TY  - JOUR
AU  - Evans,Martin D.D.
AU  - Lyons,Richard K.
TI  - A New Micro Model of Exchange Rate Dynamics
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 10379
PY  - 2004
Y2  - March 2004
UR  - http://www.nber.org/papers/w10379
L1  - http://www.nber.org/papers/w10379.pdf
N1  - Author contact info:
Martin Evans
Department of Economics
Georgetown University
Washington, DC  20057
Tel: 202-687-1570
E-Mail: evansm1@georgetown.edu

Richard K. Lyons
460 Michigan Ave
Berkeley, CA 94707
Tel: 510-642-1059
Fax: 510-642-4700
E-Mail: lyons@haas.berkeley.edu
AB  - We address the exchange rate determination puzzle by examining how information is aggregated in a dynamic general equilibrium (DGE) setting. Unlike other DGE macro models, which enrich either preference structures or production structures, our model enriches the information structure. The model departs from microstructure-style modeling by identifying the real activities where dispersed information originates, as well as the technology by which information is subsequently aggregated and impounded. Results relevant to the determination puzzle include: (1) persistent gaps between exchange rates and macro fundamentals, (2) excess volatility relative to macro fundamentals, (3) exchange rate movements without macro news, (4) little or no exchange rate movement when macro news occurs, and (5) a structural-economic rationale for why transaction flows perform well in accounting for monthly exchange rate changes, whereas macro variables perform poorly. Though past micro analysis has made progress on results (1) through (3), results (4) and (5) are new. Excess volatility arises in our model for a new reason: rational exchange rate errors feed back into the fundamentals that the exchange rate is trying to track.
ER  -