Abstract

In theory, a currency's value should gravitate over time in the direction of its real long-run equilibrium value. The intent of this paper is to investigate the sustainability of basic exchange rate theory and to construct econometric models capable to generate consistent and rational forecasts for the dollar/euro exchange rate. Considering past values of dollar/euro exchange rate, we build first an ARIMA model and we study the volatility of this exchange rate time series. However, since macroeconomics variables influence the exchange rate, we construct a model for dollar/euro exchange rate determination including macroeconomic variables whose choices have been theoretically driven. The most important outcomes of this research are the specifications of an economic model for dollar/euro exchange rate as well the estimation of the model in The Vector Error Correction Model form.

 

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