Testing the portfolio balance approach of exchange rate for turkish economy

The portfolio balance approach is a theory developed to explain short-term changes in exchange rates. In this context, the short-term changes in exchange rate is determined by the deviations from the state of equilibrium in the supply and demand of financial assets as a result of interactions in the financial asset markets. With the economic stabilization measures which was taken on the 24th of January 1980, Turkey made a radical change in economic policy and begun a new economic era. Correspondingly, the exchange regime was liberalized, steps were taken to set exchange rates under free market conditions and restrictions on capital movements were removed over time. Thus, the effect of economic authority on currencies decreased gradually and the determinants of financial capital flows on currencies increased. By passing to flexible exchange rate regime in 2001, the impact of financial capital flows on currencies have increased considerably. Therefore, the connection between economic agents' decisions on their own portfolios and the change of exchange rates, has become strong enough. In this thesis, short-term changes in the nominal exchange rates for the Turkish Economy were tried to be explained within the framework of the portfolio balance approach. Therefore, two models were built to test the impact of reallocation process on the portfolio of domestic and foreign residents in the short run on the exhange rate. These two models were created by selecting the largest asset items in the financial portfolio of economic agents (both domestic and foreign) and were examined by ARDL time series method. As a result, the hypothesis that the exchange rate is influenced by financial asset markets in the short run, which the portfolio balance approach suggests, were confirmed for the Turkish Economy.