In August 2026, a project submitted by Associate Professor Wang Xiaowen of the China Institute of Economic Research, entitled “The Exchange Rate Puzzle and the Endogenous Evolution Mechanism of the Fluctuation Band: A Perspective Based on Rational Inattention and Limited Attention,” was awarded funding under the 2026 National Natural Science Foundation of China Young Scientists Fund (Category C).

Project Abstract

The Exchange Rate Puzzle and the Endogenous Evolution Mechanism of the Fluctuation Band: A Perspective Based on Rational Inattention and Limited Attention

Understanding the nonlinear fluctuations and decoupling of exchange rates from macroeconomic fundamentals is one of the core challenges in international finance. Traditional theories, constrained by the assumption of perfect information, not only struggle to explain the exchange rate volatility puzzle and the disconnection puzzle, but also fail to adequately characterize the nonlinear dynamic features of exchange rates within a fluctuation band. In response to the limitations of existing theories and the realistic characteristics of high information acquisition costs in China’s financial markets, this project introduces two types of information frictions—rational inattention and limited attention—to investigate the exchange rate evolution mechanisms induced by these frictions. First, we construct an incomplete-information consumption–investment decision model based on recursive utility to reveal how information frictions affect exchange rates through their impact on the stochastic discount factor, thereby explaining the exchange rate volatility and disconnection puzzles. Second, we incorporate information frictions into a dynamic general equilibrium framework and build a capital flow model under the dual frictions of “transaction costs + information frictions” to explore the endogenous determination mechanism of nonlinear exchange rate fluctuation bands. Finally, using micro-level survey data and macroeconomic data, we employ the generalized method of moments (GMM) and threshold autoregressive models for structural parameter identification and empirical testing of the information friction mechanisms. This research not only provides a unified micro-founded explanation for classic exchange rate puzzles but also offers scientific evidence for China to stabilize exchange rate risks through improved data disclosure and expectation management.

Biography

Wang Xiaowen holds a Ph.D. in Economics from the University of Hong Kong and is currently an Associate Professor at the China Institute of Economic Research, Liaoning University. She previously worked at the Institute for Advanced Research, Shanghai University of Finance and Economics. Her research fields include macroeconomics and international economics. Her work has been published in leading international journals such as the Journal of Monetary Economics.