Exchange Rates and International Macroeconomics Essay

3927 WordsApr 8, 201416 Pages
This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research Volume Title: Exchange Rates and International Macroeconomics Volume Author/Editor: Jacob A. Frenkel, ed. Volume Publisher: University of Chicago Press Volume ISBN: 0-226-26250-2 Volume URL: http://www.nber.org/books/fren83-1 Publication Date: 1983 Chapter Title: Risk Averse Speculation in the Forward Foreign Exchange Market: An Econometric Analysis of Linear Models Chapter Author: Lars Peter Hansen, Robert J. Hodrick Chapter URL: http://www.nber.org/chapters/c11378 Chapter pages in book: (p. 113 - 152) Risk Averse Speculation in the Forward Foreign Exchange Market: An Econometric Analysis of Linear Models Lars Peter Hansen and Robert J. Hodrick 4.1 Introduction In this paper we study the determination of forward foreign exchange rates. An exchange rate is the price of one currency in terms of another currency, and a forward rate is a contractual exchange rate established at a point in time for a transaction that will take place at the maturity date on the contract in the future. Well-organized forward markets exist for all major currencies of the world for various maturities, with the most active contract lengths being one, three, six, and twelve months. The existence and efficiency of organized forward markets for foreign exchange were critical links in the case for flexible exchange rates. Friedman (1953) stated, Under flexible exchange rates traders can almost always protect themselves against changes in the rate by hedging in a futures market. Such futures markets in foreign currency readily develop when exchange rates are flexible. Lars Peter Hansen is associate professor of economics at the University of Chicago. Robert J. Hodrick is associate professor of finance at Northwestern University. The major portion of this work was done while the

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