A New Micro Model of Exchange Rate Dynamics / Martin D.D. Evans, Richard K. Lyons.

Format:

Book

Author/Creator:

Evans, Martin D.D.

Contributor:

National Bureau of Economic Research.

Lyons, Richard K.

Series:

Working Paper Series (National Bureau of Economic Research) no. w10379.

NBER working paper series no. w10379

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2004.

Summary:

We address the exchange rate determination puzzle by examining how information is aggregated in a dynamic general equilibrium (DGE) setting. Unlike other DGE macro models, which enrich either preference structures or production structures, our model enriches the information structure. The model departs from microstructure-style modeling by identifying the real activities where dispersed information originates, as well as the technology by which information is subsequently aggregated and impounded. Results relevant to the determination puzzle include: (1) persistent gaps between exchange rates and macro fundamentals, (2) excess volatility relative to macro fundamentals, (3) exchange rate movements without macro news, (4) little or no exchange rate movement when macro news occurs, and (5) a structural-economic rationale for why transaction flows perform well in accounting for monthly exchange rate changes, whereas macro variables perform poorly. Though past micro analysis has made progress on results (1) through (3), results (4) and (5) are new. Excess volatility arises in our model for a new reason: rational exchange rate errors feed back into the fundamentals that the exchange rate is trying to track.

Notes:

Print version record

March 2004.