There are two features of exchange rate behaviour that are difficult to explain with conventional theoretical explanations. First, exchange rates are very volatile relative to fundamentals, and, second, departures from ‘fair value’ are very persistent. In this paper the implications of pricing-to-market models for exchange rate behaviour are examined. It is found that these models do better at explaining exchange rate behaviour than traditional models, though it would seem that there is still some way to go before we have a full understanding of high-to-medium frequency fluctuations in the exchange rate.
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