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Discussion Paper Details

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Title: Exchange Rate Dynamics, Learning and Misperception

Author(s): Pierre-Olivier Gourinchas and Aaron Tornell

Publication Date: January 2003

Keyword(s): delayed overshooting, forward premium puzzle, monetary policy and predictable returns

Programme Area(s): International Macroeconomics

Abstract: We propose a new explanation for the forward-premium and the delayed-overshooting puzzles. Both puzzles arise from a systematic under-reaction of short-term interest rate forecasts to current innovations. Accordingly, the forward premium is always a biased predictor of future depreciation; the bias can be so severe as to lead to negative coefficients in the ?Fama? regression; delayed overshooting may or may not occur depending upon the persistence of interest rate innovations and the degree of under-reaction; lastly, for G-7 countries against the US, these puzzles can be rationalized for values of the model's parameters that match empirical estimates.

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Bibliographic Reference

Gourinchas, P and Tornell, A. 2003. 'Exchange Rate Dynamics, Learning and Misperception'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=3725