L8_SRD1 - Spot Exchange Rate Determination The spot rate is...

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1 1 Spot Exchange Rate Determination • The spot rate is just the relative price of two currencies: S t • What is behavior of spot rates in the data? • What determines the movements of spot rates? 2
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2 3 4 Spot exchange rate $/€
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3 5 6 Summary of Behaviors of Spot Rates • Very volatile • Much more volatile than real fundamentals • Large swings of up-and-downs • More volatile in flexible exchange rate system than in fixed exchange rate system • The cost of volatile spot rates: greater uncertainty Stresses the importance of the study on the spot rates determination.
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4 7 Overview of Spot Rate Determination • News and Foreign Exchange Rates: An Introduction • Exchange Rates and News Stories: Three Illustrations • News and Foreign Exchange Rates: A Summary • Flow vs. Stock Models of the Exchange Rate • An Overview of the Flow Approach • An Overview of the Stock Approach • Combining Flow and Stock Concepts of the Exchange Rate 8 Overview 2 • Asset Models of the Spot Exchange Rate The Monetary Approach The Portfolio-Balance Approach • Empirical Evidence on Exchange Rate Models In-Sample Results Post-Sample Results The Role of News
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5 9 News and Foreign Exchange Rates: An Introduction • Financial markets are preoccupied with news. • However, we usually cannot find a simple unambiguous link between a news announcement and an exchange rate reaction. • The market is forward-looking , and permanent changes versus transitory phenomena are viewed differently. • While two news announcements may seem similar, their underlying aspects may be in fact different. 10 Exchange Rates and News Stories: Story 1 • At time t 1 , it is announced that the U.S. money supply grew by $3 billion in the most recent week. (The consensus market forecast was $2 billion.) Case a: The US$ weakens: Case b: The US$ strengthens: Case c: The US$ weakens and then steadily depreciates:
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6 11 Exchange Rates and News Stories: Story 1 • At time t 1 , it is announced that the U.S. money supply grew by $3 billion in the most recent week. (The consensus market forecast was $2 billion.) Case a: The US$ weakens: Higher money supply will be maintained. Case b: The US$ strengthens: Case c: The US$ weakens and then steadily depreciates: 12 Story 1: An Increase in the U.S. Money Supply U.S. money supply Time t 1 t 2 $ interest rate U.S. price level Nominal exchange rate ($/ FC ) a a a a
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7 13 Exchange Rates and News Stories: Story 1 • At time t 1 , it is announced that the U.S. money supply grew by $3 billion in the most recent week. (The consensus market forecast was $2 billion.) Case a: The US$ weakens: Higher money supply will be maintained. Case b:
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L8_SRD1 - Spot Exchange Rate Determination The spot rate is...

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