Chapter 19 Empirical studies of exchange rates: Price behavior, rate determination and market efficiency

This chapter provides an overview of empirical results concerning recent exchange rate behavior. Alternative valuation measures, time series, and distributional properties have been covered in the chapter, along with estimates of transaction costs in the foreign exchange market. The chapter reviews empirical tests of specific models of exchange rate determination. It tests a particular model of exchange rate determination to forecast exchange rates or to examine the effect of other economic policies on exchange rates and vice versa. The chapter discusses the simple monetary approach, where exchange rates are determined by the relative demand for two moneys, and then proceeds to a portfolio balance approach that introduces bonds. It presents tests of foreign exchange market efficiency. Finally, the chapter provides an overview of efficient market theory, a review of evidence on the efficiency of markets in removing risk-free opportunities, and the evidence of the efficiency of markets in removing risky profit opportunities. It includes the evidence on the relationship between the forward rate and future spot rate.