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The Feeble Link between Exchange Rates and Fundamentals: Can We Blame the Discount Factor?

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  • LUCIO SARNO
  • ELVIRA SOJLI

Abstract

Recent research demonstrates that the well‐documented feeble link between exchange rates and economic fundamentals can be reconciled with conventional exchange rate theories under the assumption that the discount factor is near unity (Engel and West 2005). We provide empirical evidence that this assumption is valid, lending further support to the above explanation of the empirical disconnect between nominal exchange rates and fundamentals.

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  • Lucio Sarno & Elvira Sojli, 2009. "The Feeble Link between Exchange Rates and Fundamentals: Can We Blame the Discount Factor?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(2‐3), pages 437-442, March.
    • Handle: RePEc:wly:jmoncb:v:41:y:2009:i:2-3:p:437-442
    DOI: 10.1111/j.1538-4616.2009.00212.x
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    1. 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.
    2. Charles Engel & Nelson C. Mark & Kenneth D. West, 2008. "Exchange Rate Models Are Not as Bad as You Think," NBER Chapters, in: NBER Macroeconomics Annual 2007, Volume 22, pages 381-441, National Bureau of Economic Research, Inc.
    3. Cheung, Yin-Wong & Chinn, Menzie D. & Pascual, Antonio Garcia, 2005. "Empirical exchange rate models of the nineties: Are any fit to survive?," Journal of International Money and Finance, Elsevier, vol. 24(7), pages 1150-1175, November.
    4. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-218, March.
    5. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
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