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Excess volatility of exchange rates with unobservable fundamentals

  • Leonardo Bartolini
  • Lorenzo Giorgianni

We present tests of excess volatility of exchange rates that impose minimal structure on the data and do not commit to a choice of exchange rate "fundamentals." Our method builds on existing volatility tests of 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 volatility with respect to the predictions of the canonical asset-pricing model of the exchange rate with rational expectations.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 103.

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Date of creation: 2000
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Handle: RePEc:fip:fednsr:103
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  8. Huang, Roger D, 1981. "The Monetary Approach to Exchange Rate in an Efficient Foreign Exchange Market: Tests Based on Volatility," Journal of Finance, American Finance Association, vol. 36(1), pages 31-41, March.
  9. Robert P. Flood & Mark P. Taylor, 1996. "Exchange Rate Economics: What's Wrong with the Conventional Macro Approach?," NBER Chapters, in: The Microstructure of Foreign Exchange Markets, pages 261-302 National Bureau of Economic Research, Inc.
  10. Miller, Merton, 1998. "Asian financial crisis," Japan and the World Economy, Elsevier, vol. 10(3), pages 355-358, July.
  11. Flood, Robert P & Rose, Andrew K, 1993. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," CEPR Discussion Papers 838, C.E.P.R. Discussion Papers.
  12. Mankiw, N.G. & Romer, D. & Shapiro, M.D., 1989. "Stock Market Forecastability And Volatility: A Statistical Appraisal," Papers 89-21, Michigan - Center for Research on Economic & Social Theory.
  13. Ronald Macdonald & Mark P. Taylor, 1992. "Exchange Rate Economics: A Survey," IMF Staff Papers, Palgrave Macmillan, vol. 39(1), pages 1-57, March.
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  17. Jeffrey A. Frankel & Andrew K. Rose, 1994. "A Survey of Empirical Research on Nominal Exchange Rates," NBER Working Papers 4865, National Bureau of Economic Research, Inc.
  18. Tim Bollerslev & Robert J. Hodrick, 1992. "Financial Market Efficiency Tests," NBER Working Papers 4108, National Bureau of Economic Research, Inc.
  19. Gardeazabal, Javier & Regulez, Marta & Vazquez, Jesus, 1997. "Testing the Canonical Model of Exchange Rates with Unobservable Fundamentals," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(2), pages 389-404, May.
  20. Robert J. Shiller, 1980. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," NBER Working Papers 0456, National Bureau of Economic Research, Inc.
  21. Paul R. Masson, 1998. "Contagion; Monsoonal Effects, Spillovers, and Jumps Between Multiple Equilibria," IMF Working Papers 98/142, International Monetary Fund.
  22. Alan C. Stockman, 1978. "A Theory of Exchange Rate Determination," UCLA Economics Working Papers 113, UCLA Department of Economics.
  23. Wadhwani, Sushil B., 1987. "Are exchange rates 'excessively' volatile?," Journal of International Economics, Elsevier, vol. 22(3-4), pages 339-348, May.
  24. Liu, Peter C. & Maddala, G. S., 1992. "Rationality of survey data and tests for market efficiency in the foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 11(4), pages 366-381, August.
  25. Eichengreen, Barry & Tobin, James & Wyplosz, Charles, 1995. "Two Cases for Sand in the Wheels of International Finance," Economic Journal, Royal Economic Society, vol. 105(428), pages 162-72, January.
  26. Calvo, Guillermo A & Rodriguez, Carlos Alfredo, 1977. "A Model of Exchange Rate Determination under Currency Substitution and Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 617-25, June.
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