Rational speculators and exchange rate volatility
By: C.L. Osler, John A. Carlson.
Contributors: Carlson, John A., 1933-; Federal Reserve Bank of New York.
Series: Staff reports ;; no. 13; Staff reports (Federal Reserve Bank of New York : Online) ;; no. 13.
Publisher: Federal Reserve Bank of New York
Published: 1996
Place of publication: [New York, N.Y.]
Language: eng
Format: Electronic resource
Number of pages: 32
Subjects: Foreign exchange rates -- Mathematical models.; Investments $z United States.; Equilibrium (Economics)
Description: "This paper examines whether rational, fully informed speculators will smooth exchange rates.  Friedman's (1953) claim that they must do so is challenged, based on the exclusion of interest rate differentials from his interpretation of speculator behavior.  Once one recognizes that interest rates matter to speculators, it becomes apparent that rational speculators could sometimes violate Friedman's description of their behavior, and buy currency when its value is relatively high or sell currency when its value is low.  For this reason the presence of rational, fully informed speculators may increase exchange rate volatility under floating exchange rates.  Whether or not speculators increase exchange rate volatility depends on the extent of speculative activity and the types of economic shocks that dominate.  At low levels of speculative activity, speculation will be stabilizing when the dominant shocks to exchange rates are associated exclusively with real economic activity, such as international trade in goods and services.  It becomes destabilizing when the dominant shocks are changes in interest rates, perceived risk, or transactions costs--factors whose influence on exchange rates derives in part from their direct effect on speculators' positions"--Federal Reserve Bank of New York web site.
Notes: Includes bibliographical references.
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