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Identifying Terms of Trade Effects in Real Exchange Rate Movements: Evidence from Asia


Dungey, MH, Identifying Terms of Trade Effects in Real Exchange Rate Movements: Evidence from Asia, Journal of Asian Economics, 15, (2) pp. 217-235. ISSN 1049-0078 (2004) [Refereed Article]

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DOI: doi:10.1016/j.asieco.2004.01.001


Empirical examinations of the relationship between the real exchange rate and the terms of trade are hampered by the need to control for other factors. In some studies these controls are not considered, and in others they are imposed in an ad hoc manner. The use of a latent factor model for real exchange rate changes overcomes this obstacle. However, latent factor models have the disadvantage that it is not possible to identify the role of a particular observed variable in the model. This paper proposes a method of incorporating observed information on changes in the terms of trade into a latent factor model of real exchange rate changes, relying on the observed covariance structure of the data to identify and calibrate some of the parameters. The method is applied to annual real exchange rate data for six Asian economies and shows that the contribution of terms of trade volatility ranges up to 24% of real exchange rate volatility. These terms of trade effects are offset in a number of countries by the covariation between the latent factors and the terms of trade.

Item Details

Item Type:Refereed Article
Keywords:Latent factor models; Exchange rate volatility; Terms of trade; GMM
Research Division:Economics
Research Group:Applied economics
Research Field:International economics
Objective Division:Economic Framework
Objective Group:Macroeconomics
Objective Field:Exchange rates
UTAS Author:Dungey, MH (Professor Mardi Dungey)
ID Code:56995
Year Published:2004
Deposited By:Economics and Finance
Deposited On:2009-06-11
Last Modified:2010-06-18
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