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Exchange Rate Puzzles: A Tale of Switching Attractors

  • De Grauwe, Paul

    ()

    (University of Leuven)

  • Grimaldi, Marianna

    ()

    (Research Department, Central Bank of Sweden)

Registered author(s):

    The rational expectations efficient market model of the exchange rate has failed empirically. In this paper we develop a model of the exchange rate in which agents use simple forecasting rules. Based on an ex post evaluation of the relative profitability of these rules they decide whether to switch or not. In addition, transactions costs in the goods market are introduced. We show that this simple model creates great complexity in the market which is characterised by the fact that the exchange rate is disconnected from its fundamental most of the time. Finally we show that this model mimicks most of the empirical puzzles uncovered in the literature.

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    File URL: http://www.riksbank.se/upload/WorkingPapers/WP_163.pdf
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    Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 163.

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    Length: 42 pages
    Date of creation: 01 May 2004
    Date of revision:
    Publication status: Published in European Economic Review, 2006, pages 1-33.
    Handle: RePEc:hhs:rbnkwp:0163
    Contact details of provider: Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
    Phone: 08 - 787 00 00
    Fax: 08-21 05 31
    Web page: http://www.riksbank.com/
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