Puzzling exchange rate dynamics and delayed portfolio adjustment

Philippe Bacchetta and Eric van Wincoop

Journal of International Economics, 2021, vol. 131, issue C

Abstract: The objective of this paper is to show that the proposal by Froot and Thaler (1990) of delayed portfolio adjustment can account for a broad set of puzzles about the relationship between interest rates and exchange rates. The puzzles include: i) the delayed overshooting puzzle; ii) the forward discount puzzle (or Fama puzzle); iii) the predictability reversal puzzle; iv) the Engel puzzle (high interest rate currencies are stronger than implied by UIP); v) the forward guidance exchange rate puzzle; vi) the absence of a forward discount puzzle with long-term bonds. These results are derived analytically in a simple two-country model with portfolio adjustment costs. Quantitatively, this approach can match all targeted moments related to these puzzles.

Keywords: Fama puzzle; Delayed overshooting; Predictability reversal; Portfolio frictions (search for similar items in EconPapers)
JEL-codes: F3 F31 F41 G11 G12 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Related works:
Working Paper: Puzzling Exchange Rate Dynamics and Delayed Portfolio Adjustment (2019)
Working Paper: Puzzling Exchange Rate Dynamics and Delayed Portfolio Adjustment (2019)
Working Paper: Puzzling Exchange Rate Dynamics and Delayed Portfolio Adjustment (2019)
Working Paper: Puzzling Exchange Rate Dynamics and Delayed Portfolio Adjustment (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:131:y:2021:i:c:s0022199621000374

DOI: 10.1016/j.jinteco.2021.103460

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