Handbook of Exchange Rates is an impressive compilation of research from more than thirty-five leading researchers and experts on the topic. The book is clearly organized into five succinct sections that explore the foreign exchange (FX) market, from its background and economic foundation to current practices, obstacles, and policies in the modern foreign exchange market. Part I presents an overview of the history of the FX market and exchange rate regimes, the key instruments/players in the FX trading environment, and both macro and micro approaches to FX determination. Next, Part II focuses on forecasting exchange rates, featuring methodological contributions on the sstatistical methods for evaluating forecast performance, parity relationships, fair value models, and flow-based models. Part III treats FX as an asset class, outlining active currency management, currency hedging, hedge accounting, high frequency and algorithmic trading in FX, and FX strategy-based products. Part IV discusses products and pricing in FX, the FX options market, and volatility derivatives. Finally, the book concludes with a section on FX markets and policy, prediction and management of FX crises, FX regimes and policy; regulation in FX market that also features discussion of the effects of exchange rate regime choice on international trade. Each chapter follows the same easy-to-follow format. Following an introduction, a description of theory is presented along with key formulae. Next, the discussed theory is applied to a real data set and accompanied with illustrative descriptions. Exercises and real-world examples from the finance industry are spread throughout each chapter, and a summary provides a brief overview of main points and concepts.
Preface xxiii Contributors xxvii part one Overview 1 Foreign Exchange Market Structure, Players, and Evolution 3 1.1 Introduction, 3 1.2 Geography and Composition of Currency Trading, 4 1.2.1 Which Currencies are Traded? 6 1.2.2 What Instruments are Traded? 9 1.2.3 How is Trading Regulated? 9 1.3 Players and Information in FX Markets, 11 1.3.1 Who Needs Liquidity? 12 1.3.2 Who Provides Liquidity? 15 1.3.3 Asymmetric Information and Exchange Rate Determination, 19 1.4 Electronic Trading Revolution in FX Markets, 21 1.4.1 The Telephone Era, 22 1.4.2 The Rise of the Computer, 22 1.4.3 Recent Developments in Electronic Trading, 30 1.5 Survey of Multibank FX Platforms, 35 1.6 Summary, 38 Glossary, 39 Acknowledgments, 41 References, 42 2 Macro Approaches to Foreign Exchange Determination 45 2.1 Introduction, 45 2.2 Models of the Nominal Exchange Rate, 46 2.2.1 The Monetary Model, 46 2.2.2 Portfolio Balance Models, 49 2.2.3 Empirical Evidence, 51 2.3 Real Models of the Real Exchange Rate, 54 2.3.1 Purchasing Power Parity, 55 2.3.2 Balassa--Samuelson and Productivity-Based Models, 56 2.3.3 Two-Good Models, 59 2.4 New Directions in Exchange-Rate Modeling, 60 2.4.1 Taking Reaction Functions Seriously, 60 2.4.2 The Impact of Financial Globalization, 63 2.4.3 The Risk Premium and Order Flow, 64 2.5 Conclusions, 65 Acknowledgments, 65 References, 66 3 Micro Approaches to Foreign Exchange Determination 73 3.1 Introduction, 73 3.2 Perspectives on Spot-Rate Dynamics, 74 3.2.1 Decomposition of Depreciation Rates, 74 3.2.2 Macro- and Microperspectives, 77 3.3 Currency Trading Models and their Implications, 80 3.3.1 The Portfolio Shifts Model, 81 3.3.2 Empirical Implications, 88 3.4 Exchange Rates, Order Flows, and the Macro Economy, 95 3.4.1 A Micro-Based Macro model, 96 3.4.2 Empirical Implications, 100 3.5 Conclusion, 105 Appendix, 105 3.6 Acknowledgment, 108 References, 108 4 The Exchange Rate in a Behavioral Finance Framework 111 4.1 Introduction, 111 4.1.1 Mainstream Exchange Rate Models, 111 4.1.2 Away from the Mainstream, 113 4.2 Exchange Rate Puzzles, 114 4.2.1 Disconnect Puzzle and Excess Volatility Puzzle, 114 4.2.2 Unit Root Property, 115 4.2.3 Volatility Clustering, 118 4.2.4 Fat-Tailed Distributed Exchange Rate Returns, 119 4.3 A Prototype Behavioral Model of the Foreign Exchange Market, 122 4.4 Conclusion, 127 References, 129 5 The Evolution of Exchange Rate Regimes and Some Future Perspectives 133 5.1 Introduction, 133 5.2 A Brief History of Currency Regimes, 135 5.3 Performance of the Laisser-Faire Exchange Rate System, 1973--2010, 138 5.3.1 Market Discipline, 139 5.3.2 Economic Policy Coordination, 140 5.3.3 Integration of Emerging Market Countries into the Global Economy, 140 5.4 Trends in Currency Use, 141 5.4.1 Global Imbalances and the Financial Crisis of 2007--2009, 143 5.5 Prospects for the Future, 144 5.5.1 The Current System, 144 5.5.2 Toward a more Managed International Monetary System? 146 5.5.3 How and When Will Reform Occur? 150 5.5.4 A Global Nominal Anchor? 151 5.6 Concluding Comments, 153 Appendix A: A Formal Test of Hollowing Out, 154 References, 156 part two Exchange Rate Models and Methods 6 Purchasing Power Parity in Economic History 161 6.1 Introduction, 161 6.2 Categorization of Purchasing-Power-Parity Theories, 162 6.3 Historical Application of PPP: Premodern Periods, 163 6.3.1 Ancient Period, 163 6.3.2 Medieval Period, 164 6.3.3 Sixteenth-Century Spain, 165 6.4 Techniques of Testing PPP Theory in Economic-History Literature, 165 6.4.1 Comparative-Static Computation, 165 6.4.2 Regression Analysis, 165 6.4.3 Testing for Causality, 165 6.4.4 Nonstationarity and Spurious Regression, 166 6.4.5 Testing for Stationarity, 167 6.4.6 Cointegration Analysis, 167 6.5 Price Variable in PPP Computations, 168 6.6 Modern Period: Testing of PPP, 169 6.6.1 Early North America, 169 6.6.2 Bullionist Periods, 170 6.6.3
