IDEAS home Printed from
MyIDEAS: Login to save this paper or follow this series

Rational speculators and exchange rate volatility

  • Carol L. Osler
  • John A. Carlson

This paper examines whether rational, fully informed speculators will smooth exchange rates. Friedman's (1953) claim that they must do so is challenged, based on the exclusion of interest rate differentials from his interpretation of speculator behavior. Once one recognizes that interest rates matter to speculators, it becomes apparent that rational speculators could sometimes violate Friedman's description of their behavior, and buy currency when its value is relatively high or sell currency when its value is low. For this reason the presence of rational, fully informed speculators may increase exchange rate volatility under floating exchange rates. Whether or not speculators increase exchange rate volatility depends on the extent of speculative activity and the types of economic shocks that dominate. At low levels of speculative activity, speculation will be stabilizing when the dominant shocks to exchange rates are associated exclusively with real economic activity, such as international trade in goods and services. It becomes destabilizing when the dominant shocks are changes in interest rates, perceived risk, or transactions costs--factors whose influence on exchange rates derives in part from their direct effect on speculators' positions.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: no

File URL:
Download Restriction: no

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 13.

in new window

Date of creation: 1996
Date of revision:
Handle: RePEc:fip:fednsr:13
Contact details of provider: Postal: 33 Liberty Street, New York, NY 10045-0001
Web page:

More information through EDIRC

Order Information: Web: Email:

References listed on IDEAS
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.:

as in new window
  1. Richard K. Lyons, 1993. "Tests of Microstructural Hypotheses in the Foreign Exchange Market," NBER Working Papers 4471, National Bureau of Economic Research, Inc.
  2. Robert P. Flood & Andrew K. Rose, 1993. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," NBER Working Papers 4503, National Bureau of Economic Research, Inc.
  3. Baxter, Marianne & Stockman, Alan C., 1989. "Business cycles and the exchange-rate regime : Some international evidence," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 377-400, May.
  4. Stein, Jeremy C., 1987. "Informational Externalities and Welfare-Reducing Speculation," Scholarly Articles 3660740, Harvard University Department of Economics.
  5. Osler, C. L., 1995. "Exchange rate dynamics and speculator horizons," Journal of International Money and Finance, Elsevier, vol. 14(5), pages 695-719, October.
  6. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August.
  7. Ito, T. & Lyons, R. & Melvin, M.T., 1997. "Is There Private Information on the FX Market? The Tokyo Experiment," Papers 97-04, Economisch Institut voor het Midden en Kleinbedrijf-.
  8. Ronald Macdonald & Mark P. Taylor, 1992. "Exchange Rate Economics: A Survey," IMF Staff Papers, Palgrave Macmillan, vol. 39(1), pages 1-57, March.
  9. Osler, C. L., 1998. "Short-term speculators and the puzzling behaviour of exchange rates," Journal of International Economics, Elsevier, vol. 45(1), pages 37-57, June.
  10. Goodhart, Charles, 1988. "The Foreign Exchange Market: A Random Walk with a Dragging Anchor," Economica, London School of Economics and Political Science, vol. 55(220), pages 437-60, November.
  11. Kouri, Pentti J.K., 1981. "Balance of Payments and the Foreign Exchange Market: A Dynamic Partial Equilibrium Model," Working Papers 81-09, C.V. Starr Center for Applied Economics, New York University.
  12. repec:oup:restud:v:58:y:1991:i:3:p:565-85 is not listed on IDEAS
  13. Hart, Oliver D. & Kreps, David M., 1986. "Price Destabilizing Speculation," Scholarly Articles 3448679, Harvard University Department of Economics.
  14. Bhattacharya, Utpal & Weller, Paul, 1997. "The advantage to hiding one's hand: Speculation and central bank intervention in the foreign exchange market," Journal of Monetary Economics, Elsevier, vol. 39(2), pages 251-277, July.
  15. Dow, James & Gorton, Gary, 1993. "Trading, Communication and the Response of Asset Prices to News," Economic Journal, Royal Economic Society, vol. 103(418), pages 639-46, May.
  16. Baxter, M. & Stockman, A.C., 1988. "Business Cycles And The Exchange Rate System: Some International Evidence," RCER Working Papers 140, University of Rochester - Center for Economic Research (RCER).
  17. Pentti J.K. Kouri, 1981. "Balance of Payments and the Foreign Exchange Market: A Dynamic Partial Equilibrium Model," NBER Working Papers 0644, National Bureau of Economic Research, Inc.
  18. 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.
  19. Gallant, A Ronald & Rossi, Peter E & Tauchen, George, 1992. "Stock Prices and Volume," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 199-242.
  20. Bradford Cornell, 1981. "The relationship between volume and price variability in futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 1(3), pages 303-316, 09.
  21. Hau, Harald, 1998. "Competitive Entry and Endogenous Risk in the Foreign Exchange Market," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 757-87.
  22. Dacorogna, Michael M. & Muller, Ulrich A. & Nagler, Robert J. & Olsen, Richard B. & Pictet, Olivier V., 1993. "A geographical model for the daily and weekly seasonal volatility in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 12(4), pages 413-438, August.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:fip:fednsr:13. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Amy Farber)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.