Granger-causes of the Ringgit-US dollar exchange rate after 2005

Abstract

Purpose This study aims to investigate Granger-causal relations between the Ringgit-USD exchange rate and selected domestic and international economic variables after the flotation of the Ringgit beginning with 25 July 2005. Design/methodology/approach The study uses lag-augmented vector autoregression (LA-VAR) developed by Toda and Yamamoto (1995) to test for Granger-causality. To visualize short-run dynamics in the Malaysian Ringgit (RM)-USD exchange rate to shocks in predictor variables, generalized impulse-response functions (Pesaran and Shin, 1998) are derived from the estimated LA-VAR models. Findings Results based on LA-VAR generalized impulse responses and data measured in daily frequency indicate strong Granger-causal relationships with the Dow Jones Industrial Average and oil prices. Evidence is also indicative for a causal relationship with the Shanghai Composite Index. Positive shocks in these three variables lead an appreciation of the Ringgit. Practical implications These results provide insights for policymakers in East Asia in their attempt to manage the floating of their currency. Originality/value The paper adds to existing empirical literature in three ways. First, it investigates the RM-USD exchange rate after its managed flotation beginning with 25 July 2005. Second, the study provides results for exchange rates measured in two frequencies, namely, daily and monthly. Third, the empirical LA-VAR model applied includes variables capturing economic and financial conditions in China. Prior literature puts a focus on macroeconomic conditions in the USA. Yet, since 2009, China has been the largest trading partner of Malaysia.