Rational Speculators and Exchange Rate Volatility

European Economic Review

Posted: 22 Apr 1998

See all articles by Carol L. Osler

Carol L. Osler

Brandeis University - International Business School

John A. Carlson

Purdue University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Abstract

This paper examines whether rational, fully informed speculators stabilize floating exchange rates. Friedman's claim that they must do so (1953), because they buy low and sell high, is challenged. Friedman excluded any consideration of interest rate differentials from his interpretation of speculator behavior. We show that, if interest differentials affect speculators' profits, rational speculative activity can increase exchange-rate volatility. Since they do this by changing the exchange rate's generating process, the connection between rational speculation and exchange rate volatility highlighted here can be considered microstructural. Low levels of rational speculation are stabilizing and high levels are destabilizing.

JEL Classification: F31

Suggested Citation

Osler, Carol L. and Carlson, John A., Rational Speculators and Exchange Rate Volatility. European Economic Review. Available at SSRN: https://ssrn.com/abstract=78833

Carol L. Osler (Contact Author)

Brandeis University - International Business School ( email )

Mailstop 32
Waltham, MA 02454-9110
United States
781-736-4826 (Phone)

John A. Carlson

Purdue University - Department of Economics ( email )

Krannert School of Management
West Lafayette, IN 47907-1310
United States

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