SHORT-TERM SPECULATORS AND THE PUZZLING BEHAVIOR OF EXCHANGE-RATES

This paper shows that rational short-term speculative activity transfo rms exchange rates' response to shocks. Transitory shocks will have a permanent impact on exchange rates when such speculators are active, a nd the impact of shocks will be smoothed. The model may help explain t he observed extended response of exchange rates to sterilized interven tion. Further, the model suggests that exchange rate fundamentals may be properly identified even when those variables fail to forecast bett er than a random walk. Finally, the model could help explain why excha nge rates closely resemble a random walk while most fundamentals do no t follow such a process. (C) 1998 Elsevier Science B.V.