Non-elementary Movements in Currency Exchange

Most of existing theories of currency exchange rates relate currency exchange movements and volatility to shocks in fundamentals. But many policy makers believe the presence of a non-fundamental component behind the volatility. Let us try to understand non-elementary movements in currency exchange a little more.

A survey on dealers found that excessive speculation and hedge fund manipulation were regarded to be the major forces behind forex exchange movements. These were found to be the main factors preventing exchange rates from reflecting their fundamental value The next most heavily supported factor became the excessive intervention by central banks. It is interesting to note that the views taken by major trading banks and slowness of dealers to respond did not receive as much support.

An uncertainty in trade within meetings and poor substitutability among currencies can produce currency exchange movements consistent with empirics. Both nominal and real exchange rates are unrelated to fundamentals and are much more volatile than them.

Whilst speculation has for some time been seen as a force that can potentially destabilize exchange rate movements, only in recent years have hedge funds been one of the factors held responsible for unpredicted swings in exchange rates.

Alternative approaches to produce accurate paths for exchange rate movements, independent of fundamentals were taken in order to present price levels and changes in exchange rates. Results communicate that forex exchange rates may change independently of fundamentals during certain intervals like movements in money supply and that fundamentals can be used to determine changes in nominal and real exchange rates.