Technical trading, monetary policy, and exchange rate regimes

The paper extends and empirically tests the noise trader exchange rate model of Jeanne and Rose (2002). We introduce technical trading in the exchange market as a source of noise and explicitly incorporate monetary and exchange rate policy. With these modifications, it is possible to directly test the model's prediction of an U-shaped relation between exchange trend and volatility. We find strong empirical evidence supporting the implications of the model. As a corollary, we develop a measure of excess exchange rate volatility and categorize exchange rate regimes based on the de facto behavior of the exchange rates.