| The primary objectives of this dissertation are (1) to examine the relationship between Hungary's nominal exchange rate and various macroeconomic variables and (2) to empirically test a theoretical model similar to that developed by Frankel (1993). The model relaxes the unrealistic assumption of a one world bond which suggests that the investment risk between countries is equal and that capital flows are a result of interest rate differentials only, and captures the effects of factors other than the trade balance. Thus, Hungary's capital account balance is employed to capture all capital movements including direct foreign investments, borrowing from foreign sources by the NBH and domestic business as well as foreign investments in stocks, bonds and real estate. In addition, a set of variables is introduced to measure the risk differential between countries. Finally, the current account balance is employed to replace the trade balance.; The models include the Conventional Monetarist Model, the Respecified Conventional Model, and the proposed Monetary-Balance of Payments-Risk Paradigm (M-BOP-R). The exchange rates employed are the forint/U.S. dollar and the forint/deutschemark.; The Conventional Monetarist Model uses the relative money supplies, industrial production, interest rates, expected inflation, and the cumulative trade deficit of Hungary as independent variables. The Respecified Conventional Model employs relative money supplies, industrial production, expected investment returns, expected prices, and the trade balance. Finally, the M-BOP-R paradigm utilizes the Hungarian current account, capital account, and an investment risk factor (B {dollar}-{dollar} A) (where B is Hungarian government debt and A is the government debt held by the National Bank of Hungary) in addition to relative money supplies, industrial production, and expected change in prices.; First, the traditional logarithmic form of the models is estimated by regressing the exchange rate against macroeconomic variables. Second, an extended Box-Cox transformation is estimated to ascertain the optimal specification. Then, the optimal specification is employed for a second round of analysis.; Employing the log form, the M-BOP-R Paradigm yielded the best results. Industrial production, the current account and the risk factor were significant at the 5% level for the forint/U.S. dollar. For the forint/deutschemark, all independent variables were significant except money supplies and the expected change in prices. Furthermore, the risk factor was a major contributor to the explanatory power of the model.; After employing the extended Box-Cox transformation, all transformed independent variables except money supplies and expected price changes were significant at the 5% level. In addition, the extended Box-Cox transformation raised the explanatory power of the Conventional Monetarist Model, the Respecified Conventional Model considerably, and the M-BOP-R paradigm.; The M-BOP-R Paradigm is the best model for explaining the relationship between Hungarian exchange rates and macroeconomic fundamentals and in future research may be employed in forecasting models. |
