Exchange rates and fundamentals: Further evidence based on asymmetric causality test

Abstract

This article uses an approach developed by Hatemi-J (2012) which is based on country-specific bootstrap critical values to disclose the nexus between the US dollar-based real exchange rates and observed macroeconomic fundamentals—relative price and interest rate differential. The Granger non-causality test reveals that fundamentals drive the US dollar exchange rates before the Asian financial crisis (AFC) in some cases. The exchange rate–fundamentals nexus is unstable and has reversed in the aftermath of the crisis. Exchange rates help to predict fundamentals in the post-AFC period, as suggested by the present value model. The result holds even after the Federal Reserve announces the termination of quantitative easing programs. Asian currency movements are expected to trigger adjustments in fundamentals in an asymmetric fashion. It tells us that the success of fundamental-based models in predicting the future path of Asian currencies against the US dollar may not be robust after all.