Diffusion Process for Exchange Rates in SEACEN Countries: Exchange Rate Equilibrium Level and its Volatility
A stochastic differential equation is at the very core of short-term dynamics of financial market, especially short-term interest rate dynamics. Various parameter restrictions on the unrestricted model have led to many special models. Recently, the diffusion process have been applied to short-term exchange rate movements, and verified from an empirical standpoint. Using short-term market exchange rate data of some SEACEN countries, this paper evaluates which special model best fits the exchange rate data, and examines the way to obtain the equilibrium level of exchange rate. The modeling and estimation framework establish an approach for explaining the volatility in exchange rate as well as for detecting the equilibrium exchange rate. For policy implications of indivisual countries, more work such as examining the structural change need to be done.