UNOFFICIAL EXCHANGE RATES IN BANGLADESH: A COINTEGRATION ANALYSIS
Jalal U. Siddiki
This article estimates a structural model for unofficial market foreign exchange (forex) rates "(E"U")" and examines the stability of the forex market in Bangladesh using an autoregressive distributed lag approach to cointegration analysis on quarterly data from 1976Q2-1995Q2. It also compares the in-sample and out-of-sample (from 1995Q3-1999Q2) forecasting performances of the structural model with other timE-series models. With "E"U"" as a dependent variable and official exchange rates "(E"O")", money supply "(M)", the difference between foreign and domestic interest rates "(I)", forex reserves relative to imports "(Q)" and political along with some structural factors "(D85)" as explanatory variables, a multivariate cointegrated relationship is found in which "E"O", Q", and "I" cause an appreciation and "M" and "D85" cause a depreciation in "E"U"". These results imply that the overvaluation of the official exchange rate, increases in money supply, the paucity of official forex reserves, and structural factors are the main causes for the creation of the unofficial market for forex in Bangladesh. Results also reveal that the forex market in Bangladesh is stable during the sample period. The structural model performs well in in-sample prediction, and the random walk model performs best in out-of-sample forecasting. Copyright 2002 Western Economic Association International.
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