Endogenous Liquidity Providers and Exchange Rate Dynamics

Hamid Faruqee and Lee Redding

Canadian Journal of Economics, 1999, vol. 32, issue 4, 976-994

Abstract: The high variance of exchange rates can be partially explained by the fact that traders with transitory demands can have temporary effects on the market rates. In this paper we explore theoretically the effect on market prices of these non-informational traders when the number of market makers providing liquidity to the traders is endogenous. A primary empirical implication of the model is that the expected reversion towards fundamentals will be proportionally greater when the deviation from fundamentals is large. This implication is then tested and verified using exchange rate data from the G7 countries. The results cast doubts on the random walk hypothesis of exchange rates.

JEL-codes: F31 G12 (search for similar items in EconPapers)
Date: 1999
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Citations: View citations in EconPapers (4)

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