Equilibrium Exchange Rate

BMW’s fair value range of 1.15 US$/€ to 1.17 US$/€ is an example of ITMEER (Intermediate-term model-based equilibrium exchange rate model) equilibrium Model

Some of the popular methods of estimating equilibrium exchange rates are listed in the table below.

In general, the monetary models,

BEERs, ITMEERs and CHEERs are most closely related to short-run equilibrium concepts;

FEERs and DEERs provide measures of medium-run equilibria; while

APEERs, PEERs, NATREX models aim to capture some concept of long-run equilibrium.

Alternative methods such as SVARs and DSGE models can provide helpful information on the likely response of the exchange rates in the face of shocks and also on their short, medium and long-run response

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The Intermediate-term model-based equilibrium exchange rate model (ITMEER) model suggests that exchange rates move to reflect interest rate differentials and an additional risk premium.

The risk premium introduced in the model is influenced by fundamental variables such as the current account, unemployment rates, net foreign assets, relative prices, and yield differentials on financial assets. The model for ITMEER is shown below. The first two terms are the estimated deviations from the equilibrium exchange rate, and Z is a set of variables that helps predict the returns on other assets.

Estimated deviations from the equilibrium exchange rate

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The Variables are:

|CAD |differential of current account over GDP |

|UNED |unemployment rate |

|NFAD |net foreign assets |

|DY |lagged dividend yield |

|EQR |lagged equity return |

|PI |past inflation |

|RWPCP |relative productivity...