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A New Micro Model of Exchange Rate Dynamics (March 2004)

We address the puzzle of what determines exchange rates by examining information aggregation in a dynamic general equilibrium (DGE) setting. Unlike other DGE macro models, which enrich either preference structures or production structures, our model enriches the information structure. The model departs from microstructure-style modeling by identifying real activities where dispersed information originates, as well as the technology by which information is subsequently aggregated and impounded. Results relevant to the determination puzzle include: (1) persistent gaps between exchange rates and fundamentals, (2) excess volatility relative to fundamentals, (3) exchange rate movements without macro news, (4) little or no exchange rate movement when macro news occurs, and (5) a structural rationale for why transaction flows perform well in accounting for monthly exchange rate changes, whereas macro variables perform poorly.

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Paper provided by Georgetown University, Department of Economics in its series Working Papers with number gueconwpa~05-05-04.

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Date of creation: 04 May 2005
Handle: RePEc:geo:guwopa:gueconwpa~05-05-04
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Georgetown University Department of Economics Washington, DC 20057-1036

Phone: 202-687-6074
Fax: 202-687-6102
Web page: http://econ.georgetown.edu/
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Order Information: Postal: Roger Lagunoff Professor of Economics Georgetown University Department of Economics Washington, DC 20057-1036
Web: http://econ.georgetown.edu/ Email:


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  3. Rime,D., 2000. "Private or public information in foreign exchange markets? : an empirical analysis," Memorandum 14/2000, Oslo University, Department of Economics.
  4. Martin Evans, 2000. "FX trading and Exchange Rate Dynamics," Working Papers gueconwpa~00-00-04, Georgetown University, Department of Economics.
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  18. Hoidal Bjonnes, Geir & Rime, Dagfinn, 2003. "Dealer Behavior and Trading Systems in Foreign Exchange Markets," SIFR Research Report Series 17, Institute for Financial Research.
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  28. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can sticky price models generate volatile and persistent real exchange rates?," Staff Report 277, Federal Reserve Bank of Minneapolis.
  29. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
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  32. Fukuda, Shin-ichi & Hoshi, Takeo & Ito, Takatoshi & Rose, Andrew, 2006. "International Finance," Journal of the Japanese and International Economies, Elsevier, vol. 20(4), pages 455-458, December.
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