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New Shocks, Exchange Rates and Equityprices

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Author Info

  • Pietro Cova
  • Alessandro Rebucci
  • Akito Matsumoto
  • Massimiliano Pisani

Abstract

We study exchange rate and equity price dynamics, in general equilibrium, in the presence of news shocks about future productivity and monetary policy. We identify a condition under which these asset prices become more volatile without affecting the volatility of the underlying processes-a positive correlation between news and current shocks. This condition also explains why persistent underlying processes generate volatile asset prices. In addition, we show that the correlation between exchange rate and equity returns depends critically on the currency denomination of the equity return and the monetary policy reaction to productivity shocks. The model we set up does well at matching second moments of exchange rate and equity returns for major floating currencies.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 08/284.

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Length: 36
Date of creation: 01 Dec 2008
Date of revision:
Handle: RePEc:imf:imfwpa:08/284

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Related research

Keywords: Exchange rates; Productivity; External shocks; Stock prices; Floating exchange rates; Economic models; exchange rate; monetary policy; money supply; exchange rate volatility; money stock; monetary economics; home currency; inflation; real exchange rate; monetary response; currency depreciation; monetary fund; foreign exchange; exchange rate dynamics; exchange rate change; exchange rate changes; monetary shocks; money demand; nominal exchange rate; money supply volatility; policy on exchange rate; central bank; local currencies; monetary authority; monetary policy rule; real exchange rates; exchange rate policy; exchange rate pass; exchange markets; monetary policy rules; monetary policy regimes; foreign exchange markets; money balance; money market; optimal monetary policy;

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References

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  1. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Clara Vega, 2003. "Real-Time Price Discovery in Stock, Bond and Foreign Exchange Markets," PIER Working Paper Archive 04-028, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 28 Jun 2004.
  2. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  3. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," NBER Working Papers 7869, National Bureau of Economic Research, Inc.
  4. Beaudry, Paul & Portier, Franck, 2003. "Stock Prices, News and Economic Fluctuations," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3844, C.E.P.R. Discussion Papers.
  5. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Vega, Clara, 2007. "Real-time price discovery in global stock, bond and foreign exchange markets," Journal of International Economics, Elsevier, Elsevier, vol. 73(2), pages 251-277, November.
  6. Jan J J Groen & Akito Matsumoto, 2004. "Real exchange rate persistence and systematic monetary policy behaviour," Bank of England working papers, Bank of England 231, Bank of England.
  7. Brandt, Michael W. & Cochrane, John H. & Santa-Clara, Pedro, 2006. "International risk sharing is better than you think, or exchange rates are too smooth," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(4), pages 671-698, May.
  8. Engel, Charles & West, Kenneth D., 2003. "Exchange rates and fundamentals," Working Paper Series, European Central Bank 0248, European Central Bank.
  9. M.B. Devereux & Ch. Engel, 2003. "Exchange Rate Pass-Through, Exchange Rate Volatility, and ExchangeRate Disconnect," DNB Staff Reports (discontinued), Netherlands Central Bank 77, Netherlands Central Bank.
  10. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1992. "International Real Business Cycles," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(4), pages 745-75, August.
  11. Charles Engel & Nelson C. Mark & Kenneth D. West, 2008. "Exchange Rate Models Are Not As Bad As You Think," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 2007, Volume 22, pages 381-441 National Bureau of Economic Research, Inc.
  12. Harald Hau & Helene Rey, 2004. "Can Portfolio Rebalancing Explain the Dynamics of Equity Returns, Equity Flows, and Exchange Rates?," NBER Working Papers 10476, National Bureau of Economic Research, Inc.
  13. Monacelli, Tommaso, 2004. "Into the Mussa puzzle: monetary policy regimes and the real exchange rate in a small open economy," Journal of International Economics, Elsevier, Elsevier, vol. 62(1), pages 191-217, January.
  14. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, Elsevier, vol. 14(1-2), pages 3-24, February.
  15. Benigno, Gianluca, 2004. "Real exchange rate persistence and monetary policy rules," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(3), pages 473-502, April.
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Citations

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Cited by:
  1. Fabio Milani & John Treadwell, 2012. "The Effects of Monetary Policy “News” and “Surprises”," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 44(8), pages 1667-1692, December.
  2. Marcel Fratzscher & Roland Straub, 2009. "Asset Prices and Current Account Fluctuations in G-7 Economies," IMF Staff Papers, Palgrave Macmillan, vol. 56(3), pages 633-654, August.
  3. Paul Beaudry & Franck Portier, 2013. "News Driven Business Cycles: Insights and Challenges," NBER Working Papers 19411, National Bureau of Economic Research, Inc.

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