On the Foreign-Exchange Risk Premium in Sticky-Price General Equilibrium Models
AbstractThis paper investigates the behavior of the foreign exchange risk premium in two recent two-country intertemporal-optimizing general equilibrium models with sticky nominal prices: Obstfeld-Rogoff (1998) and Devereux-Engel (1998). The foreign exchange risk premium in any general equilibrium model arises from the correlation of the exchange rate with consumption. In flexible price models, that requires correlation of monetary and output supply shocks. In sticky-price models, the correlation arises endogenously because monetary shocks cause output and consumption to change. The size of the risk premium depends on how prices are set (in producers' currencies versus consumers' currencies), and on the form of the money demand function. In some cases, the risk premium generated by the model is quite large.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7067.
Date of creation: Apr 1999
Date of revision:
Publication status: published as Isard, Peter, Assaf Razin and Andrew Rose (eds.) International Finance and Financial Crises: Essays in Honor of Robert P. Flood, Jr. Kluwer Academic Publishers, 1999.
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Other versions of this item:
- Charles Engel, 1999. "On the Foreign Exchange Risk Premium in Sticky-Price General Equilibrium Models," International Tax and Public Finance, Springer, vol. 6(4), pages 491-505, November.
- F3 - International Economics - - International Finance
- F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
This paper has been announced in the following NEP Reports:
- NEP-ALL-1999-04-27 (All new papers)
- NEP-DGE-1999-04-27 (Dynamic General Equilibrium)
- NEP-IFN-1999-04-27 (International Finance)
- NEP-MON-1999-04-27 (Monetary Economics)
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