An Equilibrium Foundation of the Soros Chart
The most prominent characteristic of the Japanese yen/U.S. dollar nominal exchange rate in the post-Plaza Accord era is its near random-walk behavior sharing a common stochastic trend with the monetary base differential, which is augmented by the excess reserves, between Japan and the United States. In this paper, we develop a simple two-country incomplete-market model equipped with a specification of domestic reserve markets to structurally investigate this anecdotal evidence known as the Soros chart. In this model, we theoretically verify that a market discount factor close to one generates near random-walk behavior of an equilibrium nominal exchange rate in accordance with a permanent I(1) component of the augmented monetary base differential as an economic fundamental. Results of a Bayesian posterior simulation with post-Plaza Accord data of Japan and the United States plausibly support our model as a data generating process of the Japanese yen/U.S. dollar exchange rate.
Authors: | Kano, Takashi ; Morita, Hiroshi |
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Institutions: | Tokyo Center for Economic Research (TCER) |
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