Foreign Currency Bubbles
Robert A. Jarrow
Cornell University - Samuel Curtis Johnson Graduate School of Management
June 21, 2010
Johnson School Research Paper Series No. 29-2010
This paper develops a new model for studying foreign currency exchange rate bubbles. The model constructed is a modification of the Martingale-based bubble approach of Jarrow, Protter, and Shimbo , . This model generates some new insights into our understanding of exchange rate bubbles and it can be utilized empirically to test for their existence. The new insights are: (i) exchange rate bubbles can be negative, in contrast to asset price bubbles, (ii) exchange rate bubbles are caused by price level bubbles in either or both of the relevant countries’ currencies, and (iii) price level bubbles decrease the expected inflation rate in the domestic economy.
Number of Pages in PDF File: 18
Date posted: June 21, 2010