The Foreign Exchange Market: A Random Walk with a Dragging Anchor

Abstract

This paper explores some anomalies in the foreign exchange market. It is hard to find evidence of either short-term overshooting or of longer-term reversion to an equilibrium. The forward exchange rate contains virtually no information on future spot rates. Discussions with practitioners indicate that longer-term speculation based on fundamentals is strictly limited, and survey data and other evidence suggest that expectations and speculation are based on a variety of models. The interplay between speculation based on fundamentals, and on a random walk, or Chartist, approach, influences the outcome. This endorses the prior model of J. A. Frankel and K. A. Froot. Copyright 1988 by The London School of Economics and Political Science.