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Identifying Terms of Trade Effects in Real Exchange Rate Movements: Evidence from Asia
journal contribution
posted on 2023-05-16, 23:40 authored by Dungey, MHEmpirical 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.
History
Publication title
Journal of Asian EconomicsVolume
15Pagination
217-235ISSN
1049-0078Department/School
TSBEPublisher
Elsevier BVPlace of publication
NetherlandsRights statement
The definitive version is available at http://www.sciencedirect.comRepository Status
- Restricted