TESTING FOR THE RELATIONAL BETWEEN NORMAL EXCHANGE RATES AND ECONOMIC FUNDAMENTALS

Shady Kholdy and Ahmad Sohrabian

The purpose of this paper is to examine the causal relationship between exchange rates and economic fundamentals based on the asset-market approach to exchange rate determination for four major U.S. trading partners using the technique of cointegration and error correction model. The sample period ranges from January 1976 to December 1992. While the results from the cointegration tests deny a long-run relationship between the nominal exchange rates and economic fundamentals, Granger-causality tests reveal that a shortrun relationship among some variables does exist.