Portfolio Balance Approach to Exchange Rate Determination: Testing a Model by Applying Bilateral Data of Turkey and United States1

Abstract

Turkish economy started to be liberated in thebeginning of 1980’s and gradually to be a part ofglobal economic and financial system. But as a resultof economic articulation of Turkey to the globalworld, global economic and financial headwindshave affected trade and economy especially viaexchange rates. Since Turkey is of ever-growingforeign trade volume with global economic worlddetermination of fluctuations in exchange rates hasincreased in importance. Due to global integrationof financial markets, inflow and outflow of foreignbonds could cause economic agents to changecurrency composition of foreign assets to reducethe risks arisen from exchange rates. This situationcan negatively affect exchange rates by fluctuatingthem. Aim of this study is to empirically investigatethe portfolio balance effect on exchange rates. Inthis context, different version of Cushman’s model(2007) using monthly bilateral data of Turkeyand U.S. covering the period 2006-2016 will beemployed and portfolio balance approach to theexchange rates determination will be tested byperforming cointegration test allowing for multiplestructural breaks.