Model uncertainty and exchange rate volatility
International Economic Review , Volume 53 - Issue 3 p. 815- 844
This article proposes an explanation for shifts in the volatility of exchange-rate returns. Agents are uncertain about the true data generating model and deal with this uncertainty by making inference on the models and their parameters' approach, I call model learning. Model learning may lead agents to focus excessively on a subset of fundamental variables. Consequently, exchange-rate volatility is determined by the dynamics of these fundamentals and changes as agents alter models. I investigate the empirical relevance of model learning and find that the change in volatility of GBP/USD in 1993 was triggered by a shift between models.
|ERIM Article Series (EAS)|
|International Economic Review|
|Organisation||Erasmus Research Institute of Management|
Markiewicz, A. (2012). Model uncertainty and exchange rate volatility. International Economic Review, 53(3), 815–844. doi:10.1111/j.1468-2354.2012.00702.x