Portfolio approach in the identification of equilibrium exchange rate in Turkey

In the period after 1980, the portfolio preferences of decision makers have started to be effective on equilibrium exchange rate by the removal of limitations on financial markets and by providing full liberty for capital movement. In the portfolio approach which was developed for this reason, the portfolio structure of the decision mechanisms are identified by instruments representing financial assets and liabilities. According to this, it has been accepted that the assests of decision mechanisms are allocated between foreign and national currencies and financial instruments. Because of this reason, equilibrium exchange rate is a pricing unit decided upon by the financial instruments that are in foreign or national currency units. Since there is not a full substitution between these financial instruments, there is always a financial risk. Hence, the economic decision mechanisms create their portfolios subordinate to these risks.The aim of this study is to identify the portfolio preferences of Turkish decision mechanisms and the effect of their portfolio preferences on equilibrium exchange rate. The validity of portfolio approach on forming the equilibrium exchange rate was analysed by one of the nonlinear models; Markov Regime Switching Approach and SETAR model. With these techniques, multiple unstructural breaks and nonlinear structures in time series were examined in order to identify the probabilities among regimes.The study identifies a process with double regimes. Regime 1 represents a process in which the exchange rate is unstable (exchange rate has a tendency to increase) and Regime 2 represents a process in which the exchange rate is stable (exchange rate has a downward tendency). According to the results of analyses of the models, in regime 1, the portfolio preferences of decision mechanisms have no effect on the change on equilibrium exchange rate. Contrary to this result, the variables mentioned in regime 2 have higher probability to explain the changes on equilibrium exchange rate.In this period which tries to explain the formation of equilibrium exchange rate in the framework of portfolio approach with these two models, the crisis processes of regime peroids were identified. Although it seems that the periods of crisis end with high devaluation and increases in export according to the approach that was investigated, actually the loan accounts of private sector is effective in that regard. The variables such as debt of private sector in foreign currency units, current account deficits and interest rates are determinants in the formation of equilibrium exchange rate.