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Optimal exchange-rates: a market-microstructure approach

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  • Alexander Gümbel

    ()

  • Oren Sussman

    ()

Abstract

We analyze exchange-rate management by the central bank when it makes the FX market for the sake of social-welfare objectives. It is assumed that markets are incomplete, so that agents are exposed to exchange-rate volatility against which they cannot fully hedge. It follows that the central bank may provide insurance by smoothing the exchange rate. However, smoothing the exchange rate also creates arbitrage opportunities for spec-ulators. We show that the central bank cannot smooth the exchange rate and deter speculation at the same time. A Tobin tax may provide a way out.

Suggested Citation

  • Alexander Gümbel & Oren Sussman, 2001. "Optimal exchange-rates: a market-microstructure approach," OFRC Working Papers Series 2001fe13, Oxford Financial Research Centre.
  • Handle: RePEc:sbs:wpsefe:2001fe13
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    File URL: http://www.finance.ox.ac.uk/file_links/finecon_papers/2001fe13.pdf
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    Cited by:

    1. Killeen, William P. & Lyons, Richard K. & Moore, Michael J., 2006. "Fixed versus flexible: Lessons from EMS order flow," Journal of International Money and Finance, Elsevier, vol. 25(4), pages 551-579, June.
    2. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2015. "Wave function method to forecast foreign currencies exchange rates at ultra high frequency electronic trading in foreign currencies exchange markets," MPRA Paper 67470, University Library of Munich, Germany.

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