Exchange rates and fundamentals: A bootstrap panel data analysis

Abstract This study attempts to re-examine the Granger non-causality from exchange rates to observed fundamentals based on the present value model of Engel and West (2005). To this end, we employ the bootstrap panel Granger non-causality analysis, which allows us to untangle the causal nexus between exchange rates and fundamentals in panel data. Among the main results, it is found that the null hypothesis of no cross-sectional dependence across the members of the panel is strongly rejected, indicating that the bootstrap critical value is required in conducting the panel Granger non-causality test. The null hypothesis of Granger non-causality running from the fundamentals to exchange rates is significantly rejected, implying that the monetary approach of exchange rate determination is a useful benchmark to understand the evolution of the exchange rate. Empirical evidences also show that exchange rates Granger-case the fundamentals, supporting the view that exchange rates are determined as the present value that depends in part on observed fundamentals.