Explaining exchange rate behavior in the long run assumes that changes in price levels and real interest rates affect nominal exchange rates so that interest parity and PPP hold. Short-run deviations from PPP may be explained by an alternative theory called the:
A) relative PPP approach.
B) asset approach to exchange rate determination.
C) long-run equilibrium approach.
D) law of one price.

Question

Quizplus · Accepted Answer

The asset approach to exchange rate determination suggests that short-run deviations from PPP can be explained by differences in expected returns from holding financial assets denominated in different currencies, rather than just differences in price levels or real interest rates. This approach takes into account factors such as risk and uncertainty in the global financial markets.

Explaining Exchange Rate Behavior in the Long Run Assumes That