The portfolio-balance approach to exchange rate determination is part of the Asset
Market Models and is largely attributed to economists after 1973 when the exchange
rate became flexible (market determined). This article first introduces the setting of
the model embedded in the portfolio balance approach that encompasses two assets
(money and bonds), which deviates a little from the models and approaches used
for the monetary approach to the balance of payment, the overshooting model, and
from the associated market equilibria. The effects of monetary policy, of current
account, and of wealth under the portfolio-balance approach are examined, here,
theoretically and empirically. The current econometric results show that the
exchange rate is determined by the foreign bonds, the domestic interest rate, and the
foreign interest rate.
JEL classification numbers: F31, F47, E52, E41, C52, E21, E43.
Keywords: Foreign Exchange, Forecasting and Simulation, Monetary Policy,
Demand for Money, Model Evaluation and Testing, Consumption and Saving,
Interest Rates.
Exchange Rate Determination: The Portfolio-Balance Approach
