# Time Varying Parameters in Exchange Rate Models

Sammanfattning: This thesis consists of five papers on different aspects of parametervariation in some common exchange rate models.The first paper investigates the stability in the real exchange rate, witch is equivalent to purchasing power parity (PPP). In recent empirical literature on purchasing power parity, the focus has been on the stationarity of real exchange rates, instead of strict constancy. Earlier studies have either tested the null hypothesis of stationarity, or tested the null hypothesis of non-stationarity. This paper, finds that the conclusion that PPP does not hold, i.e. that real exchange rates are non stationary, does not depend on which hypothesis is the null. It is found that, when using data from three major OECD countries, the general conclusion is that a null hypothesis of the absence of PPP cannot be rejected and that a null hypothesis of the presence of PPP can be rejected. The second paper utilizes some tests, proposed in the literature, to investigate if there is significant variation of the parameters in monetary exchange rate models, using data from six large OECD countries. The findings are that in all cases significant parameter variation can be found. The third paper examins how exchange rate variation affects international trade, by utilizing a recently proposed exponential GARCH technique with a multivariate set-up. The findings in this study are that, when using data from three large OECD countries, there is no significant relationship between exchange rate variation and international trade, in general. The only significant effect found, is a positive impact of exchange rate variation on the growth of the UK's international trade. The fourth paper aims at investigating the time varying volatility in the 14 potential EMU countries exchange rates versus the US dollar and how this volatility is generated. The volatilities are estimated in a multivariate stochastic volatility model and the decomposed into principal components. The findings are that a tentative explanation for the two most important components of the volatility can be to what extent a currency is a core currency in Europe, and the degree of expansion in the monetary policy. It is also found that the volatility hits Europe in a non symmetric fashion. Some support is also found for the idea of initiating the EMU at two speeds, that a group of core countries initially forms a monetary union and that the remaining countries follows when convergence is done. The fifth paper studies the relationship between exchange rate variation and variation in interest rate differentials in, using Swedish-Us data. The data is split into two sub-samples covering a period of fixed exchange rate regime and a period of a floating exchange rate regime. The area of particular interest is whether there is a trade off between variability in the exchange rate and variability in interest rate differentials. The problem is studied by estimating a multivariate GARCH model. The findings are that there seems to be no clear trade-off within regimes, while there seems to be a significant trade-off between the two regimes.

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