Modelling the Interaction of Fundamental and Portfolio Exchange Rate Behaviour: An Application to Australia and the ASEAN3

This paper explores the interaction of fundamental and portfolio factors in the determination of the exchange rate. The weights on the factors evolve endogenously as a function of relative fundamental and portfolio errors. The model also generates exchange rate mixture distributions that may be skewed, leptokurtic or bimodal and as such can explain small and large changes endogenously. The model is applied to the exchange rates of Australia and the ASEAN3 to examine the role of fundamental and portfolio behaviour, especially over the 1997/98 currency crisis period.