English

Khan Aima,Abbas Zaheer

doi:10.5897/jeif2014.0579

Abstract

Exchange rate plays vital role in an economy and thus has gained much attention in the literature. The purpose of the study is to test the portfolio balance approach which proposes that money supply and bonds of a country impact its exchange rate. For this purpose, Augmented Dickey Fuller and Phillips Perron test have been applied on the quarterly data from 2001 to 2010 to test the stationarity of the data. Auto regressive distributed lag model has been used to analyze the data. Results validate the empirical evidence and reveal that long term relationship is found among the variables. Money supply of US, money supply of Pakistan and bonds for US are having an impact on the exchange rate of these countries. Key words: Portfolio balance approach, exchange rate, money supply, bonds, balance of payments.

Highlights

Determination and forecasting of exchange rate has been widely investigated by academics and practitioners through different models and theories
Results in the table from Augmented Dickey Fuller and Philips Perron test show that exchange rate is not stationary at level and becomes stationary at first difference
The portfolio balance approach is an extension of the monetary models and considers the impact of bonds which are part of portfolio investments in capital accounts of balance of payments on exchange rates

Summary

Introduction

Determination and forecasting of exchange rate has been widely investigated by academics and practitioners through different models and theories. It is because exchange rate plays fundamental role in any economy especially in international trade and competitiveness in the global market. Due to liberalization, markets for financial assets gained more importance and models having the asset approaches are more successful in explaining the determinants of exchange rate. These approaches include monetary and portfolio approaches

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Conclusion