Explaining Foreign Exchange Market Puzzles

Norman Miller

No 1999/027, IMF Working Papers from International Monetary Fund

Abstract: The paper develops a flow model of the exchange rate with speculative capital flows integrated in a rigorous manner. The model is consistent with five foreign exchange market puzzles: (1) occasional discontinuous jumps in the exchange rate; (2) periodic short-term regimes of persistent appreciation/depreciation that can develop into a long swing; (3) the forward discount bias; (4) volatility clusters in the foreign exchange market that create conditional heteroskedasticity; and (5) the dual profitability of betting in the short run against any official foreign exchange intervention, and betting with the intervention in the long run.

Keywords: WP; interest rate differential; exchange rate; balance of payments; FX market; time horizon; Exchange Rates; Foreign Exchange Puzzles; long term speculator; profit taking; home interest rate; prediction error; differential in favor; Currency markets; Trade balance; Return on investment (search for similar items in EconPapers)
Pages: 29
Date: 1999-03-01
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