Third-Currency Effects in a Tri-Polar Model of Foreign Exchange

This paper investigates possible contribution of third-currency effects to exchange rate movements. It reopens the subject of currency substitution and examines whether the third-currency effects change when the third-currency is a complement as opposed to when it is a substitute for currencies appearing in a bilateral exchange rate quote. The analysis and tests are carried out within a simple macro-econometric model with one common permanent component driving the system of bilateral exchange rates for the US dollar, the Japanese yen and the euro.