We survey the empirical literature on floating nominal exchange rates over the past decade. Exchange rates are difficult to forecast at short- to medium-term horizons. There is a bit of explanatory power to monetary models such as the Dornbusch "overshooting " theory, in the form of reaction to "news " and in forecasts at long-mn horizons. Nevertheless, at short horizons, a driftless random walk characterizes exchange rates better than standard models based on observable macroeconomic fundamentals. Unexplained large shocks to floating rates must then, logically, be due either to innovations in unobservable fundamentals, or to non-fundamental factors such as speculative bubbles. The observed difference in exchange rate and macroeconomic volatility under different nominal exchange rate regimes makes us skeptical of the first view. The theory and evidence on speculative bubbles, however, is not conclusive. We conclude with the hope that promising new studies of the microstructure of the foreign exchange

Central banks have several reasons for extracting information from asset prices. Asset prices may embody more accurate and more up-to-date macroeconomic data than what is currently published or directly available to policy makers. Aberrations in some asset prices may indicate

In a duopoly model of informed speculation, we show that overconfidence may strictly dominate rationality since an overconfident trader may not only generate higher expected profit and utility than his rational opponent, but also higher than if he were also rational. This occurs because overconfidence acts like a commitment device in a standard Cournot duopoly. As a result, for some parameter values the Nash equilibrium of a two-fund game is a Prisoner's Dilemma in which both funds hire overconfident managers. Thus, overconfidence can persist and survive in the long run. 2 The rational expectations hypothesis implies that economic agents make decisions as though they know a correct probability distribution of the underlying uncertainty. According to the traditional view (Alchian (1950) and Friedman (1953)), the rational expectations hypothesis is empirically plausible because rational beliefs are better able to survive the market test than irrational beliefs. Yet, the empirical liter...

We wish to thank Julia Marsh and Julia Lowell for research assistance, and Dr. Franz Scholl of the Bundesbank for making the daily intervention data available. This paper is part of NBER's research program in International Studies. Any opinions expressed are those of the authors and not those of the National

this paper was published in National Saving and Economic Performance, D. Bernheim and J. Shoven, eds., University of Chicago Press: Chicago, for the National Bureau of Economic Research, 1991. (A more complete version appeared as NBER Working Paper No. 2856.) A somewhat revised version is to be reprinted in Current Issues in International Trade and International Finance, edited by Dilip Das, Oxford University Press, Oxford, UK. The present version was further revised and is to appear as a chapter in On Exchange Rates, a collection of the author's writings, forthcoming from M.I.T. Press

We examine the ability of the standard intertemporal asset pricing model and a model of noise trading to explain why the forward premium predicts the future depreciation with the `wrong ' sign. We ¯nd that the intertemporal asset pricing model is unable to predict risk premia with the correct sign to be consistent with the data. The noise-trader model, while highly stylized, receives fragmentary support from empirical research on survey expectations.

In December 1983, Australia abandoned its management of the exchange rate, ushering in a period of floating rates which has continued until the present. This decision to float the Australian dollar ($A) lagged behind that of the major countries, which ceased their commitment to fixed parities in March 1973. Over

We analyze the performance and robustness of some common simple rules for monetary policy in a new-Keynesian open economy model under different assumptions about the determination of the exchange rate. Adding the exchange rate to an optimized Taylor rule gives only slight improvements in terms of the volatility of important variables in the economy. Furthermore, although the rules including the exchange rate (and in particular,the real exchange rate) perform slightly better than the Taylor rule on average,they sometimes lead to very poor outcomes. Thus,the Taylor rule seems more robust to model uncertainty in the open economy.

We propose a new explanation for the foreign exchange forward-premium and delayedovershooting puzzles. We show that both puzzles arise from a systematic distortion in investors’ beliefs about the interest rate process. Accordingly, the forward premium is always a biased predictor of future depreciation; the bias can be so severe as to lead to negative coefficients in the ‘Fama’ regression. Delayed overshooting may or may not occur depending upon the persistence of interest rate innovations and the degree of misperception. We document empirically the extent of this distortion using survey data for G-7 countries against the U.S. and find that it is strong enough to account for these irregularities.

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