Causal relationship testing with applications to exchange rates

Abstract

This paper undertakes two causality studies with exchange rate applications in a framework of Zero-Non-Zero (ZNZ) patterned Vector Error-Correction Modelling (VECM). The first study shows that money supply is a source of financial and economic influence on the Euro. The second gives evidence of support for Purchasing Power Parity (PPP) using monthly data between Japan and the USA. The results indicate that high-frequency finance data can reveal the existence of long-term PPP. This evidence sheds light on the adjustment mechanisms through which PPP is achieved. Also, the proposed ZNZ patterned VECM modelling allows better insights from this kind of financial time-series analysis.error correction modelling; e-finance; Granger causality; purchasing power parity; PPP; electronic finance; causal relationships; causality; exchange rates; Euro; money supply; Japan; USA; United States.