Are Exchange Rates Excessively Variable?
88 Pages Posted: 27 Apr 2000 Last revised: 26 Aug 2022
Date Written: May 1987
Abstract
"Unnecessary variation" is defined as variation not attributable to variation in fundamentals. In the absence of a good model of macroeconomic fundamentals, the question "are exchange rates excessively variable?" cannot be answered by comparing the variance of the actual exchange rate to the variance of a set of fundamentals. This paper notes the failure of regression equations to explain exchange rate movements even using contemporaneous macroeconomic variables. It notes as well the statistical rejections of the unbiasedness of the forward exchange rate as a predictor of the spot rate. It then argues that, given these results, there is not much to be learned from the variance-bounds tests and bubbles tests. The paper also discusses recent results on variation in the exchange risk premiums arising from variation in conditional variances, both as a source of the bias in the forward rate tests and as a source of variation in the spot rate. It finishes with a discussion of whether speculators' expectations are stabilizing or destabilizing, as measured by survey data. The paper concludes that it is possible that exchange rates have been excessively variable -- as, for example, when there are speculative bubbles -- but that if policy-makers try systematically to exploit their credibility in order to stabilize exchange rates, they may see their current credibility vanish.
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
The Covariation of Risk Premiums and Expected Future Spot Exchange Rates
-
The Time-Variation of Risk and Return in the Foreign Exchange and Stock Markets
-
International Lending and Borrowing in a Stochastic Sequence Equilibrium
-
Recent Estimates of Time-Variation in the Conditional Variance and in the Exchange Risk Premium
-
Exchange Rate Volatility and its Impact on the Transaction Costs of Covered Interest Rate Parity
By Ramaprasad Bhar, Toan M. Pham, ...
-
An International Economy with Country-Specific Money and Productivity Growth Processes
-
Foreign Exchange Market Efficiency, Speculators, Arbitrageurs and International Capital Flows
By Tin Nguyen