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Solving exchange rate puzzles with neither sticky prices nor trade costs

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  • Moore, Michael J.
  • Roche, Maurice J.

Abstract

We present a simple framework in which both the exchange rates disconnect and forward bias puzzles are simultaneously resolved. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habit persistence is modeled using Campbell Cochrane preferences with 'deep' habits along the lines of the work of Ravn, Schmitt-Grohe and Uribe. By deep habits, we mean habits defined over goods rather than countries. The model is simulated using the artificial economy methodology. It offers a neo-classical explanation of the Meese-Rogoff puzzle and mimics the failure of fundamentals to explain nominal exchange rates in a linear setting. Finally, the model naturally generates the negative slope in the standard forward market regression.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 29 (2010)
Issue (Month): 6 (October)
Pages: 1151-1170

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Handle: RePEc:eee:jimfin:v:29:y:2010:i:6:p:1151-1170

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Web page: http://www.elsevier.com/locate/inca/30443

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Keywords: Exchange rate puzzles Forward foreign exchange Habit persistence;

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References

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Citations

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Cited by:
  1. Francis Breedon & Dagfinn Rime & Paolo Vital, 2010. "A Transaction Data Study of the Forward Bias Puzzle," Working Paper 2010/26, Norges Bank.
  2. Gianluca Benigno & Pierpaolo Benigno & Salvatore Nisticò, 2011. "Risk, Monetary Policy and the Exchange Rate," NBER Chapters, in: NBER Macroeconomics Annual 2011, Volume 26, pages 247-309 National Bureau of Economic Research, Inc.
  3. Emanuel Kohlscheen, 2011. "The Impact of Monetary Policy on the Exchange Rate: puzzling evidence from three emerging economies," Working Papers Series 259, Central Bank of Brazil, Research Department.
  4. Jingyi Liu, 2008. "Can a Lucas model with habit generate realistic conditional volatility in exchange rate returns?," ESE Discussion Papers 181, Edinburgh School of Economics, University of Edinburgh.
  5. Martin D. D. Evans, 2012. "Exchange-Rate Dark Matter," Working Papers gueconwpa~12-12-01, Georgetown University, Department of Economics.
  6. Onishchenko, Kateryna, 2011. "Can a pure real business cycle model explain the real exchange rate: the case of Ukraine," Cardiff Economics Working Papers E2011/17, Cardiff University, Cardiff Business School, Economics Section.
  7. Menzie D. Chinn & Michael J. Moore, 2008. "Private Information and a Macro Model of Exchange Rates: Evidence from a Novel Data Set," NBER Working Papers 14175, National Bureau of Economic Research, Inc.
  8. Maurice J. Roche & Michael J. Moore, 2010. "For Rich or for Poor: When does Uncovered Interest Parity Hold?," Working Papers 015, Ryerson University, Department of Economics.

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