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Viewpoint: Towards a solution to the puzzles in exchange rate economics: where do we stand?
Author(s) -
Sarno Lucio
Publication year - 2005
Publication title -
canadian journal of economics/revue canadienne d'économique
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.773
H-Index - 69
eISSN - 1540-5982
pISSN - 0008-4085
DOI - 10.1111/j.0008-4085.2005.00298.x
Subject(s) - economics , purchasing power parity , interest rate parity , exchange rate , mean reversion , value (mathematics) , relative purchasing power parity , interest rate , monetary economics , econometrics , mathematical economics , financial economics , microeconomics , mathematics , statistics
Abstract. This paper provides a selective overview of puzzles in exchange rate economics. We begin with the forward bias puzzle: high interest rate currencies appreciate when one might guess that investors would demand higher interest rates on currencies expected to fall in value. We then analyse the purchasing power parity puzzle: the real exchange rate displays no (strong) reversion to a stable long‐run equilibrium level. Finally, we cover the exchange rate disconnect puzzle: the lack of a link between the nominal exchange rate and economic fundamentals. For each puzzle, we critically review the literature and speculate on potential solutions. JEL classification: F31