School of Economics

2009 Discussion Papers

School of Economics Discussion Paper 09/09
July 2009

On causal relationships between exchange rates and fundamentals: better than you think

Dimitris Christopoulos and Miguel A. León-Ledesma

School of Economics
University of Kent

Abstract:

This note revisits the temporal causality between exchange rates and fundamentals put forward by Engel and West (2005). We analyze the causal link within multivariate VARs by making use of the concept of multi-step causality. Our results show that, considering information content beyond one-period ahead, the causal link between exchange rates and fundamentals is stronger than previously reported. We nd Granger-causality running from exchange rates to fundamentals at some horizon in 49% of our tests
and running from fundamentals to exchange rates in 59% of them.

JEL Classification: F31, F37, C32.

Keywords: Granger-causality, multi-step, exchange rates, fundamentals.

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