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Can Information Heterogeneity Explain the Exchange Rate Determination?

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Author Info
Philippe Bacchetta (Study Center Gerzensee, University of Lausanne, FAME and CEPR)
Eric van Wincoop (University of Virginia, NBER)

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Abstract

Empirical 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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Publisher Info
Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp155.

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Date of creation: Aug 2005
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Handle: RePEc:fam:rpseri:rp155

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Related research
Keywords: 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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  1. Philippe Aghion & Philippe Bacchetta & Romain Rancière & Kenneth Rogoff, 2005. "Productivity Growth and the Exchange Rate Regime: The Role of Financial Development," Economics Working Papers 850, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
  2. Anella Munro, 2005. "UIP, Expectations and the Kiwi," Reserve Bank of New Zealand Discussion Paper Series DP2005/05, Reserve Bank of New Zealand. [Downloadable!]
  3. George-Marios Angeletos & Alessandro Pavan, 2007. "Policy with Dispersed Information," NBER Working Papers 13590, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Kurz, Mordecai, 2006. "Beauty contests under private information and diverse beliefs: how different?," MPRA Paper 233, University Library of Munich, Germany, revised Apr 2006. [Downloadable!]
  5. 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. [Downloadable!]
    Other versions:
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