Testing Exchange Rate Models For Ethiopia (a V Ar Approach)

This paper is intended to design and select an exchangernrate model that is consistent with the available informationrnin Ethiopia. The models include: the Interest ParityrnCondition(IPC), a version of the Frankel's(1979) long-runrnexchange rate model and a Meese's(1986) model of exchange raternwhich is constructed from the deviation of Purchasing Powerrnparity(PPP). For this task, we have adopted Johansen's andrnVector Autoregressive Representation (VAR) modelling methodologyrnto conduct a test for the application of three popular exchangernrate models. The validity of these models have been repeatedlyrnanalyzed under three major currencies against Ethiopian Birr.rnBased on the finding of this paper, we are inclined tornconclude that to construct exchange rate model for Ethiopia,rnFrankel's model is strongly supported by the empiricalrnevidence. Exchange rate models representation implied by therninterest parity condition and model of Meese(1986) are rejectedrnfor all currencies for Ethiopian data. The failure of thernmodel suggested by interest parity condition and Meese's modelrncan be capture by various econometric tests such as Johansen'srnco integration and VAR modelling tests and variance ratio test

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