How Much You Know Matters: A Note on the Exchange Rate Disconnect Puzzle

Abstract

This paper o¤ers a dynamic model of the foreign exchange market where some investors in the market are more informed than others. By adjusting the proportion of informed investors in the market, it is shown that the disconnect between macroeconomic variables and the exchange rate is sensitive to the amount of asymmetric information in the market. A surprising …nding is that this disconnect is bigger when the proportion of informed investors in the market is smaller.JEL CODE: F31; D82