Unraveling the Complex Interrelationships between Exchange Rates and Fundamentals

This research provides insights on puzzling exchange rate phenomena. Empirical support is supplied for forward rates incorporating a small probability of a large spot decline when a current account deficit exists. Investors are found to expect countries to be more likely to choose devaluation solutions to BOP problems when inflation is lower and when the solution of a drop in real income growth is more 'painful'. Evidence is uncovered of currency unions positively (negatively) impacting investor confidence in formerly weaker (stronger) currencies. The U.S. Presidential election effect on exchange rates is discovered to have some relationship to fundamentals