Are exchange rates determined by macroeconomic factors?

Abstract

In this study, we consider 15 countries and examine the relationship between exchange rate volatility and macroeconomic volatility. We show that, in general, empirical support for the existence of a link between exchange rates and macroeconomic fundamentals is very weak and that other factors are more important in casting light on the behaviour of exchange rates. In particular, we investigate the links between risk premia and exchange rates across our sample of countries. Using ARCH and GARCH techniques, we illustrate that despite the targeting policies of the ERM, risk premia are evident for the majority of countries in our sample.