Short-Run Exchange-Rate Dynamics: Theory and Evidence
CREATES Research Paper 2008-1
58 Pages Posted: 19 Jun 2008
Date Written: July 1, 2008
Recent research has revealed a wealth of information about the microeconomics of currency markets and thus the determination of exchange rates at short horizons. This information is valuable to us as scientists since, like evidence of macroeconomic regularities, it can provide critical guidance for designing exchange-rate models. This paper presents an optimizing model of short-run exchange-rate dynamics consistent with both the micro evidence and the macro evidence, the first such model of which we are aware. With respect to microeconomics, the model is consistent with the institutional structure of currency markets, it accurately reflects the constraints and objectives faced by the major participants, and it fits key stylized facts concerning returns and order flow. With respect to macroeconomics, the model is consistent with most of the major puzzles that have emerged under floating rates.
Keywords: Exchange-rate dynamics, currency market microstructure
JEL Classification: F31, G12, G15
Suggested Citation: Suggested Citation