Rational expectations and monetary models of exchange rate determination. An empirical examination

One asset model of exchange rate determination that has received substantial attention in the literature is the monetary model. As with other asset models, expectations of future exchange rates play a key role. Usually these expectations are assumed to be formed rationally. However, to date there has been no attempt to empirically estimate a complete monetary model with rational expectations. In this paper, such a model is estimated and the restrictions implicity imposed by the rational expectation hypothesis tested. The results suggest that both the parameter constraints associated with the monetary model and those implied by the REH are consistent with recent exchange rate behavior.