Exchange Rate "Fundamentals" versus Speculation in a Developing Economy: An Illustrative Example Using Lebanese Data

Competing hypotheses about what causes excessive exchange rate volatility--speculative bubbles or "fundamental" economic variables--are examined for the Lebanese pound during its protracted depreciation from end-1982 to November 1987 and its marked appreciation over the following six months. Reduced-form and time-series models of the exchange rate are estimated and tested for nonstationarity. The results suggest that much of the pound's volatility was consistent with excessive growth in domestic-versus foreign-currency-denominated liquidity rather than speculation.