Abstract
Previous tests of the martingale property of the exchange rate have examined the random walk property of the exchange rate or have tested for Granger causality of the exchange rate by macroeconomic variables. Interestingly, if purchasing power parity (PPP) holds in the long run, causality tests should be conducted by estimating a vector error correction model which includes price levels. This paper conducts exchange rate causality tests employing vector error correction models and finds evidence that the Swiss exchange rate is Granger caused by lagged deviations in PPP and, hence, is Granger caused by prices.
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Pippenger, M.K. Testing price-exchange rate noncausality: Results from a vector error correction model. Atlantic Economic Journal 23, 255–266 (1995). https://doi.org/10.1007/BF02298762
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DOI: https://doi.org/10.1007/BF02298762