Micro Approaches to Foreign Exchange Determination

Abstract

Micro-based exchange-rate research examines the determination and behavior of spot exchange rates in an environment that replicates the key features of trading in the foreign exchange (FX) market. This chapter provides an overview of micro-based research on exchange-rate determination. Recent micro-based research focuses on the link between currency trading and macroeconomic conditions in the general equilibrium setting of modern macro economic models. The chapter overviews the key differences between the traditional macro view of exchange-rate determination and the micro-based approach. Laying out the key features of the FX market and describing how they are incorporated into a canonical partial equilibrium model of currency trading, the chapter discusses the empirical implications of the model and the relevant micro-based empirical literature. Finally, research that links spot-rate dynamics to macro economic conditions via currency trading is examined before some thoughts on the directions of future micro-based exchange-rate research are presented. Controlled Vocabulary Terms currency trading; exchange rate determination studies; exchange-rate modeling; foreign exchange markets; macroeconomic approaches

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