Difference-equations solution of exchange rate dynamics

Hiroya Akiba

Research output: Contribution to journalArticle

1 Citation (Scopus)

Abstract

The paper focuses on an appropriate and consistent theoretical as well as empirical model of the rational-expectations version of the asset-market approach to exchange rate determination. Using a "sticky-price" monetary model, and formulating the model by a difference-equations system, explicit solutions are obtained as functions of forcing variables extending to past dates only. This "backward-looking" characteristic of the solution is in stark contrast to conventional "forward-looking" models, and alleviates empirical investigation because of the need for past data only. This discrete dynamic model is superior to the corresponding continuous model, because its solutions neither exhibit the empirically unfounded "overshooting" behavior, nor have saddle-point (in)stability. Rather, the exchange rate is shown to follow an oscillatory path with asymptotic stability, and this seems to replicate the actual movements closely approximated by a random-walk process.

Original languageEnglish
Pages (from-to)237-249
Number of pages13
JournalReview of International Economics
Volume10
Issue number2
Publication statusPublished - 2002
Externally publishedYes

ASJC Scopus subject areas

  • Geography, Planning and Development
  • Development

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