Testing for Sunspot in the Foreign Exchange Market

It has been shown that the nonfundamental uncertainty called sunspots matters in many areas of the economy. Noting the fact that nationwide capital movement and the speculative demand for foreign currencies are rapidly increasing, this paper conducts empirical tests on the sunspot exchange rate model. The empirical result shows that the sunspot equilibrium exchange rate deviating from Purchasing Power Parity (PPP) and Interest Rate Parity (IRP) is consistent with the real data. More importantly, the Generalized Method of Moments (GMM) over-identification test is shown to support the evidence that more general Euler equations are in favor of our sunspot equilibrium exchange rate model. [C52, E44]