Relevance of Financial Markets for Exchange Rate Modeling in Ghana

This paper employs the cointegration and Vector Error Correction (VEC) methodology to explore exchange rate modeling in Ghana, by considering the interactions between the goods and capital assets market, using monthly data spanning from January 1997 to December 2007. The empirical evidence supports a long-run relationship between prices, interest rates and exchange rates in which the signs are consistent with the joint validity of the unrestricted Purchasing Power Parity (PPP) and Uncovered Interest Parity (UIP) conditions. Further, Likelihood Ratio (LR) tests based on the cointegration vector show that the strict forms of the PPP and UIP conditions between Ghana and the USA do not hold as stationary relations. The findings suggest that the interactions between the goods and capital assets market matter for the conduct of monetary policy and exchange rate modeling in Ghana