The portfolio balance effect: an empirical analysis for Japan and Eurozone

Abstract

In this study the validity of the portfolio balance model in the short and in the long run for the Yen-U.S. dollar and Euro- U.S. dollar exchange rate is examined which is based on the Branson and Henderson specification. A distinguishing feature of the portfolio balance model among exchange rate models is the assumption of imperfect substitutability between domestic and foreign assets. The econometric method used here is the dynamic OLS approach which corrects for regressor endogeneity and is a robust method implemented in small samples. Furthermore, the stationarity of the variables is examined by unit root and stationary tests.