Exchange Rates & International Finance

Cover......Page 1
Contents......Page 6
List of exhibits......Page 12
Preface and acknowledgements......Page 13
 Introduction......Page 16
 1.1 What is an exchange rate?......Page 18
 1.2 The market for foreign currency......Page 24
 1.3 The balance of payments......Page 34
 1.5 Exchange rates since World War II: a brief history......Page 39
 1.6 Overview of the book......Page 50
 Summary......Page 52
 Notes......Page 53
PART 1 The international setting......Page 58
  Introduction......Page 60
  2.1 The law of one price in the domestic economy......Page 61
  2.2 The law of one price in the open economy......Page 68
  2.3 A digression on price indices......Page 72
  2.4 Purchasing power parity......Page 75
  2.5 Purchasing power parity – the facts at a glance......Page 80
  2.6 Purchasing power parity extensions......Page 86
  2.7 Empirical research......Page 91
  2.8 Conclusions......Page 92
  Summary......Page 94
  Reading guide......Page 95
  Notes......Page 96
  Introduction......Page 99
  3.1 Uncovered interest rate parity......Page 100
  3.2 Covered interest rate parity......Page 107
  3.3 Borrowing and lending......Page 109
  3.4 Covered interest rate parity – the facts......Page 112
  3.5 Efficient markets – a first encounter......Page 114
  3.6 The carry trade paradox......Page 116
  3.7 Purchasing power parity revisited......Page 121
  Summary......Page 126
  Notes......Page 127
  Introduction......Page 130
  4.1 IS–LM model of aggregate demand......Page 131
  4.2 Aggregate supply......Page 151
  Summary......Page 157
  Notes......Page 159
PART 2 Exchange rate determination......Page 162
  Introduction......Page 164
  5.1 The simple monetary model of a floating exchange rate......Page 165
  5.2 The simple monetary model of a fixed exchange rate......Page 172
  5.3 Interest rates in the monetary model......Page 184
  5.4 The monetary model as an explanation of the facts......Page 186
  Summary......Page 190
  Notes......Page 191
  Introduction......Page 193
  6.1 Setting......Page 194
  6.3 Monetary expansion with a floating exchange rate......Page 197
  6.4 Fiscal expansion with a floating exchange rate......Page 199
  6.5 Monetary expansion with a fixed exchange rate......Page 201
  6.6 Fiscal expansion with a fixed exchange rate......Page 202
  6.7 The monetary model and the Mundell–Fleming model compared......Page 204
  6.8 Evidence......Page 207
  Summary......Page 208
  Notes......Page 209
  Introduction......Page 211
  7.1 Outline of the model......Page 212
  7.2 Monetary expansion......Page 217
  7.3 A formal explanation......Page 220
  7.4 Case study: oil and the UK economy......Page 225
  7.5 Empirical tests: the Frankel model......Page 230
  Summary......Page 232
  Notes......Page 233
  Introduction......Page 235
  8.1 Specification of asset markets......Page 236
  8.2 Short-run equilibrium......Page 239
  8.3 Long-run and current account equilibrium......Page 245
  8.4 Evidence on portfolio balance models......Page 246
  Summary......Page 251
  Notes......Page 252
  Introduction......Page 254
  9.1 The model......Page 255
  9.2 Evidence on currency substitution......Page 261
  9.3 Conclusions......Page 262
  Reading guide......Page 263
  Notes......Page 264
  Introduction......Page 266
  10.1 The Redux model......Page 268
  10.2 Extensions of Redux......Page 285
  10.3 Evidence......Page 287
  10.4 Conclusions......Page 288
  Summary......Page 289
  Reading guide......Page 290
  Notes......Page 291
  Appendix 10.1 Derivation of price index (Equation 10.2)......Page 293
  Appendix 10.2 Derivation of household demand (Equations 10.6 and 10.6′)......Page 294
  Appendix 10.3 Log linearisation of model solution (Equations L1–L4)......Page 295
  Appendix 10.4 Sticky prices......Page 297
PART 3 A world of uncertainty......Page 298
  Introduction......Page 300
  11.1 Mathematical expected value......Page 301
  11.2 Rational expectations......Page 304
  11.3 Market efficiency......Page 307
  11.5 The random walk model......Page 309
  11.6 Testing for efficiency: some basic problems......Page 312
  11.7 Spot and forward rates: background facts......Page 313
  11.8 Results......Page 315
  11.9 Conclusions......Page 318
  Reading guide......Page 319
  Notes......Page 320
  Introduction......Page 323
  12.1 The ‘news’ model: a simple example......Page 324
  12.2 The monetary model revisited......Page 326
  12.3 Testing the ‘news’......Page 332
  12.4 Results......Page 335
  12.5 Volatility tests, bubbles and the peso problem......Page 338
  Summary......Page 343
  Reading guide......Page 344
  Notes......Page 345
  Introduction......Page 348
  13.1 Assumptions......Page 349
  13.2 A simple model of the risk premium: mean–variance analysis......Page 350
  13.3 A more general model of the risk premium......Page 353
  13.4 The evidence on the risk premium......Page 361
  13.5 Conclusions......Page 363
  Summary......Page 364
  Notes......Page 365
  Appendix 13.1 Derivation of Equation 13.16......Page 368
PART 4 Fixed exchange rates......Page 370
  Introduction......Page 372
  14.1 What is a target zone?......Page 374
  14.2 Effect of target zones......Page 375
  14.3 Smooth pasting......Page 379
  14.4 An option interpretation......Page 381
  14.5 A honeymoon for policymakers?......Page 388
  14.6 Beauty and the beast: the target zone model meets the facts......Page 390
  14.7 Intramarginal interventions: leaning against the wind......Page 391
  14.8 Credibility and realignment prospects......Page 395
  14.9 Conclusions......Page 396
  Summary......Page 397
  Notes......Page 398
  Appendix 14.1 Formal derivation of the model......Page 400
  Introduction......Page 402
  15.1 First-generation model......Page 403
  15.2 Second-generation crisis models......Page 410
  15.3 Third-generation models......Page 419
  15.4 The 2008 crisis......Page 425
  15.5 Conclusions......Page 428
  Summary......Page 429
  Reading guide......Page 430
  Notes......Page 431
  Introduction......Page 434
  16.1 Benefits of monetary union......Page 438
  16.2 Costs of monetary union......Page 442
  16.3 Other considerations......Page 446
  16.4 Currency boards......Page 454
  16.5 The eurozone......Page 456
  Summary......Page 466
  Notes......Page 468
PART 5 Alternative paradigms......Page 474
  Introduction......Page 476
  17.1 The market maker model......Page 477
  17.2 Introduction to expectations with heterogeneous information......Page 486
  17.3 Conclusions......Page 503
  Summary......Page 504
  Notes......Page 505
  A. Derivation of the first-order condition for money (Equation 17.36)......Page 507
  C. Proof of the solution for the exchange rate (Equation 17.43)......Page 508
  D. Proof that Equation 17.50 is the solution for Equation 17.49......Page 509
  Introduction......Page 510
  18.1 The structure of the foreign currency market......Page 511
  18.2 Defining order flow......Page 515
  18.3 Fear of arbitrage, common knowledge and the hot potato......Page 517
  18.4 The pricing process......Page 518
  18.5 Empirical studies of order flow......Page 519
  18.6 Conclusions......Page 522
  Notes......Page 523
  Introduction......Page 525
  19.1 Deterministic versus stochastic models......Page 526
  19.2 A simple nonlinear model......Page 527
  19.3 Time path of the exchange rate......Page 528
  19.4 Chaos......Page 543
  19.5 Evidence......Page 547
  19.6 Conclusions......Page 552
  Summary......Page 553
  Notes......Page 554
PART 6 Conclusions......Page 558
  20.1 Summary of the book......Page 560
  20.2 The research agenda......Page 562
  Notes......Page 563
Appendix: list of symbols......Page 564
Bibliography......Page 566
Index......Page 578