Title: Empirical evidence of the monetary approach to the exchange rate determinants under a fully flexible regime: the case of Mexico

Authors: Alberto Gallegos-David; Arturo Lorenzo-Valdes; Bárbara Trejo-Becerril

Addresses: Faculty of Economics and Finance, Universidad Anáhuac México Norte, 46 Universidad Anáhuac Ave., Lomas Anáhuac, 52786, Huixquilucan, Estado de México ' Business Deanery, UPAEP University, 17 Sur # 901, Barrio de Santiago, 72410, Puebla, Mexico ' Faculty of Economics and Finance, Universidad Anáhuac México Norte, 46 Universidad Anáhuac Ave., Lomas Anáhuac, 52786, Huixquilucan, Estado de México

Abstract: The purpose of this paper is to examine the empirical evidence on the evolution of the nominal peso-dollar exchange rate based on the monetary approach under a fully flexible exchange rate regime. We use a standardised framework where the uncovered interest rate (UIP) and the purchase power parities (PPP), flexible prices, and a typical demand for real money balances determine prices in the long run. Once we identify that time series of the nominal exchange rate and the fundamental macroeconomic variables are non-stationary, we estimate a vector error-correction model (VECM) and, for comparative purposes, an ARIMA-EGARCH model and an ARIMA-EGARCH model with monetary approach. Models' assessment based on the post estimation results shows that the model with the lowest HRMSE for all the steps-ahead forecast is the ARIMA-EGARCH model followed by the VECM model. Likewise, the lowest HMAE for the first three-steps ahead forecast is the VECM model, followed by the ARIMA-EGARCH model.

Keywords: monetary approach; purchasing power parity; cointegration; conditional variance; volatility.

DOI: 10.1504/IJMEF.2022.121560

International Journal of Monetary Economics and Finance, 2022 Vol.15 No.1, pp.35 - 57

Received: 12 Oct 2020
Accepted: 04 May 2021
Published online: 18 Mar 2022 *

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