can learning affect exchange rate behavior the case of the dollar in the early 1980 s this paper demonstrates that a change in parameters of the money market that is not immediately understood will affect the behavior of exchange rate forecast errors while the market is learning the analysis is applied to the behavior of u s dollar german mark forecast errors during the early 1980 s when the market appeared to systematically underpredict the strength of the dollar consistent with this observation empirical estimates of implied forecast errors based upon bayesian learning suggest that forecast errors would have been on average negative during the period as the market came to realize the increase in u s money demand

are shocks to real effective exchange rates permanent or transitory evidence from pacific island countries in this article we consider the stability of the real effective exchange rates for four pacific island countries using the lee and strazicich 2003a b unit root test which allows one to incorporate at most two structural breaks in the data series our main finding is that for papua new guinea and samoa exchange rates are stable implying that shocks will have a transitory effect on real effective exchange rates while for fiji and the solomon islands we find exchange rates to be unstable implying that shocks will have a permanent effect on real effective exchange rates

forward exchange bias hedging and the gains from international diversification of investment portfolios abstract the gains to the us investor from international diversification of investment portfolios are examined for portfolio strategies that hedge and strategies that do not hedge exchange rate risk via the interbank forward market using the sharpe performance index and stochastic dominance as performance measures almost all the unhedged strategies outperformed the hedged strategies for 1985 1988 the opposite held for 1981 1984 the results are explained by the biasedness of forward rates in predicting future spot rates jel f30

heterogeneity and volatility puzzles in international finance we develop an equilibrium model in a 2 country 2 good pure exchange economy in which investors with logarithmic utility functions have heterogeneous beliefs about exogenously given output or endowment processes we obtain closed form representations of real ex change rates and of stock prices we show that heterogeneous beliefs together with hetero geneous preferences make the volatility of real exchange rates and of stocks exhibit some properties that have been well documented in the empirical literature these properties include the high volatility of both real exchange rates and stocks compared with that of economic fundamentals the high correlation of stocks during periods of volatile markets the model can also generate the clustering of the volatility of foreign exchange rates and stocks if the differences of beliefs are clustering

the costs and benefits of foreign borrowing a survey of multi period models this article surveys the literature on multi period models of foreign borrowing to shed light on the issue of how much a country should borrow and under what circumstances there is a role for public intervention it identifies the essential structural elements of multi period models and draws out the ramifications of the alternative specifications adopted it discusses the insights and shortcomings of three classes of models non optimising optimising borrower and jointly optimising borrower and lender

purchasing power parity modeling and testing mean reversion abstract a model of mean reversion of exchange rates to purchasing power parity is developed and tested where exchange rates are assumed to follow a mean reverting elastic random walk toward a stochastic ppp rate the model recognizes the possibility that mean reversion towards ppp may be nonlinear which allows greater flexibility in the adjustment process regression equations consistent with the theoretical model are derived the model is tested using long and short term data for six countries while the results are generally consistent with the findings of previous studies evidence is presented which demonstrates that the mean reversion process is not linear for some countries

empirical tests of the monetary approach to exchange rate determination there has been much discussion as to whether or not the turbulence in foreign exchange rates that has existed since 1973 is consistent with an efficient foreign exchange market this empirical question can only be tested relative to an equilibrium exchange rate model in this paper we conduct variance tests and efficient markets tests of three different models of exchange rate determination the equilibrium rational expectations model ere the currency substitution model cs and dornbusch s exchange rate dynamics model erd we find that the uncertainty in realised exchange rate movements can only be explained by the erd model and that actual exchange rates could have been predicted in a manner that is inconsistent with the efficient markets hypothesis

a model of international asset pricing under imperfect commodity arbitrage abstract this paper examines the effect of imperfect international commodity arbitrage i e violation of the law of one price modeled as the existence of non traded goods on the structure of purchasing power risk optimal portfolio rules of the risk averse investors and the equilibrium yield relationship among assets the major results of the paper include i there are two separate sources of purchasing power risk i e relative price risk and inflation risk relative price risk is specific to the country in which the investor resides ii in a world of n countries investors may hold n 1 hedge portfolios as vehicles to hedge against purchasing power risk facing different relative prices investors residing in different countries display divergent portfolio behavior iii in equilibrium investors are compensated in terms of excess return for bearing not only the systematic world market risk but also the systematic inflation and relative price risks

deviations from purchasing power parity and capital flows abstract this article examines the implications of deviations from purchasing power parity ppp for an investor s portfolio decision and the consequent capital flows in a two country intertemporal model with complete financial markets in the presence of deviations form ppp investors from different nations hold disparate portfolios and the equilibrium that results is not a pooling one we solve eplicitly for asset demands and derive the relationship between the direction of capital flows and deviations from ppp in contrast to the small country assumption in the existing literature the world interest rate in this model is determined endogenously

the collapse of purchasing power parities during the 1970 s one of the striking facts concerning the relationship beiveen prices and exchange rates during the 1970 s has been the dismal performance of the predictions of the simple versions of the purchasing power parity doctrine ppp that doctrine in its absolute version states that the equilibrium exchange rate between domestic and foreign currencies equals the ratio of domestic to foreign price levels the relative version of the doctrine relates equilibrium changes in exchange rates to changes in the ratio of domestic to foreign prices during the 1970 s short run changes in exchange rates bore little relationship to short run differentials in national inflation rates and frequently divergences from purchasing power parities have been cumulative this paper reviews and analyzes the empirical record of exchange rates and prices during the 1970 s and the analysis is based on the experience of the dollar pound the dollar frecch franc and the dollar dm exchange rates section 2 presents the evidence on ppp during the 1970 s and contrasts it with the evidence from the 1920 s a period during which the doctrine held up reasonably well this analysis is relevant for assessing whether the flexible exchange rate system was successful in providing national economies with an added degree of insulation from foreign shocks and whether it provided policymakers with an added instrument for the conduct of macroeconomic policy the evidence regarding devia tions from purchasing power parities is also relevant for determining whether there is a case for managed float section 3 attempts to explain what went wrong with

the division of labor local markets and worker organization the model developed here explains differences in the degree of the division of labor across local markets for example the typical doctor in one local market may treat a wider range of patients problems than his counterpart in another local market the extent of the division of labor depends on variables affecting the local demand for services two different forms of worker organization cooperation and noncooperation yield divergent results for example specialization increases with the local number of producers under cooperation but may decrease under noncooperation with the number of producers constant local demand variables affect individual specialization under noncooperation but not under cooperation

real exchange rate behavior abstract using random simulations with artificial data with identical sample characteristics to the long sample exchange rate data employed by lothian and taylor lothian j r and taylor m p 1996 the recent float from the perspective of the past two centuries journal of political economy 104 488 509 we show that standard unit root tests have extremely low power over sample sizes corresponding to the recent float the probability of rejecting the null hypothesis when it is false is extremely low with 20 years or even 50 years of data and only reaches an acceptable level over much longer spans

a note on exchange rate expectations and nominal interest differentials a test of the fisher hypothesis this note tests the hypothesis that nominal interest differentials between similar assets denominated in different currencies can be explained entirely by the expected change in the exchange rate over the holding period this proposition often called the fisher open hypothesis or the hypothesis of perfect asset substitutability has been a major component of recent theories of exchange rate determination and has important implications for monetary policy 1 the fisher hypothesis differs from the covered interest parity theorem enunciated by keynes 11 while covered interest parity equates the nominal interest differential between financial centers to a known premium or discount on forward foreign exchange and is thus in principle riskless fisher parity involves risk in an essential way the two conditions are equivalent only when forward exchange rates equal expected future spot rates recent theoretical work for example that of grauer litzenberger and stehle 8 kouri 12 and frankel 6 shows that this need not be the case when market participants are risk averse thus while covered interest parity must always hold exactly in an informationally efficient asset market with no transactions costs fisher parity need not nominal interest differentials may reflect risk premia in addition to expected exchange rate movements 2 it should be emphasized at the outset that the tests conducted in this paper are really joint tests of the fisher hypothesis and a weak form of foreign exchange market informational efficiency levich 14 has argued that tests of market efficiency are always joint tests involving some hypothesized structure of normal equilibrium returns below we assume informational efficiency and instead test fisher s hypothesized arbitrage condition that nominal interest differentials equal expected percentage changes in exchange rates

the persistence of the peso problem when policy is noisy abstract the peso problem the market s belief that a discrete event may occur has frequently been blamed for the persistence of on average mistaken forecasts of macroeconomic variables this paper demonstrates how beliefs that a policy process may have switched can induce apparent ex post biased forecasts of exchange rates even after the switch has occurred furthermore during this peso problem period exchange rates may appear to contain a speculative bubble component since they will systematically deviate from the levels implied by observing fundamentals ex post and the conditional variance of exchange rates will exceed the variance implied by observing fundamentals

is the division of labour limited by the extent of the market evidence from french cities abstract this paper provides supportive evidence to the notion that the division of labour is limited by the extent of the local market we first propose a theoretical model its main prediction is that scarce specialists occupations are over represented in large cities using census data for french cities we find strong empirical support for this prediction

is the sticky price assumption reasonable for exchange rate models abstract the testable implications of sticky price exchange rate models are discussed the empirical examples suggest that the predetermined or sticky price assumption employed in recent asset models of exchange rate determination appears to be appropriate for germany japan the united states and the united kingdom

a quantitative reassessment of the purchasing power parity hypothesis evidence from norway and the united kingdom summary annual data from norway and the united kingdom from 1874 to 1971 are used to reassess the empirical performance of the purchasing power parity ppp doctrine the simple version of the ppp relationship is supported by the data only if different short run dynamics during a floating rate period 1914 1928 is allowed for two sets of factors were found to be important in amending the simple ppp model these were short run cyclical variables affecting the adjustment towards the ppp equilibrium relationship and long run structural factors such as productivity and terms of trade within this expanded model the proportionality between the exchange rate and relative price levels could not be rejected

learning and the volatility of exchange rates abstract this paper investigates the implications for the volatility of exchange rates of specifying market uncertainty as parameter uncertainty private agents learn by means of bayes rule about a parameter of the stochastic process generating the exogenous variables learning is shown to magnify the reaction of exchange rates to random shocks to the market fundamentals this magnification effect of learning can explain the rejections of the econometric tests on the variance bounds and on the absence of bubbles that have been reported in the literature

marketplaces and matching this paper models equilibrium trading patterns when marketplaces exist and goods are differentiated when first visiting the market a buyer samples a stock of goods if fortunate the buyer matches with and purchases one of these goods and then exits the market if an initial match does not exist the buyer can now only match with the flow of new goods for sale the previous stock has been sampled and rejected in a steady state the current stock of unmatched traders on one side of the market is trying to match with the flow of new traders on the other side it is shown that this market behaviour describes matching patterns between unemployed job seekers and vacancies in uk job centres

exchange rate and relative monetary expansions the case of simultaneous hyperinflation and rational expectations abstract the relationship between the exchange rate and relative monetary expansions of poland and germany in the 1920s when the countries are under simultaneous hyperinflation is studied the results show that for this period of predominantly monetary shocks the conventional specifications of the monetary model of exchange rate determination with rational expectations cannot be rejected the results therefore support the monetary approach in its most conducive environment

post bretton woods deviations from purchasing power parity in g7 exchange rates an empirical exploration abstract exchange rates have deviated substantially and idiosyncratically from purchasing power parity ppp since the breakdown of bretton woods in this paper a model incorporating both traditional ppp and financial market variables is constructed and tested on the us dollar s six g7 exchange rates during the floating rate era empirical tests show that the model s common set of variables with consistent signs can explain the divergent behavior of g7 exchange rates during 1973 2 90 2 idiosyncracies are reflected in different subsets of the model s variables entering significantly into each exchange rate s regression the existence of stable relationships is demonstrated by the equations co integration

agglomeration opportunism and the organization of production abstract recent economic analysis of outsourcing has emphasized its international dimension in contrast this paper focuses on local outsourcing the paper specifies and solves a model where the organization of production vertically integrated or not and the location of production agglomerated or not are jointly determined the paper shows that agglomeration reduces opportunism a thick market effect and so serves as a substitute for integration this force will lead firms to agglomerate the paper also shows that the normative properties of equilibrium with local outsourcing are not as clear cut as for international outsourcing since local agglomeration is achieved at the cost of congestion local markets may be too thick which would not be the case for an increase in the thickness of a world market finally the many changes in economic and social circumstance that have been labeled globalization do not impact only vertically integrated firms they also impact cities and industry clusters to the extent that agglomeration is a substitute for vertical integration

empirical determinants of purchasing power parity deviations abstract this paper investigates the empirical determinants of purchasing power parity ppp deviations over the recent period of flexible exchange rates transitory ppp deviations arise in a world in which prices are sticky but where exchange rates respond instantaneously to news permanent ppp deviations occur when price indices differ across countries and the world is subject to real shocks regressions consistent with the hypothesis that current exchange rate changes create immediate ppp deviations which are slowly dissipated but not eliminated imply that both sticky prices and real shocks are responsible for the recent failure of ppp

debt and the developing countries a simple model of optimal borrowing this article proposes a simple macroeconomic model of optimal borrowing for ldcs using a two period framework it is shown that optimal debt levels are functions of interest rates on debt shadow exchange rates the shares of investment in domestic output and foreign inflows the multiplier effects of investment and borrowing on output growth and inter temporal consumption preferences empirical evidence is considered on the main observable variables and provides a basis for simulation exercises for appropriate parameter values optimal borrowing is found to be particularly sensitive to the interest rate capital productivity and the extent of foreign inflows invested

the links between international parity conditions and granger causality a study of exchange rates and prices this article investigates granger causality between exchange rates and prices for the us and four of its trading partners canada germany japan and the uk we emphasize the distinction between direct and indirect granger causality exchange rates directly cause prices if movements in exchange rates lead movement in prices and exchange rates indirectly cause prices if deviations from the purchasing power parity ppp condition can help forecast movement in prices but only by including the interest rate differential in our error correction model do we obtain results that align with economic theory the economic theory of ppp suggests that exchange rates and prices are cointegrated with exchange rates moving proportionally to prices in the long run in general we find either direct or indirect feedback mechanisms between exchange rates and prices

spatial wage disparities sorting matters spatial wage disparities can result from spatial differences in the skill composition of the workforce in non human endowments and in local interactions to distinguish between these explanations we estimate a model of wage determination across local labour markets using a very large panel of french workers we control for worker characteristics worker fixed effects industry fixed effects and the characteristics of the local labour market our findings suggest that individual skills account for a large fraction of existing spatial wage disparities with strong evidence of spatial sorting by skills interaction effects are mostly driven by the local density of employment not controlling for worker heterogeneity leads to very biased estimates of interaction effects endowments only appear to play a small role

a note on the burden of the mexican foreign debt abstract this paper examines the macroeconomic repercussions of the future foreign debt restrictions that mexico will face our view is that credit conditions will be fundamentally modified in the years to come so that the foreign debt will have to grow at a substantial lower rate than in the recent past given the reduced availability of foreign savings the relevant question is whether the country will be able to generate enough internal savings to compensate for the fall of foreign savings and thus produce the necessary flow of investment to sustain an adequate rate of growth we also examine the burden of the interest rate that mexico is paying on its foreign debt in terms of additional required savings and or lower economic growth

on exchange rates nominal and real abstract the paper first develops an australian commodity currency exchange rate model which is extended to deal with real exchange rates as well the nominal and real exchange rate versions are then tested on swiss data for the post bretton woods period while the model tracks the swiss franc nominal exchange rate vis a vis the dollar and the major european currencies very well swiss ppp real exchange rates are found to be heavily contaminated with measurement error as that error explains the large co movements in nominal and ppp real exchange rates those co movements are largely irrelevant to the ppp debate

accounting for exchange rate variability in present value models when the discount factor is near 1 a well known stylized fact about nominal exchange rates among low inflation advanced countries particularly u s exchange rates is that their logs are approximately random walks michael i mussa 1979 is most frequently cited for observing this regularity in a famous pair of papers richard a meese and kenneth rogoff 1983a b found that the structural models of the 1970 s could not beat a random walk in explaining exchange rate movements recently some authors menzie chinn and meese 1995 nelson mark 1995 mark and donggyu sul 2001 have argued that the models can outforecast the random walk at long horizons but a comprehensive recent study by yin wong cheung et al 2003 documents that no model consistently outperforms a random walk why one obvious explanation is that the macroeconomic variables that determine the exchange rate themselves follow random walks if the log of the nominal exchange rate is a linear function of forcing variables that are random walks then it will inherit the random walk property the problem with this explanation is that the economic fundamentals proposed in the most popular models of exchange rates do not in fact follow simple random walks one resolution to this problem is that there may be some other fundamentals ones that have been proposed in some models but are not easily measurable or ones that have not yet been proposed at all that are important in determining exchange rates if these unobserved fundamentals follow random walks and dominate the variation in exchange rate changes then exchange rates will nearly be random walks even if the standard observed fundamentals are not in engel and west 2003a hereinafter ew we propose an alternative explanation we consider linear models of the exchange rate that are in the asset market approach to exchange rates these models emphasize the role of expectations of future economic fundamentals in determining the current exchange rate the exchange rate expressed as the home currency price of foreign currency in this paper can be written as a discounted sum of the current and expected future fundamentals

local market size social capital and outsourcing evidence from emilia romagna based on a unique dataset concerning small firms operating in the machinery and equipment industry in emilia romagna italy we estimate the separate effects of social capital and local market size on the probability to either fully or partially outsource parts of the production process we are able to distinguish 29 different phases of the production cycle from design to early processing to post production our estimates show that 1 social capital influences the full outsourcing of core assembly and post assembly activities while local market size affects the full outsourcing of early processing activities 2 neither social capital nor local market size have a statistically significant effect on the probability of partially outsourcing any step of the production process robustness tests confirm our results vis a vis the endogeneity of the local market size and social capital and the potential modifiable area unit problem relating to local market size

does the law of one price hold in a high inflation environment a tale of two cities in turkey this study addresses the price convergence in two cities in turkey istanbul and ankara using annual data over the three quarters of the twentieth century 1922 1998 characterized by prevailing high inflation rates for most of the period in contrast to the rest of the literature addressing convergence in price levels with a typical result of extremely slow convergence rates at best we argue that convergence is much easier detected in growth rates rather than levels of prices we suggest using the bounds testing procedure of pesaran et al 2001 for this purpose we find a clear cut evidence on the existence of a common driving force behind inflation dynamics in istanbul and ankara a finding that is in contrast with the results typically reported in related literature

flexible exchange rates prices and the role of news lessons from the 1970s recent experience with flexible exchange rate systems has led to renewed interest in the operation of foreign exchange markets as reflected in many recent studies of the principal determinants of exchange rates the 1970s witnessed the dramatic alteration of the international monetary system from a regime of pegged exchange rates which prevailed for about a quarter of a century since the bretton woods conference into a regime of flexible though managed rates as a consequence of the emergence of the new legal and economic system traders national governments and international organisations were confronted with new economic problems choices and instruments during the 1970s ex change rates fluctuated widely and inflation rates accelerated the international monetary system had to accommodate extraordinarily large oil related shocks which affected trade flows in goods and assets huge oil payments had to be recycled uncertainties concerning future developments in international politics reached new heights and the prospects for the world economy got gloomier these developments placed unprecedented pressures on the markets for foreign exchange as well as on other asset markets they were associated with a large slide in the value of the us dollar and resulted in speeding up the creation of new institutions like the european monetary system which provided the formal framework for the management of exchange rates among members

trade concentration openness and deviations from purchasing power parity abstract economists have often explained deviations from ppp in terms of random relative price changes while all countries are subject to such real shock empirical studies indicate that ppp seems to hold closer for some countries than others this paper emphasizes two major reasons why we should expect systematic differences across countries in deviations from ppp a the concentration of trade and b openness the more diversified trade the less susceptible the country to random shocks affecting individual goods so that shifts in the ppp ratio are lower the more open the economy the greater the weight of traded goods in the overall price indices so that if exchange rates are determined by traded goods prices yet empirical tests of ppp use national price indices ppp should hold better in more open economies

physicians services and the division of labor across local markets this paper reports empirical evidence of systematic cross locale variation in the degree of division of labor among physicians a theoretical model based on an individual producer s trade off between increasing returns and falling marginal revenue within each activity motivates the empirical tests at two levels of aggregation specialization is correlated with local demand shifters for medical services at the individual level i find systematic differences in the range of procedures performed within a specialty class general practitioners working fewer hours practicing in more populated counties or practicing in countries with more elderly produce a narrower range of procedures

the monetary approach to the exchange rate revisited 1984 the monetary approach to the exchange rate revisited applied economics vol 16 no 5 pp 771 782

purchasing power parity and real factors it is acknowledged that purchasing power parity ppp fails in empirical tests the position adopted is that real factors are an omitted variable from the ppp relationship and are the cause of divergences from ppp the real exchange rate as being determined by supply and demand shift factors as in stockman 1987 and neary 1988 is modelled we then empirically estimate a real exchange rate equation and use the fitted value as a generated regressor in tests of ppp it is demonstrated that when changes in the real exchange rate are incorporated into the ppp relationship ppp improves

beyond the purchasing power parity testing for cointegration and causality between exchange rates prices and interest rates abstract this paper reexamines the causality between the dollar and the yen in a multivariate framework with the aid of cointegration and error correcting modeling for the 1951 94 period the phillips perron tests and johansen s tests are performed while causality from interest rates to exchange rates is found in the short run no causality between prices and exchange rates is found in the short run however causality is found running from relative prices to exchange rates along with interest rates between the u s and japan in the long run which supports the long run ppp hypothesis

real interest rates home goods and optimal external borrowing the paper investigates the optimal time path of consumption and external borrowing in the dependent economy model the small country faces given world prices and a given world real interest rate the presence of a home goods sector implies that the relevant real interest rate appropriate to consumption decisions depends on the rate of change of the real price of home goods the paper shows how transitory disturbances in output or in the world real interest rate affect the time profile of consumption and the trade balance in particular it is shown that the presence of a home goods sector dampens the consumption effects of changes in the world interest rate

the dollar pound exchange rate in the 1920s an empirical investigation much of the empirical support for the monetary approach to exchange rate determination has been obtained with data from the 1920s for example clements and frenkel 4 frenkel 8 9 frenkel and clements 11 and huang 18 all obtained favorable empirical evidence estimating different versions of the monetary model the empirical results with data from the 1970s however are mixed bilson 1 2 3 edwards 7 hoffman and schlagenhauf 16 and woo 25 obtained favorable empirical evidence while dornbusch 6 hartley 14 huang 17 meese and rogoff 20 and shafer and loopesko 24 obtained contrary empirical evidence this mixed performance of the monetary exchange rate model in the 1970s has been attributed by dornbusch 6 and frenkel 10 to the failure of purchasing power parity ppp to hold in the short run and by meese and rogoff 21 to the instability of the u s money demand function we re examine the empirical evidence on the dollar pound exchange rate in the 1920s using the simple monetary exchange rate model popularized by bilson 1 2 and frenkel 8 9 thus it is not the purpose of this paper to suggest new empirical monetary exchange rate models nevertheless there are several important reasons why we re examine the simple monetary exchange rate model first several important implications of the monetary exchange rate model in our opinion are not adequately tested in existing work second there is a presumption that the failure of the monetary exchange rate model in the 1970s and the 1980s is due to special events such as real shocks that affected ppp and the instability of the u s money demand function by using the data from the 1920s we hope to avoid the problem of the instability of the u s money demand equation in the 1970s moreover frenkel 10 found that ppp held up reasonably well in this period thus the period of the 1920s provides a favorable setting to test the monetary approach finally we choose the dollar pound exchange rate based on data availability our empirical methodology differs from most previous empirical studies in that we estimate the reduced form equation of the exchange rate within a system of three equations in addition to the reduced form equation of the exchange rate there are also two equations describing monetary equilibrium one for the domestic economy and one for the foreign economy the estimation

the monetary approach to exchange rate in an efficient foreign exchange market tests based on volatility the variance bounds on exchange rate movements implied by the monetary approach to exchange rate in an efficient foreign exchange market is shown to be violated by sample data the paper also presents evidence showing that the forecast errors implied by the monetary model can be forecasted using historical data the results are interpreted to suggest either the incompatibility of the monetary approach with sample data or an inefficient foreign exchange market or both models of exchange rate determination based on the monetary approach to the balance of payments imply when coupled with an interest rate parity relation and the assumption of an efficient foreign exchange market that exchange rates are related to a long average of money stocks differentials 1 2 the long average is analogous to the difference across countries of the long average of expected future money stocks which was supposed to characterize the price level of a single country see e g sargent and wallace 20 since long averages are known to have certain smoothing properties it appears that the observed volatility of exchange rates may be inconsistent with these models thus alternative tests of the models may be produced which rely on those properties the aim of this paper is to determine if the observed volatility is consistent with those properties the paper is the first to use tests based on the volatility of the exchange rate in an efficient market model of the monetary approach the first set of tests is based on the property of implied variance bounds for exchange rate movements and the second set consists of the more familiar efficient market tests of forecastability the empirical results violate these two sets of tests of the model thus casting doubt on the model even though the claim that exchange rates are too volatile has been commonly made few direct attempts have been made in the past to determine the validity of the claim some studies have presented estimates of variances of spot and forward rates but lacking an objective criterion to determine what constitutes

fundamentals uncertainty bubbles and exchange rate dynamics abstract using a monetary model of exchange rate determination we study exchange rate dynamics with bubbles which depend on stochastic market fundamentals these dynamics can be either stochastically stable or unstable and either monotonic or non monotonic including cyclic in an extreme case they converge with probability one and exhibit cyclic movements implications for the analysis of time dependent regime shifts are also explored exchange rates with bubbles are likely to appear less volatile than the fundamentals in finite samples both the variance bounds and cointegration tests might thus be ineffective in testing the absence of bubbles under fundamentals uncertainty

simulated likelihood estimation of diffusions with an application to exchange rate dynamics in incomplete markets abstract we present an econometric method for estimating the parameters of a diffusion model from discretely sampled data the estimator is transparent adaptive and inherits the asymptotic properties of the generally unattainable maximum likelihood estimator we use this method to estimate a new continuous time model of the joint dynamics of interest rates in two countries and the exchange rate between the two currencies the model allows financial markets to be incomplete and specifies the degree of incompleteness as a stochastic process our empirical results offer several new insights into the dynamics of exchange rates

testing the canonical model of exchange rates with unobservable fundamentals in this paper the authors test the asset market approach or canonical model of exchange rates they treat exchange rate fundamentals as unobservable the empirical results do not reject the canonical model and therefore the embedded rational expectations assumption in sharp contrast with previous empirical evidence the authors also find evidence of feedback from the exchange rate to fundamentals which is normally omitted in the theoretical literature copyright 1997 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

the division of labor coordination costs and knowledge this paper considers specialization and the division of labor a more extensive division of labor raises productivity because returns to the time spent on tasks are usually greater to workers who concentrate on a narrower range of skills the traditional discussion of the division of labor emphasizes the limitations to specialization imposed by the extent of the market we claim that the degree of specialization is more often determined by other considerations especially emphasized are various costs of coordinating specialized workers who perform complementary tasks and the amount of general knowledge available