FACTOR BASED MODEL TO IDENTIFY THE DETERMINANTS OF EXCHANGE RATE FLUCTUATION IN SRI LANKA

This study is focused on the exchange rate behavior patterns in Sri Lanka through the exchange rate volatility. Exchange rate volatility refers to the tendency for foreign currencies to appreciate or depreciate in value, thus affecting the profitability of foreign exchange trades. Usually the returns of exchange rates can be represented by a factor model. There are six daily exchange rate values Euro, Great Britain Pound, Japanese Yen, US Dollar, Indian Rupee, Pakistan Rupee against the Sri Lankan Rupee that are used during the time period of October, 2013 to November, 2015. The factor model is estimated using Principal Component Analysis. Euro, Great Britain Pound, Japanese Yen are defined by factor one, Pakistan Rupee, Indian Rupee are defined by factor two and US Dollar is defined by factor three. Therefore the six variables can be reduced into three factors and they represented 78% of total variance.