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Welfare and excess volatility of exchange rates

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  • M. Salto

    ()

  • T. Pietra

    ()

Abstract

We study the properties of a GEI model with nominal assets, outside money (injected into the economy as in Magill and Quinzii (J Math Econ 21:301–342, 1992 )), and multiple currencies. We analyze the existence of monetary equilibria and the structure of the equilibrium set under two different assumptions on the determination of the exchange rates. If currencies are perfect substitutes, equilibrium allocations are indeterminate and, generically, sunspot equilibria exist. Generically, given a nonsunspot equilibrium, there are Pareto improving (and Pareto worsening) sunspot equilibria associated with an increase in the volatility of the future exchange rates. We interpret this property as showing that, in general, there is no clear-cut effect on welfare of the excess volatility of exchange rates, even when due to purely extrinsic phenomena. Copyright Springer-Verlag 2013

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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 52 (2013)
Issue (Month): 2 (March)
Pages: 501-529

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Handle: RePEc:spr:joecth:v:52:y:2013:i:2:p:501-529

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Related research

Keywords: Incomplete markets; Exchange rates; Real indeterminacy; Sunspots; Efficiency; D52;

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  1. Pietra, Tito, 1992. "Indeterminacy in general equilibrium economies with incomplete financial markets : Mixed asset returns," Journal of Mathematical Economics, Elsevier, vol. 21(2), pages 155-172.
  2. PIETRA, Tito, . "The structure of the set of sunspot equilibria in economies with incomplete financial markets," CORE Discussion Papers RP -997, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  3. Cheung, Yin-Wong & Chinn, Menzie & Garcia Pascual, Antonio, 2003. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," Santa Cruz Department of Economics, Working Paper Series qt5fc508pt, Department of Economics, UC Santa Cruz.
  4. Antoine Martin, 2002. "Endogenous multiple currencies," Research Working Paper RWP 02-03, Federal Reserve Bank of Kansas City.
  5. Magill,Michael & Quinzii,Martine, 1989. "Real effects of money in general equilibrium," Discussion Paper Serie A 232, University of Bonn, Germany.
  6. King, Robert G. & Wallace, Neil & Weber, Warren E., 1992. "Nonfundamental uncertainty and exchange rates," Journal of International Economics, Elsevier, vol. 32(1-2), pages 83-108, February.
  7. M. Salto & T. Pietra, 2013. "Welfare and excess volatility of exchange rates," Economic Theory, Springer, vol. 52(2), pages 501-529, March.
  8. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  9. Tito Pietra, 2001. "The set of sunspot equilibria in economies with incomplete financial markets: variable asset prices," Economic Theory, Springer, vol. 18(3), pages 649-659.
  10. Polemarchakis, H. M., 1988. "Portfolio choice, exchange rates, and indeterminacy," Journal of Economic Theory, Elsevier, vol. 46(2), pages 414-421, December.
  11. Devereux, Michael B. & Engel, Charles, 2002. "Exchange rate pass-through, exchange rate volatility, and exchange rate disconnect," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 913-940, July.
  12. Cass, David, 1992. "Sunspots and Incomplete Financial Markets: The General Case," Economic Theory, Springer, vol. 2(3), pages 341-58, July.
  13. Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May.
  14. Irasema Alonso, 2004. "Persistent, Nonfundamental Exchange Rate Fluctuations," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 687-706, July.
  15. Manuelli, Rodolfo E & Peck, James, 1990. "Exchange Rate Volatility in an Equilibrium Asset Pricing Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(3), pages 559-74, August.
  16. Tito Pietra, 2004. "Sunspots, indeterminacy and Pareto inefficiency in economies with incomplete markets," Economic Theory, Springer, vol. 24(3), pages 687-699, October.
  17. Werner, Jan, 1985. "Equilibrium in economies with incomplete financial markets," Journal of Economic Theory, Elsevier, vol. 36(1), pages 110-119, June.
  18. Duffie, Darrell & Shafer, Wayne, 1985. "Equilibrium in incomplete markets: I : A basic model of generic existence," Journal of Mathematical Economics, Elsevier, vol. 14(3), pages 285-300, June.
  19. Balasko, Yves & Cass, David, 1989. "The Structure of Financial Equilibrium with Exogenous Yields: The Case of Incomplete Markets," Econometrica, Econometric Society, vol. 57(1), pages 135-62, January.
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  1. M. Salto & T. Pietra, 2013. "Welfare and excess volatility of exchange rates," Economic Theory, Springer, vol. 52(2), pages 501-529, March.

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