What Drives Movements in Exchange Rates?

Understanding what causes the exchange rate to move has been on ongoing challenge for economists. Despite extensive research, traditional macro models of exchange rate determination--with the exception of the Bank of Canada's exchange rate equation--have typically not fared well, motivating economists to explore new ways to model exchange rate movements that incorporate more complex and realistic settings. Within the context of the sharp appreciation of the Canadian dollar in 2003 and 2004, Bailliu and King review the macroeconomic models of exchange rates, as well as the micro-structure studies that highlight the importance of trading mechanisms, information asymmetry, and investor heterogeneity for explaining short-term dynamics in exchange rates. In addition to summarizing the current state of knowledge, they highlight recent advances and identify promising alternative approaches.

[1]  Mark P. Taylor,et al.  Nonlinear adjustment, long-run equilibrium and exchange rate fundamentals , 2000 .

[2]  Bela Balassa,et al.  The Purchasing-Power Parity Doctrine: A Reappraisal , 1964, Journal of Political Economy.

[3]  Kenneth Rogoff,et al.  The Six Major Puzzles in International Macroeconomics: Is There a Common Cause? , 2000, NBER Macroeconomics Annual.

[4]  Maureen O'Hara,et al.  Market Microstructure Theory , 1995 .

[5]  Martin D. D. Evans,et al.  Exchange Rate Fundamentals and Order Flow , 2007 .

[6]  Mark P. Taylor,et al.  Exchange Rate Economics: What's Wrong with the Conventional Macro Approach? , 1996 .

[7]  J. Frankel,et al.  Introduction to "The Microstructure of Foreign Exchange Markets" , 1996 .

[8]  Kenneth A. Froot,et al.  Chartists, Fundamentalists and the Demand for Dollars , 1991 .

[9]  Robert E. Lucas,et al.  Interest rates and currency prices in a two-country world , 1982 .

[10]  'Once-in-A-Generation' Yen Volatility in 1998: Fundamentals, Intervention, and Order Flow , 1999 .

[11]  Dagfinn Rime,et al.  Liquidity provision in the overnight foreign exchange market , 2005 .

[12]  Barbara Rossi,et al.  Testing Long-Horizon Predictive Ability with High Persistence, and the Meese-Rogoff Puzzle , 2005 .

[13]  P. Moulton.  You Can't Always Get What You Want: Trade-Size Clustering and Quantity Choice in Liquidity , 2004 .

[14]  Mark P. Taylor,et al.  The Microstructure of the Foreign-Exchange Market: A Selective Survey of the Literature , 2001 .

[15]  Martin D. D. Evans,et al.  Order Flow and Exchange Rate Dynamics , 2002, Journal of Political Economy.

[16]  Robert P. Flood,et al.  Fixing Exchange Rates: A Virtual Quest for Fundamentals , 1993 .

[17]  M. Chinn.  Productivity, Government Spending and the Real Exchange Rate: Evidence for OECD Countries , 1999 .

[18]  Fixed versus flexible: Lessons from EMS order flow , 2006 .

[19]  Kenneth Rogoff,et al.  Empirical exchange rate models of the seventies , 1983 .

[20]  Paul A. Samuelson,et al.  Theoretical Notes on Trade Problems , 1964 .

[21]  Francis Breedon,et al.  An Empirical Study of Liquidity and Information Effects of Order Flow on Exchange Rates , 2004, SSRN Electronic Journal.

[22]  M. Chinn,et al.  Testing Uncovered Interest Parity at Short and Long Horizons During the Post-Bretton Woods Era , 2002 .

[23]  R. MacDonald.  The economics of exchange rates , 1991 .

[24]  David H. Papell.  Expectations and exchange rate dynamics after a decade of floating , 1988 .

[25]  Lukas Menkhoff,et al.  The Use of Flow Analysis in Foreign Exchange: Exploratory Evidence , 2004 .

[26]  Richard K. Lyons,et al.  The Microstructure Approach to Exchange Rates , 2001 .

[27]  Kenneth A. Froot,et al.  The Information Content of International Portfolio Flows , 2001 .

[28]  R. Lyons,et al.  Customer trades and extreme events in foreign exchange , 2003 .

[29]  C. Osler,et al.  Stop-Loss Orders and Price Cascades in Currency Markets , 2002 .

[30]  Paolo Vitale.  A Guided Tour of the Market Microstructure Approach to Exchange Rate Determination , 2004 .

[31]  Yin-Wong Cheung,et al.  Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive? , 2002 .

[32]  Michael L. Mussa,et al.  The Exchange Rate, The Balance Of Payments and Monetary and Fiscal Policy Under A Regime of Controlled Floating , 1976 .

[33]  Andrew K. Rose,et al.  Empirical research on nominal exchange rates , 1995 .

[34]  C. Osler.  Short-term speculators and the puzzling behaviour of exchange rates , 1998 .

[35]  N. Mark,et al.  Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability , 1995 .

[36]  Ananth N. Madhavan,et al.  Market Microstructure: A Survey , 2000 .

[37]  Lutz Kilian,et al.  Exchange Rates and Monetary Fundamentals: What Do We Learn from Long-Horizon Regressions? , 1999 .

[38]  Martin D. D. Evans.  FX Trading and Exchange Rate Dynamics , 2000 .

[39]  Alan C. Stockman.  A Theory of Exchange Rate Determination , 1980, Journal of Political Economy.

[40]  Lucio Sarno,et al.  Toward a New Paradigm in Open Economy Modeling: Where Do We Stand? , 2001 .

[41]  W. Branson,et al.  The Specification and Influence of Asset Markets , 1984 .

[42]  J. Frenkel.  A Monetary Approach To The Exchange Rate: Doctrinal Aspects And Empirical Evidence , 1976 .

[43]  Kenneth S. Rogoff,et al.  Exchange Rate Dynamics Redux , 1994, Journal of Political Economy.

[44]  Dagfinn Rime.  Private or Public Information in Foreign Exchange Markets? An Empirical Analysis , 2000 .

[45]  Ryen W. White,et al.  Introduction , 2006, Commun. ACM.

[46]  Richard Payne.  Informed trade in spot foreign exchange markets: an empirical investigation , 2003 .

[47]  C. Osler,et al.  Currency Orders and Exchange Rate Dynamics: An Explanation for the Predictive Success of Technical Analysis , 2003 .

[48]  Richard K. Lyons,et al.  Do Currency Markets Absorb News Quickly? , 2005 .

[49]  Fabio Canova,et al.  Modelling and forecasting exchange rates with a Bayesian time-varying coefficient model , 1993 .