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The traditional model of exchange rates, which use macroeconomic variables as its determinants, cannot give a good explanation of short-term fluctuations in the exchange rate. The main reason is there are some implied assumptions in the model, such as public information, the same investors and independent of the trading system. In this paper, in order to understand better and explain the fluctuations reason of short-term exchange rate, the corresponding analysis of short-term fluctuations in exchange rate is made base on microeconomic. The international monetary system entered floating exchange rate era, after the collapse of the Bretton Woods system in 1970s. For the reason that these models use macroeconomic variables as its determinants and there are some implied assumptions, such as public information, the same investors and independent of the trading system, are impractical, the traditional exchange rate determination theory (purchasing power parity, interest rate parity, etc.) and the exchange rate model cannot give a reasonable explanation about the volatility of the exchange rate. So using microeconomic analysis, weaken the assumptions and make corresponding analysis the influence and the reason about foreign exchange markets on exchange rate changes under non-rational expectations or incomplete information are considerable practical significance. To do microeconomic analysis, we need three assumptions which is the premise of exchange rate fluctuation. 1) Existence of private information. 2) Heterogeneity of the participants in foreign exchange markets. 3) The importance of trading mechanism. We will analyze the causes of exchange rate fluctuations from the three aspects. Private Information and Exchange Rate Fluctuations In the traditional exchange rates decision, the macroeconomic model is built based on the information publicity. That means all traders in the foreign exchange markets can share the same information. But according to the market microstructure theory, the main influencing factors of exchange rate fluctuations are the effects on trades and prices caused by the incomplete information. So the basis is private information, it is considered as the key to the formation of prices. The private information has the following two distinctive features: 1) It cannot be shared by all traders. 2) It is better to predict future price movements than the public information. The most typical example of the existence of private information in foreign exchange markets is the intervention of Central Bank., Using the temporary information, which else traders cannot get, to get more benefit through certain foreign exchange dealers, the Central Bank can intervention in the foreign exchange markets. There are two main types of private information. One is private information for final profit. If this type of information makes the expectation of final profits to be changed, asset prices in the financial market would fluctuate. The other private information is for the price. Sometimes the final profit of asset investment is fixed, but usually asset prices cannot be determined. Such as the international investment of financial assets should be the interest rate differential between the two countries. The price of foreign exchange can be influenced directly by the preference of investors, status of portfolio, capital management and Investors' expectations. Now let us look at “inventory effect” and “portfolio effect”. Market makers just want to accept a few orders. But in order to improve the liquidity of orders in the market, they have to accept a lot of 2nd International Conference on Science and Social Research (ICSSR 2013) © 2013. The authors Published by Atlantis Press 675 orders by low price. This make them to take exchange rate risk which bring by the asymmetric market supply, for there are lots of short orders come out in the market. The storks are hold by the merchants, but the difference price of buyers and sellers is widening, which cannot be removed until the balance of market supply and demand is regained. This is called inventory effect of market makers. In another case, the expected of exchange rate on market has changed which lead the investors alter the portfolio and adjust the trading orders. In this case the difference price of buyers and sellers cannot be recovered immediately. We call this reason by which the price changes caused is “portfolio effect”. In a word, the price volatility of the foreign exchange markets most probably caused by the effect of private information. The different reason to form the private information always cause the different duration of the impact on the price. So the degree and frequency of price fluctuations are always different. Heterogeneity of Traders and Fluctuations of Exchange Rate Large numbers of research have shown that to demonstrate the efficient market hypothesis (risk-neutral and the assumption of rational expectations) by the exchange rate is not right. Some economists believe, heterogeneity expectation make the efficient market hypothesis cannot be established, which is the main reason the traditional exchange rate theory cannot explain why the real exchange rate fluctuates. 2.1. Trading motives of participants are different There are two kinds of investors in foreign exchange markets. One is speculators for asset appreciation; the other is risk aversion hedgers. For the objective functions of speculators and hedgers are different, the exchange rate fluctuations will comes out if the interaction of them are inconsistent with the model description. Stoll (2012) pointed out in his literature review on market structure that speculators typically use active investment strategy. They usually use the traditional methods of market introductions, that is money concentrated in one or a few assets which considered as a good income. But hedgers typically use negative investment strategy. They usually use the limited price traditional way. That is money dispersed in multiple income-irrelevant assets. So speculators need to be instantaneous for they hope the price is suitable for their trading. And to keep the instantaneous of providers is better for the price stability. The cause of such difference between speculators and hedgers is due to the ways they deal with the information and the formed expectations based on this. 2.2. The ways by which participants to analysis of the information are different Based on the expected heterogeneity of market participants some economists use the noise trader model to instead of the efficient market hypothesis. There are two kinds of traders in the noise trader model. They are smart investors and noise traders. Smart investors are the rational maximized investors, whose transactions based on economic fundamentals, which can prevent the exchange rate to deviate from economic fundamentals and promote the exchange rate back to the level of determined by economic fundamentals. But noise traders are irrational, whose transactions based on the noise information, which is nothing to do with the economic fundamentals. Their behavior would lead to the exchange rate deviate from economic fundamentals. The existence of irrational traders in market transactions leads to two cases in the market. One is every traders may consider the useless information as the information associated with the value. This case is existed in any market. The other case is some false information is made by some traders, which may lead other traders make wrong decisions. But in this case the noise trading can be avoided. With the floating exchange rates, the presence of noise traders may cause the multiple equilibriums of the foreign exchange markets. The greater the exchange rate fluctuations, the more noise traders would join in the market. And the more participators of noise traders would lead to the greater exchange

Short-Term Fluctuations Reason Analysis of Exchange Rate Based on Microeconomic