Are Exchange Rates Excessively Variable?
Abstract"Unnecessary variation" is defined as variation not attributable to variation in fundamentals. In the absence of a good model of macroeconomic fundamentals, the question "are exchange rates excessively variable?" cannot be answered by comparing the variance of the actual exchange rate to the variance of a set of fundamentals. This paper notes the failure of regression equations to explain exchange rate movements even using contemporaneous macroeconomic variables. It notes as well the statistical rejections of the unbiasedness of the forward exchange rate as a predictor of the spot rate. It then argues that, given these results, there is not much to be learned from the variance-bounds tests and bubbles tests. The paper also discusses recent results on variation in the exchange risk premiums arising from variation in conditional variances, both as a source of the bias in the forward rate tests and as a source of variation in the spot rate. It finishes with a discussion of whether speculators' expectations are stabilizing or destabilizing, as measured by survey data. The paper concludes that it is possible that exchange rates have been excessively variable -- as, for example, when there are speculative bubbles -- but that if policy-makers try systematically to exploit their credibility in order to stabilize exchange rates, they may see their current credibility vanish.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2249.
Date of creation: Mar 1988
Date of revision:
Publication status: published as Jeffrey A. Frankel, Richard Meese. "Are Exchange Rates Excessively Variable?," in Stanley Fischer, editor, "NBER Macroeconomics Annual 1987, Volume 2" The MIT Press (1987)
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Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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Other versions of this item:
- Frankel, Jeffrey A. & Meese, Richard, 1987. "Are Exchange Rates Excessively Variable?," Department of Economics, Working Paper Series qt18n4c5f6, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
- Jeffrey A. Frankel and Richard Meese., 1987. "Are Exchange Rates Excessively Variable," Economics Working Papers 8738, University of California at Berkeley.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Minford, Patrick & Marwaha, Satwant & Matthews, Kent & Sprague, Alison, 1984. "The Liverpool macroeconomic model of the United Kingdom," Economic Modelling, Elsevier, vol. 1(1), pages 24-62, January.
- Salmon, Mark & Wallis, Kenneth F, 1980. "Model Validation and Forecast Comparisons : Theoretical and Practical Considerations," The Warwick Economics Research Paper Series (TWERPS) 184, University of Warwick, Department of Economics.
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