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Exchange-rate volatility, exchange-rate disconnect, and the failure of volatility conservation

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  • Alexei Deviatov

    (New Economic School)

  • Igor Dodonov

    (New Economic School)

Abstract

Empirical analysis of exchange rates has produced puzzles that conventional models of exchange rates cannot explain. Here we deal with four puzzles regarding both real and nominal exchange rates, which are robust and inconsistent with standard theory. These puzzles are that both real and nominal exchange rates: i) are disconnected from fundamentals, ii) are much more volatile than fundamentals, iii) show little di?erence in behavior, and iv) fail to satisfy conservation of volatility. We develop a two-country, two-currency version of the random matching model to study exchange rates. We show that search and legal restrictions can produce exchange-rate dynamics consistent with these four puzzles.

Suggested Citation

  • Alexei Deviatov & Igor Dodonov, 2006. "Exchange-rate volatility, exchange-rate disconnect, and the failure of volatility conservation," Working Papers w0079, New Economic School (NES).
    • Handle: RePEc:abo:neswpt:w0079
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    Cited by:

    1. Beverly Lapham & Ayman Mnasri, 2019. "Exchange Rate Pass-Through: A Competitive Search Approach," Working Paper 1418, Economics Department, Queen's University.
    2. Ayman Mnasri & Beverly Lapham, 2023. "A competitive search approach to exchange rate pass-through," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 76(1), pages 153-201, July.

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    More about this item

    Keywords

    exchange-rate puzzles; exchange-rate volatility; bargaining; search;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory

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