Abstract
Exchange rates are important to innumerable economic activities and the exchange rate behavior has long been at the top of the list of research agenda in international finance. This article is another test of the Relative Purchasing Power Parity (RPPP) to explain exchange rate behavior in short terms. The study examine the relative form of Purchasing Power Parity theory with recent monthly exchange rate data of US Dollar and Malaysian Ringgit starting from year 2005, which was the time Malaysia’s currency went back to floating system after a few years pegging to US dollar since 1997 Asian Financial Crisis (AFC). Within this study, correlation and Ordinary Least Square (OLS) methods were applied to test the proposed RPPP model. Both the statistical and the observational results show significance power of Relative PPP on explaining exchange rate behavior of the chosen currencies. Key words: Exchange rate, purchasing power parity (PPP), Malaysian ringgit, US dollar.
Highlights
Exchange rate predication is one of the most challenging and critical decisions in international finance area
As the studies shows, it may trust more on relative purchasing power parity (PPP) as a tool for short term exchange rate prediction probably along with some other financial tools and theories. As it can ignore the actual levels of exchange rate and prices in relative forms of PPP, it can be said that being exempt of strong assumptions; it is much easier to hold relative PPP than absolute PPP
Investors care about the effect of exchange rate fluctuation on their international portfolios
Summary
Exchange rate predication is one of the most challenging and critical decisions in international finance area. One of the major theories that explain exchange rate determination is Purchasing Power Parity (PPP), which in its absolute and relative forms, has been numerously studied before. As the studies shows, it may trust more on relative PPP as a tool for short term exchange rate prediction probably along with some other financial tools and theories. As it can ignore the actual levels of exchange rate and prices in relative forms of PPP, it can be said that being exempt of strong assumptions; it is much easier to hold relative PPP than absolute PPP. When absolute PPP holds, relative PPP should hold; absolute PPP does not necessarily holds if relative PPP holds
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