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International investment positions and exchange rate dynamics: A dynamic panel analysis

Author

Listed:
  • Binder, Michael
  • Offermanns, Christian J.
Abstract
In this paper we revisit medium- to long-run exchange rate determination, focusing on the role of international investment positions. To do so, we develop a new econometric framework accounting for conditional long-run homogeneity in heterogeneous dynamic panel data models. In particular, in our model the long-run relationship between effective exchange rates and domestic as well as weighted foreign prices is a homogeneous function of a country's international investment position. We find rather strong support for purchasing power parity in environments of limited negative net foreign asset to GDP positions, but not outside such environments. We thus argue that the purchasing power parity hypothesis holds conditionally, but not unconditionally, and that international investment positions are an essential component to characterizing this conditionality. Finally, we adduce evidence that whether deterioration of a country's net foreign asset to GDP position leads to a depreciation of that country's effective exchange rate depends on its rate of inflation relative to the rate of inflation abroad as well as its exposure to global shocks.

Suggested Citation

  • Binder, Michael & Offermanns, Christian J., 2007. "International investment positions and exchange rate dynamics: A dynamic panel analysis," CFS Working Paper Series 2007/23, Center for Financial Studies (CFS).
    • Handle: RePEc:zbw:cfswop:200723
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Exchange Rate Determination; International Financial Integration; Dynamic Panel Data Models;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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