Explaining Foreign Exchange Market Puzzles
March 1, 1999
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Summary
The paper develops a flow model of the exchange rate with speculative capital flows integrated in a rigorous manner. The model is consistent with five foreign exchange market puzzles: (1) occasional discontinuous jumps in the exchange rate; (2) periodic short-term regimes of persistent appreciation/depreciation that can develop into a long swing; (3) the forward discount bias; (4) volatility clusters in the foreign exchange market that create conditional heteroskedasticity; and (5) the dual profitability of betting in the short run against any official foreign exchange intervention, and betting with the intervention in the long run.
Subject: Currency markets, Exchange rates, Financial markets, Foreign exchange, International trade, National accounts, Return on investment, Trade balance
Keywords: balance of payments, Currency markets, differential in favor, exchange rate, Exchange Rates, Foreign Exchange Puzzles, FX market, home interest rate, interest rate differential, long term speculator, prediction error, profit taking, Return on investment, time horizon, Trade balance, WP
Pages:
29
Volume:
1999
DOI:
Issue:
027
Series:
Working Paper No. 1999/027
Stock No:
WPIEA0271999
ISBN:
9781451844504
ISSN:
1018-5941
