Efficiency of Foreign Exchange Markets and Measures of Turbulence

13 Pages Posted: 12 Apr 2004

See all articles by Jacob A. Frenkel

Jacob A. Frenkel

Merrill Lynch & Co. - Sovereign Advisory Group and Global Financial Institutions Group; National Bureau of Economic Research (NBER)

Michael L. Mussa

International Monetary Fund (IMF) - Research Department; National Bureau of Economic Research (NBER)

Date Written: May 1980

Abstract

Since the move to generalized floating in1973, exchange rates between major currencies have displayed large fluctuations. This turbulence of foreign exchange rates is an important concern of government policy and its explanation is a challenge for theories of foreign exchange market behavior. In Section I of this paper, we document the extent of turbulence in foreign exchange markets by examining (i) the magnitude of short-run variations in exchange rates relative to other measures of economic variability; (ii) the degree of divergence between actual and expected changes in exchange rates; and (iii) the extent to which exchange-rate movements have diverged from movements of relative national price levels. In Section II, we provide a general explanation of this turbulence in terms of the modern "asset market theory" to exchange-rate determination. This theory emphasizes that exchange rates, like the prices of other assets determined in organized markets, are strongly influenced by the market's expectation of future events. In this context, we also discuss the narrower technical question of "foreign exchange market efficiency." Finally, in Section III, we address the question of whether turbulence in the foreign exchange markets has been "excessive" and what policy measures can (or should) be taken to reduce it.

Suggested Citation

Frenkel, Jacob A. and Mussa, Michael L., Efficiency of Foreign Exchange Markets and Measures of Turbulence (May 1980). NBER Working Paper No. w0476, Available at SSRN: https://ssrn.com/abstract=262698

Jacob A. Frenkel (Contact Author)

Merrill Lynch & Co. - Sovereign Advisory Group and Global Financial Institutions Group

New York, NY
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Michael L. Mussa

International Monetary Fund (IMF) - Research Department

700 19th Street NW
Washington, DC 20431
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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