An Empirical Investigation of the Relationship between Speculation and Price Stability in a Floating Foreign Exchange Market

TLDR: In this paper, the authors focus on the question as to whether empirical evidence may provide a basis for rejecting or accepting the latter hypothesis, and the author's inquiry will focus on whether empirically, speculators' influences could be considered destabilizing if their effects were to result in a wider variance of exchange rates, than would be true if speculative activity had not been present.

Abstract: ing from speculators' net profit positions and looking at price movements in a foreign exchange market, Professor Friedman asserts that perhaps speculators' influences could be considered destabilizing if their effects were to result in a wider variance of exchange rates, than would be true if speculative activity had not been present. The issue as to whether speculators make profits on the average of their transactions, although an interesting question, will not be analyzed in this paper. Instead, the author's inquiry will focus on the question as to whether empirical evidence may provide a basis for rejecting or accepting the latter hypothesis. In earlier studies regarding the relationship between speculation and price stability, the view was taken that the above relationship could, in a partial equilibrium analysis, be reduced to the two variable case, whereby price stability or instability could be determined by observing directional movements between the expected price and the current price. (3) As noted by Nicolas Kaldor, in his early pioneering study of speculation, questions concerning price stability or instability could be analyzed in terms of current and expected prime move ments. For instance, in the case of inelastic expectations '' if the expected price is taken as given, speculation must necessarily exert a stabilizing influence: a rise in the current price will be followed by a fall in speculative stocks and vice versa.\"(4) The reasoning behind this is that a rise in the current price would mean a fall in the ratio of the expected to current price. And as a result, *Paper delivered at the Graduate Student Session of the American Economic Association Meeting in Detroit, December 28, 1970. Mr. Dominguez is a graduate student at M. I. T. He I is indebted to Professor J. Bhagwati D. Foley, C. Kindleberger, E. Kuh, E. Solow, P. Samuel son and L. Ehurow, all of whom read this manuscript in some stage of preparation and made helpful suggestions. Nevertheless, the sole responsibility of all errors remains that of the author. 3 Sage Publications Inc. is collaborating with JSTOR to digitize, preserve, and extend access to The American Economist