Using asset prices to explain the fluctuations of nominal exchange rate is popular for decades. A majority of papers focused on Monetary Model but failed to make a consistent conclusion. In this article, we suggest that the failure of monetary model might be coming from the basic assumption of taking different countries¡¦ assets as ¡§perfect substitutes¡¨. Under such circumstances, we introduce another model named as ¡§Portfolio Balance Model¡¨ where assets of different countries are no longer be taken as ¡§perfect substitutes¡¨ , implying that UIP( Uncoverd Interest Rate Parity)exist no more either. We do not overthrow the entire theory of Monetary Model. Instead, we expect the combination of these two models will turn something out that can be much more general, consistent, and robust. We take Canada as our domestic currency and adopt Johansen(1988) and Stock & Walson(1988) by using co-integration to test on three exchange rates relation (USD/CAD,GBP/CAD,JPY/CAD) from 1973 Q1 to 2004 Q4. It turns out that most of the coefficient are correct and passing statistical significance, such result suggest that the portfolio balance effect should not be ignored in the model.

There are four chapters in my dissertation. Chapter one gives a brief introduction of the three essays. Chapter two studies the choice of exchange rate regimes in East Asia using a business-cycle approach. My results suggest that countries in East Asia are driven mainly by country-specific shocks, making more rigid exchange rate regimes less desirable. Neither a yen bloc nor a dollar bloc has been identified in East Asia. However, Japan seems more influential to countries such as Korea and Taiwan. An optimum currency area does not seem feasible for East Asia, at least in the short run. Chapter three applies the cointegration and causality analyses to the real effective exchange rates to study the degree of monetary integration in East Asia. I find that the ASEAN and the NIE countries, respectively, have achieved some degree of integration, but not East Asia as a whole. The yen is found to move closely with the NIE currencies. However, neither the yen nor the dollar imposes a dominant driving force on the East Asian currencies. My results suggest that East Asia is not an optimum currency area. Chapter four expands the traditional monetary model of exchange rate determination into a structural VAR model incorporating various capital flows and the balance of trade in addition to the macroeconomic fundamentals. The model is then applied to the Australian dollar (AUD), the Canadian dollar (CAD), and the US dollar (USD) exchange rates over 19802004. I find that capital flows, especially portfolio investments, explain a major portion of the exchange rate fluctuations in the relatively small and open economies such as Australia and Canada in the short-to-medium run. The impacts of capital flows are limited to the US dollar exchange rates. Among the macroeconomic fundamentals, the interest rate plays an important role in exchange rate determination for all three currencies. The results imply that different capital flows do influence exchange rates differently and are important determinants of exchange rates.