Integrating tax methodology and foreign exchange rates dynamics, and utilizing Miller and Scholes [1] framework, we are able to derive a testable algorithm that identifies financial flow of funds across countries, which in turn leads to short term changes in exchange rates. In this model we are going to identify changes in the flow of funds, directed toward financial investments, lending or borrowing, between two countries, and thereby the short term changes in the foreign exchange rate that solely stem s from expected changes in the tax codes. Thus, expected change in the foreign exchange rate becomes an endogenous variable, while the common view in the literature is that expected change in foreign exchange rates that differs from the market consensus is the trigger for flows of funds across countries. Alternatively, by using the above-mentioned algorithm, one can imply the market beliefs regarding expected changes in the tax code.
KeywordsTax CodeForeign ExchangeCapital Flows
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