A consensus is emerging that returns to the currency carry trade are driven by two factors. One of these is clearly consumption risk but there is disagreement about the identity of the remaining factor. This paper bolsters the case for volatility being the unknown factor. A structural model that...

We propose an exchange rate model which is a hybrid of the conventional specification with monetary fundamentals and the Evans-Lyons microstructure approach. We estimate a model augmented with order flow variables, using a unique data set: almost 100 monthly observations on inter-dealer order...

This paper addresses the puzzle of regime-dependent volatility in foreign exchange. We extend the literature in two ways. First, our microstructural model provides a qualitatively new explanation for the puzzle. Second, we test implications of our model using Europe's recent shift to rigidly...