Dear Salah,

Models for exchange rates traditionally fall under three categories: Parity Conditions, Balance of Payments and Asset Approach. You can find discussions on them in a good textbook such as "Multinational Business Finance" by Eiteman,Stonehill, and Moffett, 14th edition, 2016, Pearson. People tend to overlap in there use of these categories. Also, they tend to specify statistical equations based on relevant variables, particularly in crises situation. Good luck in your research.

You should look up the monetary and absorption approaches. I have a recent working paper summarizing them and proposing another extension with centre-periphery theme. Good luck!

Hello there. Interesting question!!!!

In the exchange rate literature, the variables driving or explaining exchange rates are called "fundamentals". The traditional fundamentals in the literature are differences between domestic and international key variables, including: interest rate differentials (i-i*), money supply differences (m-m*), inflation rates differentials (p-p*) and output differentials, like GDP growth diferentials (y-y*).

Here I am using usual letters to denote variables in the domestic country (if you are from Brazil, it will be Brazilean interest rate (i), Brazilean money supply(m), etc, etc. International variables have a star next to them : i* (international interest rate,), m* (international money supply), etc, etc. usually if you are considering exchange rates vis a vis the American Dollar, then, the international variables should be American Variables. If your exchange rate is vis a vis the Euro, of course your international interest rate will be the European one, and so on and so forth. So, a traditional model to explain or predict exchange rates will look like:

ER(t)=a+b(i-i*)+c(m-m*)+d(y-y*)+e(p-p*)+error term

Of course you can use these variables as you wish: in a VAR model, in first differences, you name it. There are tons of versions of these models out there.

Now, in developing countries you can add two or more key variables. First, it is imperative to know if there is a free float or a managed float in the country. Some countries go with a fixed exchange rate, some others have bands, some others allow the exchange rate to vary freely, some others mostly allow their currency to float with only a few interventions of monetary authorities. So, it is critical to have a notion of how managed is the exchange rate in the country of your interest.

Second, many developing countries are heavy exporters of commodities: metals, oil, timber, gold, etc, etc. Given that commodity prices have huge fluctuations in their prices, they may importantly affect the exchange rates in commodity exporter countries. So, commodity prices may be extremely relevant.

Third, the possibility of a fiscal crisis might be extremely important in determining exchange rates. When a country is running fiscal deficits for a long period of time, and there are increasing probabilities of default , then the domestic currency typically depreciates importantly. So, the fiscal situation is also another variable to consider.

Finally, international crises may affect developing countries as well. As investors go to safe investments in dollars, the domestic currency also may depreciate.

Very interesting subject.

Hope it helps!!!

The above responses include more theory. I can add a variable, if indeed you are looking for variables to use in empirical work, that is related to perceived risk. As the above point out, risk is important for interest rates and thereby exchange rates. There are assessments of risk from the The International Country Risk Guide (https://www.prsgroup.com/explore-our-products/international-country-risk-guide/) However, as I recall you have to pay for it, but there may be free versions.

You might find this relevant: Conference Paper Foreign exchange pressure in Barbados: monetary approach or ...

When exchage rate is floating, undoubtly capital flows and volatility of export prices

Besides, I consider that CDS spreads may be a factor that determines exchange rate fluctuations in developing countries.

At a deeper level exchange rates are affected by tax havens facilitating legal and illegal capital flows. Thus the City of London attracts capital flows into the UK. This inflates sterling against other currencies, so the latter are lower in relation to sterling. The US Dollar's is likewise inflated because the dollar is the global reserve currency. Back to the City, its important to realise that illicit capital flows from emerging/third world economies starve the latter of investment capital which results in them being caught in a trap. The exchange rate falls to keep them competitive yet the fall raises inflation if their economies are heavily import deoendent, which they are because import substitution is well nigh impossible due to lack of capital investment. Counties then turn to financusl institutions who are sellers of debt. Globally it the banks and financial institutions that syphon money out of economies even as they invest.

Referring back to Pablo 's excellent contribution, it should be noted that purchasing power parity does not hold. Goods markets are particularly sticky. Capital flows, and political hegemony play a huge role in exchange rate imbalances. Successful countries such as the Asian tigers and China, all have exchange rate policies. D Rodrik is good on this. My own thesis was about sterling overvaluation, which relates indirectly to exchange rates round the world as touched on above.

Key variables are: inflation differentials, interest rate, current account balance, and foreign debt service ratio. If foreign debt is primarily US$ denominated examine what is your source of US dollar revenue and compare inflows against the maturity schedule of your debt service payments. Contact me if you need additional information.

In my opinion, they are: Terms of trade, Balance of Trade, Government Expenditure, Foreign Assets, Productivy and Tariffs Rates. The best model depends on the data for each case-country (theoretically, two very well known models are: the Mundell-Fleming model and the Balassa-Samuelson model). Send me an email if you need more information: [email protected]. Cheers!

Your thrust of thought is appealing. However, do not look for a model. Look for a frame. You will find dynamical systems illuminating...if you’re ready to trek the rough terrain. So, pick a case and please bring us your paper. You might consider giving case study a deep thought. Cf. Article Public-Private Partnerships (PPP) on Moulding State Structur...

Exchange rates are to a larger extent influenced/affected by the changes in the crude oil prices. The impact would be different depending on whether the economy is a net exporter or a net importer. May be the following paper would shed some more light on the same.

Article Inflationary effects of oil price shocks in Indian economy

Article Within and Cross Volatility Contagion Effects among Stock, C...

Please recommend the answer/articles if you find it useful.

Here you can find my papers on macroeconomic variables as determinants of exchange rates in BRICS countries (including appropiate empirical and theoretical models). Cheers!!!

In addition to the above, another way to tackle the question is to explore a specific country's connection with the global commodities trade. In this paper, volatility in the price of the leading export commodity and a benchmark commodity plays a role:

https://www.tandfonline.com/doi/abs/10.1080/00036846.2018.1545077?journalCode=raec20

Elsewhere, for very small open economies, a dual-currency FX regime might be part of the policy model. That leads to a complex attempts to maintain domestic FX target (range) while supporting commodity/agricultural exports to one market and being able to import consumer goods from another.

Here's the case of Armenia with such complex balance: Article The foreign exchange regime in a small open economy: Armenia...

Hi Salah,

There is a literature on monetary and absorption approaches to the BOP and by extension exchange rate. There is also the issue of exchange market pressure. Exchange rates are determined by external factors. I summarize three factors or determinants in this paper co-authored by D. Downs:

Conference Paper Foreign exchange pressure in Barbados: monetary approach or ...

In my opinion, the key macroeconomic variables that affect the exchange rate in developing countries are Level of public debt denominated in foreign currencies, terms of trade, inflation rate, level of foreign direct investments.