A synthesis of the overshooting and portfolio balance models of exchange rates with application to the U.K. - U.S. exchange rate

The dissertation extended the Dornbusch overshooting/undershooting model of exchange rate by combining it with the portfolio balance model in an effort to include the bond market in an exchange rate model. The resulting model attempts to explain exchange rate volatility and time paths with the money and international bond markets. In order to test the ability of the model to explain and predict exchange rates, it was applied to the Pound-Sterling-Dollar exchange rate. The test period begins in the first quarter of 1973 and ends in the fourth quarter of 1986. Model simulations of the exchange rate were conducted for the fourth quarter of 1980 through the fourth quarter of 1984 since this was a speculative bubble for the exchange rate. Additionally, a first quarter 1987 to second quarter 1990 out-of-sample simulation was conducted. The estimation technique involved the use of the full information maximum likelihood and two stage least squares method. The data source was the International Monetary Fund\u27s International Financial Statistics. Generally, the results of the estimations indicate that the model has explained exchange rate movements with some success relative to naive models such as a first order autoregression