A note on interest rate defense policy and exchange rate volatility

In this paper, the effectiveness of an interest rate defense policy is investigated theoretically. Chen [Chen, Shiu-Sheng, 2006. Revisiting the interest rate-exchange rate nexus: a Markov switching approach. Journal of Development Economics 79 (1), 208-224] has documented an empirical regularity that higher interest rates are associated with higher exchange rate volatility. In order to account for the empirical findings, a simple theoretical model by incorporating interest rate rules in a noise trader model is proposed.