A Network Model of Multilaterally Equilibrium Exchange Rates

IMF Working Papers, July 6, 2016

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Paper proposes a network model of multilaterally equilibrium exchange rates that introduces a topological component into exchange rate analysis.
The model consistently takes into account simultaneous higher-order interactions among all currencies.
Defines the "currency demand indicator" and, on its basis, derives a multilateral exchange rate network.
Identifies the dynamically stationary position of the network and the multilaterally equilibrium levels of bilateral exchange rates.
Notes potential development: model can be extended to calculate deviations of observed bilateral exchange rates from their multilaterally equilibrium levels, interpretable as over- or undervaluation.
Empirical illustration uses daily 1995-2016 exchange rates among 130 currencies sourced from the Thomson Reuters Datastream.

Introduces a topological (network) component to exchange rate analysis.
Defines the currency demand indicator as a central element for constructing the multilateral exchange rate network.
Derives network stationarity to identify multilaterally equilibrium bilateral exchange rates.
Emphasizes simultaneous higher-order interactions among all currencies rather than pairwise analysis alone.

Multilaterally equilibrium levels of bilateral exchange rates can be identified through the network's dynamically stationary position.
The model provides a framework to interpret deviations of observed bilateral exchange rates from multilaterally equilibrium levels as over- or undervaluation.
The topological/network approach captures higher-order, simultaneous interactions across the currency system that conventional bilateral methods may miss.

The model can potentially be developed to calculate magnitudes of deviations (over- or undervaluation) for observed bilateral exchange rates.
By accounting for multilateral linkages, the approach could inform assessments of currency misalignment and reserve-currency dynamics in the global foreign exchange market.

Disclaimer: "This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate."

Source: IMF Working Paper — "A Network Model of Multilaterally Equilibrium Exchange Rates" by Alexei P Kireyev and Andrei Leonidov, July 6, 2016.

1. Exchange Rate Network
- 1. Exchange Rate Network (Markdown version)
- 1. Exchange Rate Network (PDF)