| dc.description.abstract | The understanding of the mechanism determining exchange rates is still an unsolved puzzle
in the field of international economics. In the search for the underlying causes of the failure
of existing approaches to explain a large proportion of short term exchange rate movements,
our review of methodology literature revealed that a significant number of scholars consider
the methodological approach employed by mainstream economics as a main cause for the
disappointing result of established approaches. In particular, the excessive use of formal
modelling and quantitative data as well as the use of oversimplified assumptions has been
criticized. In response to this critique we chose to use a more pluralistic approach in our
research methodology by employing both qualitative as well as quantitative data analysis.
For the analysis of qualitative data, we employed an approach based on grounded theory
principles, where we analyze Reuters Foreign exchange market reports. The findings of the
qualitative data analysis show that, based on market practitioners commentary, there are two
predominant variables affecting exchange rates. First, expectations on interest rate changes
appears to be a major variable affecting currency value. An upward revision of interest rate
expectations usually suggests an increase in the value of the currency concerned and vice
versa. Second major variable affecting exchange rates appear to be global equity returns. In
contrast to interest rates, which is a country specific variable, global equity returns is a
global variable affecting currencies based on their relative interest rate levels and safe haven
attributes. In particular, it is suggested that higher yielding currencies’ value is positive
related to global equity returns, while low/lower yielding and safe haven currencies’ value is
negatively related to global equity returns. The empirical test we performed to explore the
relationship between exchange rates and global equity returns suggest that they are indeed
linked. The sign of the relationship depends on the characteristics of the currencies
examined. When equity prices increase, currencies with higher interest rates tend to
appreciate, whereas currencies with lower interest rates tend to depreciate and vice versa. In
addition, the strength of the relationship depends to some extent on relative interest
differentials. A stronger relationship is observed when interest differentials are relatively
large, while the explanatory power of the model is reduced when interest rate differentials
are relatively narrow. Our study presents evidence on the role of stock markets in exchange
rate determination which is considerable different to the focus of current theory. Whereas
current research focuses on stock market’s relative stock market returns in the respective
countries, the findings of this thesis suggests that global stock market returns affect exchange
rate movements based on differentiated characteristics of different currencies. Another
important contribution of this thesis is that we illustrate the complexity of interactions and
links among different variables. For example, whereas interest changes were seen as
positively correlated to the home currency value, the relationship was seen as being reversed
because of the possible effect of higher interest rates on the subprime crisis. Another example
of complex links is the relationship between exchange rates and equity markets. For example,
whereas the USD effective exchange rate was not related equity returns during the initial
stages of the subprime crises, the strength of the relationship increased significantly when the
crisis escalated and the demand for USD increased due to safe haven flows. | en_US |
