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Different Models of Exchange Rate Determination and Their Empirical Support - Term Paper Example

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In "Different Models of Exchange Rate Determination and their Empirical Support" paper, the performance of exchange rates by the analysis of the performance of supply and demand in the foreign exchange rate market has been attempted to elucidate with the help of different models…
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Different Models of Exchange Rate Determination and Their Empirical Support
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Download file to see previous pages Specifically, some of the discussed models of exchange rate determination are the balance of payment approach model, the monetarist or asset approach model, and the martingale-random walk model. Moreover, the paper will also integrate the experiential observations and examples during the paper, in order to understand the practicality of these models.

Under the balance of payment approach, the domestic cost of foreign currency is established like the cost of any other article of trade. In other words, the market demand and supply curvatures are intersected in the exchange market for that particular foreign currency. The modeling of the abovementioned approach related to the demand and supply for foreign exchange is quite similar to the determination of international dealings regarding the flows of currency in the marketplace. In light of the balance of payment model of exchange rates, the different flows are responsible for the occurrence of supply and demand for a currency. In this regard, some of the identified flows have shown relation with a trade of goods and services, as well as, some portfolio and direct speculations. 

Moreover, the equilibrium position of the balance of payment may result in the effective fortitude of equilibrium exchange rates. In reaction, exchange rates will progress to create a disparity in the balance of payment and therefore, will refurbish the stability to its principles. It should be noted that the power purchasing parity has unconditionally integrated with the approach of the balance of payment. In specific, a number of factors related to trade, supply, and demand have played a vital role in the determination of exchange rates. For instance, if a foreign country has lower prices of a product, as compared with the prices at the domestic level, then an increment will be observed in the domestic demand for foreign goods and then the foreign currency will appreciate it. ...Download file to see next pagesRead More
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