Über die Autorin bzw. den Autor

Martin D. D. Evans is professor of economics in the Department of Economics and professor of finance in the McDonough School of Business at Georgetown University.

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"This ambitious and impressive book covers the international macroeconomics and finance literature on nominal exchange-rate determination. It will be a useful reference for those who want to understand standard theoretical models and empirical techniques, and for those who want to specialize in the microstructure of the foreign exchange markets."--Pierre-Olivier Gourinchas, University of California, Berkeley

"There is no other book of this kind. Sound and interesting, it provides a rigorous treatment of exchange-rate economics. The new concepts and interpretation of exchange-rate behavior will spur more research in this area. The book will interest a broad community in international finance, practitioners in the foreign exchange market, and policymakers."--Lucio Sarno, Cass Business School, City University London

Aus dem Klappentext

"This ambitious and impressive book covers the international macroeconomics and finance literature on nominal exchange-rate determination. It will be a useful reference for those who want to understand standard theoretical models and empirical techniques, and for those who want to specialize in the microstructure of the foreign exchange markets."--Pierre-Olivier Gourinchas, University of California, Berkeley

"There is no other book of this kind. Sound and interesting, it provides a rigorous treatment of exchange-rate economics. The new concepts and interpretation of exchange-rate behavior will spur more research in this area. The book will interest a broad community in international finance, practitioners in the foreign exchange market, and policymakers."--Lucio Sarno, Cass Business School, City University London

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EXCHANGE-RATE DYNAMICS

PRINCETON UNIVERSITY PRESS

Contents

Preface.............................................................................ixChapter 1 Macro Models without Frictions............................................3Chapter 2 Macro Models with Frictions...............................................63Chapter 3 Empirical Macro Models....................................................130Chapter 4 Rational Expectations Models..............................................183Chapter 5 Sequential Trade Models...................................................227Chapter 6 Currency-Trading Models...................................................261Chapter 7 Currency-Trading Models: Empirical Evidence...............................302Chapter 8 Identifying Order Flow....................................................342Chapter 9 Order Flows and the Macroeconomy..........................................377Chapter 10 Exchange Rates, Order Flows, and Macro Data Releases.....................422Chapter 11 Exchange-Rate Risk.......................................................464References..........................................................................523Index...............................................................................535

Chapter One

This is the first of two chapters that examine the exchange-rate implications of macroeconomic models. My aim is not to survey all the macro models of exchange-rate determination, but rather to provide a theoretical overview of how exchange rates are linked to macro variables in environments that are familiar to students of macroeconomics. This overview serves two purposes. First, it highlights the degree to which the exchange-rate implications of widely used macro models accord with the empirical characteristics of exchange-rate behavior. Second, it establishes a theoretical benchmark for judging the success of the new micro-based exchange-rate models presented in subsequent chapters.

The macro models we study have standard features. There are two countries, each populated by a large number of identical utility-maximizing households. In this chapter we study models where households have access to a rich array of financial assets. More specifically, we assume that they all have access to markets for a complete set of contingent claims. As a result, households are able to share risk completely. This feature has important implications for the behavior of exchange rates in both endowment economies (where output is exogenous) and in production economies (where output is determined optimally by firms). Another standard feature of the models we study concerns the role of money. Here we assume that households derive utility from holding real balances and that central banks have complete control of their national money supplies. This framework has a long tradition in the international macro literature. When combined with the implications of complete risk-sharing, it allows us to characterize the differences between the behavior of real and nominal exchange rates in a straightforward manner.

The final noteworthy feature of the models presented herein concerns the behavior of prices. Although "price-stickiness" plays an important role in many international macro models, in this chapter we focus on models in which all prices are fully flexible. In so doing, our analysis abstracts from the complications caused by the presence of frictions in both financial and product markets. The exchange-rate implications of these frictions are examined in Chapter 2.

1.1 Preliminaries

1.1.1 Definitions

The focus of our analysis is on the behavior of the nominal spot exchange rate, which we refer to as the spot rate. The spot rate, denoted by S, is defined as the home price of foreign currency. Throughout, we take the United States as the home country, so S identifies the price of foreign currency in U.S. dollars. According to this definition, an appreciation in the value of the dollar is represented by a fall in S because it corresponds to a fall in the dollar price of foreign currency. Conversely, a rise in S represents a depreciation in the value of the dollar. Defining spot rates in this way can be a source of confusion at first, but it turns out to be very convenient when considering the determination of spot rates from an asset-pricing perspective. For this reason it is the standard definition used in the international finance literature.

The spot exchange rate identifies the price at which currencies can be traded immediately. Forward rates, by contrast, identify the price at which currencies can be traded at some future date. The k-period forward rate at time t, F^k_t, denotes the dollar price of foreign currency in a contract between two agents at time t for the exchange of dollars and foreign currency at time t + k. Foreign currency is said to be selling forward at a discount (premium) relative to the current spot rate when S_t - F^k_t is positive (negative). Obviously, spot and forward rates are equal when the maturity of the forward contract, k, equals zero.

Two relative prices play prominent roles in international macro models. The first is the terms of trade. In international finance the convention is to define the terms of trade, T, as the relative price of imports in terms of exports:

T = P^M/SP^x,

where P^M is the price U.S. consumers pay for imports and P^X is the price foreign consumers pay for U.S. exports. (Hereafter, we use a hat, i.e., "^", to denote foreign variables.) Since S is defined as the price of foreign currency in dollars, SP^x identifies the dollar price foreign consumers pay for U.S. exports. Note that a rise (fall) in the relative price of U.S. exports, representing an improvement (deterioration) in the U.S. terms of trade, implies a fall (rise) in T. Once again, this may seem unnecessarily confusing, but the international finance literature adopts this definition to simplify the relationship between the real exchange rate and the terms of trade.

The second important relative price is the real exchange rate. This is defined as the relative price of the basket of all the goods consumed by foreign households in terms of the price of the basket of all the goods consumed by U.S. households:

ε = SP/P,

where P is the foreign currency price of the foreign basket and P is the dollar price of the U.S. basket. Hence, P and P are the U.S. and foreign consumer price indices in local currency terms, and SP identifies the foreign price index in terms of dollars. According to this definition, a depreciation (appreciation) in the real value of the U.S. dollar corresponds to a rise (fall) in ε and represents an increase (decrease) in the price of foreign goods relative to U.S. goods.

1.1.2 Price Indices

The behavior of the real exchange rate plays a central role in macro models, so it is important to relate the behavior of the price indices, P and P, to the prices of individual goods. For this purpose, macro models identify price indices relative to a particular form for the consumption basket based on either the Constant Elasticity of Substitution (CES) or Cobb-Douglas functions.

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