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Endogenous Liquidity Providers and Exchange Rate Dynamics

Author

Listed:
  • Hamid Faruqee
  • Lee Redding

Abstract

The high variance of exchange rates can be partially explained by the fact that traders with transitory demands can have temporary effects on the market rates. In this paper we explore theoretically the effect on market prices of these non-informational traders when the number of market makers providing liquidity to the traders is endogenous. A primary empirical implication of the model is that the expected reversion towards fundamentals will be proportionally greater when the deviation from fundamentals is large. This implication is then tested and verified using exchange rate data from the G7 countries. The results cast doubts on the random walk hypothesis of exchange rates.

Suggested Citation

  • Hamid Faruqee & Lee Redding, 1999. "Endogenous Liquidity Providers and Exchange Rate Dynamics," Canadian Journal of Economics, Canadian Economics Association, vol. 32(4), pages 976-994, August.
    • Handle: RePEc:cje:issued:v:32:y:1999:i:4:p:976-994
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    Citations

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    Cited by:

    1. Olivier Jeanne & Andrew K. Rose, 2002. "Noise Trading and Exchange Rate Regimes," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(2), pages 537-569.
    2. Aleš Bulíø, 2005. "Liberalized Markets Have More Stable Exchange Rates: Short-Run Evidence from Four Transition Countries," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 55(5-6), pages 206-231, May.
    3. Redding, Lee, 2005. "Endogenous liquidity in emerging markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 15(2), pages 159-171, April.
    4. Ales Bulir, 2003. "Some Exchange Rates Are More Stable than Others: Short-Run Evidence from Transition Countries," Working Papers 2003/05, Czech National Bank.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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