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Variations in the foreign exchange market influence all aspects of the world economy, and understanding these dynamics is one of the great challenges of international economics. This book provides a new, comprehensive, and in-depth examination of the standard theories and latest research in exchange-rate economics. Covering a vast swath of theoretical and empirical work, the book explores established theories of exchange-rate determination using macroeconomic fundamentals, and presents unique microbased approaches that combine the insights of microstructure models with the macroeconomic forces driving currency trading.
Macroeconomic models have long assumed that agents--households, firms, financial institutions, and central banks--all have the same information about the structure of the economy and therefore hold the same expectations and uncertainties regarding foreign currency returns. Microbased models, however, look at how heterogeneous information influences the trading decisions of agents and becomes embedded in exchange rates. Replicating key features of actual currency markets, these microbased models generate a rich array of empirical predictions concerning trading patterns and exchange-rate dynamics that are strongly supported by data. The models also show how changing macroeconomic conditions exert an influence on short-term exchange-rate dynamics via their impact on currency trading.
Designed for graduate courses in international macroeconomics, international finance, and finance, and as a go-to reference for researchers in international economics, Exchange-Rate Dynamics guides readers through a range of literature on exchange-rate determination, offering fresh insights for further reading and research.
Preface ix
PART I: MACRO MODELS
Chapter 1: Macro Models without Frictions 3
1.1 Preliminaries 4
1.2 Empirical Characteristics of Real Exchange Rates 8
1.3 Macro Exchange-Rate Models 21
1.4 Summary 50
1.5 Bibliography 51
1.6 Review Questions 52
1.A Appendix 54
Chapter 2: Macro Models with Frictions 63
2.1 The Model 63
2.2 Sticky Prices 72
2.3 International Risk-Sharing 96
2.4 Incomplete Markets 97
2.5 Summary 116
2.6 Bibliography 117
2.7 Review Questions 119
2.A Appendix 121
Chapter 3: Empirical Macro Models 130
3.1 Present Value Models 130
3.2 Monetary Models 147
3.3 External Balance Models 158
3.4 Predicting Exchange-Rate Movements 165
3.5 Summary 171
3.6 Bibliography 172
3.7 Review Questions 173
3.A Appendix 176
PART II: MICROSTRUCTURE MODELS
Chapter 4: Rational Expectations Models 183
4.1 The Model 183
4.2 Equilibrium with Common Information 186
4.3 Equilibrium with Heterogeneous Information 196
4.4 Equilibrium Problems 213
4.5 Summary 216
4.6 Bibliography 217
4.7 Review Questions 217
4.A Appendix 220
Chapter 5: Sequential Trade Models 227
5.1 The Model 227
5.2 Exchange-Rate Determination 231
5.3 Exchange-Rate Dynamics 236
5.4 Information Flows 245
5.5 Public versus Private Information 253
5.6 Uninformed Traders 255
5.7 Summary 257
5.8 Bibliography 258
5.9 Review Questions 258
Chapter 6: Currency-Trading Models 261
6.1 The Structure of the FX Market 261
6.2 The Portfolio Shifts Model 271
6.3 Extending the Portfolio Shifts Model 289
6.4 Summary 295
6.5 Bibliography 295
6.6 Review Questions 296
6.A Appendix 297
Chapter 7: Currency-Trading Models: Empirical Evidence 302
7.1 Daily Analysis 302
7.2 Intraday Analysis 314
7.3 Summary 335
7.4 Bibliography 336
7.5 Review Questions 337
7.A Appendix 338
Chapter 8: Identifying Order Flow 342
8.1 Order Flow in a Rational Expectations Model 342
8.2 Order Flow in a Limit-Order Market 352
8.3 Estimating Order Flow 359
8.4 Summary 369
8.5 Bibliography 370
8.6 Review Questions 371
8.A Appendix 372
PART III MICRO-BASED MODELS
Chapter 9: Order Flows and the Macroeconomy 377
9.1 A Micro-Based Macro Model 378
9.2 Empirical Implications 389
9.3 Re-Examining the Disconnect Puzzle 395
9.4 Summary 411
9.5 Bibliography 412
9.6 Review Questions 413
9.A Appendix 415
Chapter 10: Exchange Rates, Order Flows, and Macro Data Releases 422
10.1 The Macro Perspective 422
10.2 Micro Perspective I: High-Frequency Dynamics 429
10.3 Micro Perspective II: Low-Frequency Dynamics 446
10.4 Summary 458
10.5 Bibliography 459
10.6 Review Questions 459
10.A Appendix 462
Chapter 11: Exchange-Rate Risk 464
11.1 FX Returns and Interest Rates 464
11.2 Macro Models 474
11.3 Micro-Based Models 496
11.4 Summary 512
11.5 Bibliography 513
11.6 Review Questions 514
11.A Appendix 518
References 523
Index 535
Overview
Variations in the foreign exchange market influence all aspects of the world economy, and understanding these dynamics is one of the great challenges of international economics. This book provides a new, comprehensive, and in-depth examination of the standard theories and latest research in exchange-rate economics. Covering a vast swath of theoretical and empirical work, the book explores established theories of exchange-rate determination using macroeconomic fundamentals, and presents unique microbased ...