"Unnecessary variation" is defined as variation not attributable to variation in fundamentals. In the absence of a good model of macroeconomic fundamentals, the question "are exchange rates excessively variable?" cannot be answered by comparing the variance of the actual exchange rate to the variance of a set of fundamentals. This paper notes the failure of regression equations to explain exchange rate movements even using contemporaneous macroeconomic variables. It notes as well the statistical rejections of the unbiasedness of the forward exchange rate as a predictor of the spot rate. It then argues that, given these results, there is not much to be learned from the variance-bounds tests and bubbles tests. The paper also discusses recent results on variation in the exchange risk premiums arising from variation in conditional variances, both as a source of the bias in the forward rate tests and as a source of variation in the spot rate. It finishes with a discussion of whether speculators' expectations are stabilizing or destabilizing, as measured by survey data. The paper concludes that it is possible that exchange rates have been excessively variable -- as, for example, when there are speculative bubbles -- but that if policy-makers try systematically to exploit their credibility in order to stabilize exchange rates, they may see their current credibility vanish.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
2249.
Length: Date of creation: Mar 1988 Date of revision: Publication status: published as Jeffrey A. Frankel, Richard Meese. "Are Exchange Rates Excessively Variable?," in Stanley Fischer, editor, "NBER Macroeconomics Annual 1987, Volume 2" The MIT Press (1987) Handle: RePEc:nbr:nberwo:2249
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Jeffrey A. Frankel & Richard Meese, 1987.
"Are Exchange Rates Excessively Variable?,"
NBER Chapters,
in: NBER Macroeconomics Annual 1987, Volume 2, pages 117-162
National Bureau of Economic Research, Inc.
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Maurice Obstfeld & Kenneth Rogoff, 1998.
"Risk and Exchange Rates,"
NBER Working Papers
6694, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
Other versions:
Obstfeld, M., 1998.
"Risk and Exchange Rate,"
Papers
193, Princeton, Woodrow Wilson School - Public and International Affairs.