea Exchange Rate Fluctuations: Bayesian Approach

Author

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  • Young Min Kim

    (Department of Economics, Korea University)

  • Seojin Lee

    (School of Finance, Shanghai Lixin University)

Abstract

Recent literature emphasizes the role of unobservable fundamentals in exchange rate movements. Within the state-space model and the Bayesian approach, proposed by Balke et al. (2013), we find that unobservable fundamentals, such as the risk premium, the deviation from the purchasing power parity, and money demand shifters explain most of the Korea exchange rate fluctuations. In contrast, observed monetary fundamentals have much less effect. This result implies that Korean exchange rate movements are closely related to market expectations or sudden capital flows, rather than economic fundamentals.

Suggested Citation

  • Young Min Kim & Seojin Lee, 2017. "The Role of Unobservable Fundamentals in Korea Exchange Rate Fluctuations: Bayesian Approach," Economic Analysis (Quarterly), Economic Research Institute, Bank of Korea, vol. 23(3), pages 1-22, September.
    • Handle: RePEc:bok:journl:v:23:y:2017:i:3:p:1-22
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    References listed on IDEAS

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    1. Cheung, Yin-Wong & Chinn, Menzie David & Garcia Pascual, Antonio, 2003. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," Santa Cruz Department of Economics, Working Paper Series qt12z9x4c5, Department of Economics, UC Santa Cruz.
    2. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    3. Charles Engel & Kenneth D. West, 2005. "Exchange Rates and Fundamentals," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 485-517, June.
    4. Martin D. D. Evans, 2017. "Order Flows and the Exchange Rate Disconnect Puzzle," World Scientific Book Chapters, in: Studies in Foreign Exchange Economics, chapter 15, pages 599-643, World Scientific Publishing Co. Pte. Ltd..
    5. Engel, Charles, 2014. "Exchange Rates and Interest Parity," Handbook of International Economics, in: Gopinath, G. & Helpman, . & Rogoff, K. (ed.), Handbook of International Economics, edition 1, volume 4, chapter 0, pages 453-522, Elsevier.
    6. Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2009. "Carry Trades and Currency Crashes," NBER Chapters, in: NBER Macroeconomics Annual 2008, Volume 23, pages 313-347, National Bureau of Economic Research, Inc.
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    8. Byung-Joo Lee, 2007. "Economic fundamentals and exchange rates under different exchange rate regimes: Korean experience," Journal of Applied Economics, Universidad del CEMA, vol. 10, pages 137-159, May.
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    More about this item

    Keywords

    Bayesian MCMC algorithm; Exchange rate; Unobservable fundamentals; Currency risk premium; Capital flows;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • F3 - International Economics - - International Finance

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