The NIS/FOREX market-an improved model
Golan Benita
This paper describes an econometric model for the analysis of Israel's foreign currency market that is based on the theoretical framework of the model of the NIS/forex market developed by the Foreign Exchange Activity Department of the Bank of Israel. According to that framework, the effect of the independent variables on the exchange rate operates through their differential effects on the supply of and demand for foreign currency of the various market players. The assumption underlying the model is that at any point in time a single exchange rate is determined which is a result of the equalization of aggregate supply and demand in the market.
The model analyses the financial activity of four main market sectors: nonresidents, households, the business sector (both its real and its financial activity), and the banking system, with the activity of nonresidents divided into capital instruments and debt instruments. A system consisting of seven simultaneous equations is constructed: six equations describe the supply of and demand for foreign currency of the major sectors and the instruments via which they operate, and another equation gives the rate of change of the equilibrium NIS exchange rate.
The model is estimated from quarterly observations in the period from 1997:Q3 to 2005:Q4. The results support the system of equations describing the foreign currency market and the data system measuring the activity in that market. The direction of the effects of the independent variables was generally as expected, and their coefficients were statistically significant. The findings of the model contribute to the understanding of the various factors that affect the activity of the players in the forex market and their effect on the exchange rate.
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