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Excess Volatility and the Asset-Pricing Exchange Rate Model with Unobservable Fundamentals

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  • Lorenzo Giorgianni
  • Leonardo Bartolini

Abstract

This paper presents a method to test the volatility predictions of the textbook asset-pricing exchange rate model, which imposes minimal structure on the data and does not commit to a choice of exchange rate “fundamentals.” Our method builds on existing tests of excess volatility in asset prices, combining them with a procedure that extracts unobservable fundamentals from survey-based exchange rate expectations. We apply our method to data for the three major exchange rates since 1984 and find broad evidence of excess exchange rate volatility with respect to the predictions of the canonical asset-pricing model in an efficient market.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 99/71.

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Length: 20
Date of creation: 01 May 1999
Date of revision:
Handle: RePEc:imf:imfwpa:99/71

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Cited by:
  1. Olivier Jeanne & Andrew K Rose, 1999. "Noise trading and exchange rate regimes," Reserve Bank of New Zealand Discussion Paper Series G99/2, Reserve Bank of New Zealand.
  2. Follmer, Hans & Horst, Ulrich & Kirman, Alan, 2005. "Equilibria in financial markets with heterogeneous agents: a probabilistic perspective," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 123-155, February.

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