Exchange-rate volatility, exchange-rate disconnect, and the failure of volatility conservation

Alexei Deviatov (deviatov@list.ru) and Igor Dodonov
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Igor Dodonov: New Economic School

No w0079, Working Papers from Center for Economic and Financial Research (CEFIR)

Abstract: Empirical analysis of exchange rates has produced puzzles that conventional models of exchange rates cannot explain. Here we deal with four puzzles regarding both real and nominal exchange rates, which are robust and inconsistent with standard theory. These puzzles are that both real and nominal exchange rates: i) are disconnected from fundamentals, ii) are much more volatile than fundamentals, iii) show little di?erence in behavior, and iv) fail to satisfy conservation of volatility. We develop a two-country, two-currency version of the random matching model to study exchange rates. We show that search and legal restrictions can produce exchange-rate dynamics consistent with these four puzzles.

Keywords: exchange-rate puzzles; exchange-rate volatility; bargaining; search (search for similar items in EconPapers)
JEL-codes: C78 F31 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2006-06
New Economics Papers: this item is included in nep-cba, nep-dge, nep-ifn and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Exchange-rate volatility, exchange-rate disconnect, and the failure of volatility conservation (2006)
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