Exchange Rate Dynamics in Stochastic Monetary Models

9321506 Bekaert Despite the importance of exchange rate movements in an increasingly integrated world economy, we have not developed good economic models that guide our understanding of the behavior of exchange rates over time. This has lead to a widespread belief that currency markets are inefficient. This research develops several exchange rate models in an attempt to explain various empirical regularties of exchange rates without having to resort to market inefficiency arguments. The models assume that markets are efficient and the market participants are rational but risk averse.The empirical part of the study examines how well the models fit actual exchange rate data. The first model concentrates on high variability of exchange rates and how this variability changes over time. The second model focusses on the predictability of international asset returns. In an extension to this model, the effect of the credibility of monetary policy on asset markets is examined. The third model examines why, for example, is the dollar amount to buy a comparable basket of consumption goods in the United States versus Japan so different? Here, the study explores whether non-traded goods, such as houses, and the existence of a sizable government sector are the main source of the puzzling behavior of exchange rates and consumption prices across countries. ***