Can Information Heterogeneity Explain the Exchange Rate Determination?
AbstractEmpirical evidence shows that observed macroeconomic fundamentals have little explanatory power for nominal exchange rates (the exchange rate determination puzzle). On the other hand, the recent \microstructure approach to exchange rates" has shown that most exchange rate volatility at short to medium horizons is related to order flow. In this paper we introduce symmetric information dispersion about future fundamentals in a dynamic rational expectations model in order to explain these stylized facts. Consistent with the evidence the model implies that (i) observed fundamentals account for little of exchange rate volatility in the short to medium run, (ii) over long horizons the exchange rate is closely related to observed fundamentals, (iii) exchange rate changes are a weak predictor of future fundamentals, and (iv) the exchange rate is closely related to order flow over both short and long horizons.
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Bibliographic InfoPaper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp155.
Date of creation: Aug 2005
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Nominal Exchange Rates; Order Flow; Higher Order Expectations;
Find related papers by JEL classification:
- F3 - International Economics - - International Finance
- F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
- G0 - Financial Economics - - General
- G1 - Financial Economics - - General Financial Markets
- E0 - Macroeconomics and Monetary Economics - - General
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- NEP-ALL-2005-09-29 (All new papers)
- NEP-FIN-2005-09-29 (Finance)
- NEP-IFN-2005-09-29 (International Finance)
- NEP-MAC-2005-09-29 (Macroeconomics)
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- Eric van Wincoop & Philippe Bacchetta, 2004.
"Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?,"
Econometric Society 2004 North American Winter Meetings
628, Econometric Society.
- Philippe Bacchetta & Eric Van Wincoop, 2006. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," American Economic Review, American Economic Association, vol. 96(3), pages 552-576, June.
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