| Along with convergence of globalization, the economic activities between countries have become to be more and more frequent. So as the bond of connecting different economies and realizing internal and external economic balance, exchange rate has been considered to be a key variable in an open economy and therefore attached more and more attention.As an emerging economy, China has been developing in a high growth rate for many years, and at the meantime, China's foreign reserve grows dramatically in the past few years resulting from the sustaining trade surplus and capital surplus. Under this situation, some developed countries pointed that RMB is underestimated badly, which made them suffered from international trade. So for both internal and external point of view, People's bank of China decided to reform RMB exchange rate system. Since July 21st, 2005, China has begun to implement a managed floating exchange rate system based on market supply and demand with reference to a basket of currencies. In recent years, reform of the mechanism for setting the exchange rate proceeded orderly an effectively and played a positive role for our economic development. On 19 June 2010 people's bank of China said it will further advance the reform of the RMB exchange rate mechanism, strengthen the RMB exchange rate flexibility. During this period, the RMB exchange rate gradually appreciates. At the end of 2010, the RMB exchange rate became from 8.27 Yuan per dollar to 6.60 Yuan per dollar. At present, future trend of the RMB exchange rate has caused more and more attention.From purchasing power parity, interest rate parity and Balassa-Samuelson effect point of view, this paper intends to analyze the long- and short-run structure of RMB real exchange rate and its influencing factor and driving trends.The PPP theory is used to study and compare relationship of purchasing power between different currencies. Its general idea is that peoples need foreign currency because of their demand of foreign goods and services, and foreigners need national currency also because of the same reason. So exchange between two currencies is equivalent to that between purchasing power in two countries. That is to say, exchange rate, which means how much foreign currency is by national currency, denotes the ratio of purchasing power between two countries. Because purchasing power is the reciprocal of the general price level, the currency exchange rates between the two countries can be expressed by ratio of two price level.Although Purchasing Power Parity is a basic theory to study the determination of exchange rate, there is still controversy about its efficiency. Balassa-Samuelson effect theory is put forward to rectify the PPP theory, aiming at explaining the deviation of PPP from real exchange rate.Interest rate parity theory is that the difference between the two countries interest rates equals to the expected change rate between the forward exchange rate and the spot exchange rate. Its means when domestic interest rate is less than a foreign country, in order to seek higher returns, investors will transfer their capital from native to abroad to obtain profit caused by different interest rates. In the forward market, Investors will sell their profit gained abroad, according to forward exchange rate. Compared it to the earnings by directly invested domestically, if difference exists, there will be international movement of capital. Until, through adjustment of interest rates, income of investment to one country equals that to the other country, international capital liquidity will be terminated.The structure of this thesis is divided into 5 chapters.In chapter 1, we mainly focus on literature reviews with 5 parts. In the first part, we introduce Purchasing Power Parity and its background, followed by some foreign and domestic studies about it. Taking advantage of different econometric methods, some of the studies are favor of PPP theory, while the others are not (with reasonable explanations). The second part and the third part are about interest rate parity and Balassa-Samuelson effect separately with similar contents as the first part above. The fourth part is to introduce structure of the paper. At last is the fifth part which is about innovations involved in my study.In chapter 2, we introduce theoretical model on whose base we continued empirical researches. There are three separate parts in this chapter: purchasing power parity theory, interest rate parity theory and Balassa-Samuelson effect theory. In the first part, we address the assumption of PPP theory and its two forms: absolute purchasing power parity and relative purchasing power parity; in the second part, we demonstrate covered interest rate parity and uncovered interest rate parity separately, and at last offer a simple comment on this theory; finally, we show a model for the Balassa-Samuelson effect theory, its theoretical derivation and how it is more developed than PPP theory.In chapter 3, on the base of PPP theory and interest rate parity, we use cointegrated VAR model to analyze whether purchasing power parity is appropriate for Chinese economic condition. Finally, we get the conclusion that PPP has a mean reverting process in our country with a cycle of 21 years, which means that PPP establishes for Chinese economy.In chapter 4, under the frame of the Balassa-Samuelson effect theory and interest rate parity, we discuss the long- and short-run structure, influencing factors and driving trends of real exchange rate. The study aims at influence of relative price level and interest rate on real exchange rate. This chapter also analyzes establishing conditions of Balassa-Samuelson effects.In chapter 5, we further test the long- and short-run structure, influencing factors and driving trends of real exchange rate, on the base of simplified Balassa-Samuelson effect. This time, the focus has been changed to study influence of relative average output and interest rate on real exchange rate. Still, we also address the establishing conditions of simplified Balassa-Samuelson effect.
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