Explanations of Exchange Rate Volatility and Other Empirical Regularities in Some Popular Models of the Foreign Exchange Market

Abstract

This paper is intended to accomplish two tasks.First, exchange-rate models of the sticky-price and flexible-price varieties respectively are checked for their consistency with two key empirical regularities: (1) the observed pattern of price-level vs. exchange-rate volatility, and (2) the observed pattern of spot exchange-rate vs. forward exchange-rate volatility.Second, a widely neglected reason for exchange-rate volatility, activist monetary policy is studied.It is found that both sticky-price and flexible price models explain the empirical regularities rather well.Further, if prices are sticky it is found that exchange-rate overshooting may be empirically non-trivial.

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