Summary
Applying a VAR model based on a sample from 1981.Q1 - 2002.Q3, the nominal exchange rate in Korea was found to have a positive response to a shock to the U.S. output, real budget deficits, the price level in the U.S., and its own lagged values. The exchange rate reacts negatively to a shock to output in Korea, the interest rate differential between the U.S. and Korea, and the price level in Korea. Second only to lagged exchange rates, the price level in Korea had a very significant impact on the movement of exchange rate. The interest rate differential and government deficit are considerable factors as well, explaining up to 8.6% and 7.9% of the variation in exchange rates, respectively. By evaluating the simultaneous differential equations, exchange rate and interest rate differentials are proven to follow certain paths toward conditional equilibrium. The model and empirical results can provide insights for multinational companies in developing a business strategy that better controls the exchange rate risk of Korean won.
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Extract
The Financial Implications of a Var Model of the Determinants of Exchange Rates: The Case of South Korea
Introduction
In the deep turmoil of the Asian financial crisis, the Korean won per U.S. dollar depreciated by 78.6% from 899 in 1997.Q3 to 1,606 in 1998.Q1. The substantial depreciation had mixed impacts on the Korean economy. The depreciation stimulated the export growth by as much as 17.0% and discouraged imports by as much as 25.4% during the that time period, since Korean-made goods were cheaper than the foreign goods. Higher import prices triggered the domestic price level to rise from 109.99 to 1 17.46 during 1997.Q3 - 1998.Q1 and the inflation rate to surge from 1.45% in 1997.Q4 to 5.26%) in 1998.Q1. Furthermore, higher prices reduced real income and wealth, which in turn caused household consumption and aggregate demand to decline.In li...See the full content of this document
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