International Fisher Effect (IFE) is a theory in international finance which asserts that the spot exchange rate between countries should move in opposite direction with the interest rate differential between these countries. The aim of this thesis is to analyze whether differences in nominal interest rates between countries and the movement of spot exchange rates between their currencies tend to move together over the long run. The presence of IFE is tested among the G-5 countries and Turkey for the period from 1985:1 to 2007:12. The long run relationship is estimated with the Johansen co-integration method and supportive evidence is found for all country pairs. Individually modeled equations are further tested with the Dynamic SUR method. Those DSUR equations that include the Turkish currency provide supportive evidence for IFE that higher interest rates in favor of Turkey would cause depreciation of the Turkish Lira. The magnitude of the effect is found to be lower than expected which indicates that there might be other factors in economy, such as inflation rates, that affect the exchange rate movements.

This dissertation examines the role of the fundamental economic variables (price levels, interest rates, and income levels) in the determination of foreign exchange rates during the period 1973-1978. Purchasing power parity, the International Fisher Effect, and the relationship of exchange rates with income levels through the marginal propensity to import were integrated, as suggested by the literature, and a fairly reasonable specification of a model for exchange rate determination was measured. The results of speculation tests indicate destabilizing results for some currencies and stabilizing results for the others; the coefficient of expectation tests, however, lend support to the destabilizing hypothesis. The conclusion of the research, therefore, is that the exchange rates of the major industrial countries which are of prime importance to the international financier and investor, and to the student of international finance and trade, are primarily determined, not by the fundamental economic variables, but by speculative forces which are believed to be of a destabilizing nature.