Overshooting and the exchange rate disconnect puzzle: a reappraisal

Jean-Olivier Hairault, Lise Patureau and Thepthida Sopraseuth

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Abstract: Transitions to floating exchange rate regimes have led to sharp increases in exchange rate volatilities with no corresponding changes in the distribution of macroeconomic fundamentals. In the spirit of Dornbusch (1976), we assess whether nominal exchange rate overshooting is responsible for this phenomenon. As long as uncovered interest rate parity holds, nominal exchange rate overshooting is linked to a persistent fall in the spread between domestic and foreign nominal interest rates. We thus develop a limited participation model in a small open economy setting. With small adjustment costs on money holdings, overshooting substantially contributes to the nominal exchange rate volatility. © 2004 Elsevier Ltd. All rights reserved.

Keywords: Exchange rate disconnect puzzle; Liquidity effect; Overshooting; Uncovered interest rate parity (search for similar items in EconPapers)
Date: 2004-06
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Citations: View citations in EconPapers (6)

Published in Journal of International Money and Finance, 2004, 23 (4), pp.615--643. ⟨10.1016/j.jimonfin.2004.03.007⟩

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Journal Article: Overshooting and the exchange rate disconnect puzzle: a reappraisal (2004)
Working Paper: Overshooting and Exchange Rate Disconnect Puzzle: A Reappraisal (2004)
Working Paper: Overshooting and the exchange rate disconnect puzzle: a reappraisal (2003)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-02878003

DOI: 10.1016/j.jimonfin.2004.03.007

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