Abstract
In this chapter we detail a progressive strategy for developing exchange rate models which incorporate long-run relationships and complex short-term dynamics. Our modelling strategy follows recent developments in the econometric literature, in particular, the work of Clements and Mizon (1991), Hendry and Mizon (1993), and Johansen (1988). Essentially, this process involves starting with a general VAR model specified in levels from which the cointegrating relationships are recovered, and then simplifying the full VAR structure until a parsimonious simultaneous system is obtained. The final set of linear simultaneous equations then incorporate both long-run relationships and short-run dynamics. We begin this chapter with a discussion of the motivation for system modelling. A process of moving from the general VAR (a prerequisite of the Johansen method) to the parsimonious system is then discussed in some detail, before we turn to empirical examples.
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MacDonald, R., Marsh, I. (1999). Long-Run Econometric Modelling of Exchange Rates. In: Exchange Rate Modelling. Advanced Studies in Theoretical and Applied Econometrics, vol 37. Springer, Boston, MA. https://doi.org/10.1007/978-1-4757-2997-9_7
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DOI: https://doi.org/10.1007/978-1-4757-2997-9_7
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