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  3. American Economic Review
  4. June 2006
  5. Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?

  • Philippe Bacchetta
  • Eric Van Wincoop
American Economic Review
vol. 96, no. 3, June 2006
(pp. 552–576)
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Abstract

Empirical evidence shows that most exchange rate volatility at short to medium horizons is related to order flow and not to macroeconomic variables. We introduce symmetric information dispersion about future macroeconomic fundamentals in a dynamic rational expectations model in order to explain these stylized facts. Consistent with the evidence, the model implies that (a) observed fundamentals account for little of exchange rate volatility in the short to medium run, (b) over long horizons, the exchange rate is closely related to observed fundamentals, (c) exchange rate changes are a weak predictor of future fundamentals, and (d) the exchange rate is closely related to order flow. (JEL F3, F4, G0, G1, E0)

Citation

Bacchetta, Philippe, and Eric Van Wincoop. 2006. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?" American Economic Review, 96 (3): 552–576. DOI: 10.1257/aer.96.3.552

JEL Classification

  • F31 Foreign Exchange
  • G15 International Financial Markets