Understanding Exchange Rates and the Euro

Abstract: This paper investigates the exchange rate movements for EUR/USD, EUR/SEK and EUR/NOK using an OLS regression. Movements are tested against traditional and nontraditional explanatory variables for exchange rate movements. Traditional variables consists of current account, inflation, productivity and interest rate differentials while the nontraditional are equity returns and risk appetite. Results indicate that the nontraditional variables are significant for all currency pairs. Increased equity returns are associated with currency appreciation consistent with previous research. Furthermore is the evidence on the risk appetite variable conclusive on how investors perceive the risk exposure to the currencies. For the EUR/SEK are coefficients of the interest differentials evidence on the effect of the yield curve, suggesting that the currency is driven by expectations on future economic activity such as GDP growth and inflation instead of actual values as tested on the model. Results on the current account variables are coherent with the theory that current account is significant only when a threshold deficit is breached. Overall the results presented indicates that the exchange rates for reserve and non-reserves currencies are explained by different variables.