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General Equilibrium Model of Arbitrage Trade and Real Exchange Rate Persistence

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Author Info
Berka, Martin

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Abstract

Heterogeneity of marginal shipping costs leads to persistent and volatile deviations in real exchange rate. In a two-country, three-good endowment general equilibrium model, arbitrage firms use a transportation technology which depends positively on distance and physical mass of goods. The model exhibits endogenous tradability, non-linearity of law of one price deviations and trade-inducing and suppressing substitution effects due to heterogeneity in trade costs. When endowments follow an AR(1) process that matches quarterly HP-filtered US and EU GDPs, and the aggregate trade costs consume 1.7% of GDP, persistence of real exchange rate matches the data. A model with quadratic adjustment costs also induces sufficient real exchange rate volatility.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 234.

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Date of creation: Aug 2005
Date of revision: 06 May 2008
Handle: RePEc:pra:mprapa:234

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Related research
Keywords: Arbitrage trade heterogeneity real exchange rate persistence volatility

Find related papers by JEL classification:
F3 - International Economics - - International Finance
F49 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Other
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
F19 - International Economics - - Trade - - - Other

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References listed on IDEAS
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  5. Obstfeld, Maurice & Taylor, Alan M, 1997. "Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Heckscher's Commodity Points Revisited," CEPR Discussion Papers 1672, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  6. Bergin, Paul R. & Feenstra, Robert C., 2001. "Pricing-to-market, staggered contracts, and real exchange rate persistence," Journal of International Economics, Elsevier, vol. 54(2), pages 333-359, August. [Downloadable!] (restricted)
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  17. O'Connell, Paul G. J. & Wei, Shang-Jin, 2002. ""The bigger they are, the harder they fall": Retail price differences across U.S. cities," Journal of International Economics, Elsevier, vol. 56(1), pages 21-53, January. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Ivan Paya & David A. Peel, 2005. "The Process Followed By Ppp Data. On The Properties Of Linearity Tests," Working Papers. Serie AD 2005-23, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie). [Downloadable!]
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  2. Frederique Bec & Melika Ben Salem & Marine Carrasco, 2004. "Detecting Mean Reversion in Real Exchange Rates from a Multiple Regime STAR Model," RCER Working Papers 509, University of Rochester - Center for Economic Research (RCER). [Downloadable!]
  3. David Peel & Ivan Paya, 2005. "Temporal aggregation of an ESTAR process: some implications for purchasing power parity adjustment," Working Papers 002390, Lancaster University Management School, Economics Department. [Downloadable!]
    Other versions:
  4. David Peel & Ivan Paya, 2005. "A new analysis of the determinants of the real dollar-sterling exchange rate: 1871-1994," Working Papers 002391, Lancaster University Management School, Economics Department. [Downloadable!]
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