Still after more than thirty years of free floating exchange rates large parts of exchange
rate dynamics remain a puzzle. As this book shows much progress has been made in explaining
exchange rate movements over longer horizons. It also shows however that short-run movements
are far more challenging to explain. The book is based upon a variety of papers many of them
released recently. A key aspiration of the literature has always been not only to explain past
exchange rate behavior but also to forecast out of sample and to compare it to the simple
random walk outcome. Here some development has been made after Meese and Rogoff s (1983)
truculent verdict of the performance of common exchange rate models. By means of empirical
analysis and descriptive statistics this book further supports the established long-run
relationships between exchange rates and fundamentals such as expected productivity growth
real GDP growth domestic investment interest rates inflation government spending and
current account balances. It finds that these fundamentals affect the exchange rate to varying
degrees over time. Turning to short-term exchange rate dynamics it turns out that a different
set of forces is at play. The key to explaining short-run movements is to be found in an
extensive micro-foundation that factors in a pronounced heterogeneity among market participants
and information asymmetries as well as the possibility of sudden shifts in sentiment beliefs
and the degree of risk aversion. Promising results have been obtained by order-flow analysis
and high frequency data. Also the consideration of chartism and speculators facilitates
understanding for otherwise puzzling exchange rate movements. The last attempt to tackle the
understanding of exchange rate behavior is the use of frequency domain analysis and in
particular spectral analysis which tries to track down any cyclical patterns in the various
moments of time series. And as we shall see forex indeed incorporates cycles as well.
