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Exchange rate dynamics, asset market structure and the role of the trade elasticity

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  • Christoph Thoenissen

    (University of St Andrews)

Abstract

This paper shows that a canonical flexible price international real business cycle model with incomplete financial markets can address the exchange rate volatility puzzle, the exchange rate persistence puzzle, the consumption real exchange rate anomaly, as well as the quantity anomaly. Crucial for the success of the model is the choice of the elasticity of substitution between home and foreign produced goods. The paper shows that the range of this parameter which allows the model to address these international macroeconomics anomalies is very narrow. Furthermore, the paper highlights an anomalous relationship between real exchange rate persistence and the elasticity of substitution between home and foreign-produced goods.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 167.

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Date of creation: 2008
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Handle: RePEc:red:sed008:167

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  1. Giancarlo CORSETTI & Luca DEDOLA & Sylvain LEDUC, 2003. "International Risk-Sharing and the Transmission of Productivity Shocks," Economics Working Papers, European University Institute ECO2003/22, European University Institute.
  2. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2006. "Productivity, External Balance and Exchange Rates: Evidence on the Transmission Mechanism among G7 Countries," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5853, C.E.P.R. Discussion Papers.
  3. Benigno, Gianluca & Thoenissen, Christoph, 2008. "Consumption and real exchange rates with incomplete markets and non-traded goods," Journal of International Money and Finance, Elsevier, Elsevier, vol. 27(6), pages 926-948, October.
  4. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial autarky and international business cycles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(3), pages 601-627, April.
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  7. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 28(1), pages 3-24, August.
  8. Enders, Zeno & Müller, Gernot J., 2009. "On the international transmission of technology shocks," Journal of International Economics, Elsevier, Elsevier, vol. 78(1), pages 45-59, June.
  9. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can sticky price models generate volatile and persistent real exchange rates?," Staff Report, Federal Reserve Bank of Minneapolis 277, Federal Reserve Bank of Minneapolis.
  10. Benigno, Pierpaolo, 2001. "Price Stability with Imperfect Financial Integration," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2854, C.E.P.R. Discussion Papers.
  11. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, American Economic Association, vol. 81(4), pages 797-818, September.
  12. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, American Economic Association, vol. 85(1), pages 168-85, March.
  13. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 113(1), pages 1-45, February.
  14. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International Business Cycles: Theory and Evidence," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 93-21, New York University, Leonard N. Stern School of Business, Department of Economics.
  15. David K. Backus & Gregor W. Smith, 1993. "Consumption and Real Exchange Rates in Dynamic Economies with Non-Traded Goods," Working Papers, Queen's University, Department of Economics 1252, Queen's University, Department of Economics.
  16. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1992. "Dynamics of the trade balance and the terms of trade: the S-curve," Working Paper, Federal Reserve Bank of Cleveland 9211, Federal Reserve Bank of Cleveland.
  17. King, Robert G & Watson, Mark W, 1998. "The Solution of Singular Linear Difference Systems under Rational Expectations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 1015-26, November.
  18. Parantap Basu & Christoph Thoenissen, 2007. "Investment Frictions and the Relative Price of Investment Goods in an Open Economy Model," CDMA Working Paper Series, Centre for Dynamic Macroeconomic Analysis 200704, Centre for Dynamic Macroeconomic Analysis, revised 15 Aug 2007.
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Cited by:
  1. Martin Bodenstein, 2008. "Trade elasticity of substitution and equilibrium dynamics," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 934, Board of Governors of the Federal Reserve System (U.S.).
  2. Dmitriev, Alexandre & Roberts, Ivan, 2013. "The cost of adjustment: On comovement between the trade balance and the terms of trade," Economic Modelling, Elsevier, Elsevier, vol. 35(C), pages 689-700.
  3. Gunes Kamber & Christoph Thoenissen, 2011. "Financial intermediation and the internationalbusiness cycle: The case of small countries with big banks," CAMA Working Papers, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University 2011-22, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  4. Guglielmo Maria Caporale & Michael Donadelli & Alessia Varani, 2014. "International Capital Markets Structure, Preferences and Puzzles: The US-China Case," Discussion Papers of DIW Berlin 1362, DIW Berlin, German Institute for Economic Research.
  5. Güneş Kamber & Christoph Thoenissen, 2013. "Financial Exposure and the International Transmission of Financial Shocks," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 45(s2), pages 127-158, December.
  6. Costa, Carlos E. da & Issler, João Victor & Matos, Paulo F., 2013. "A Note on the Forward- and the Equity-Premium Puzzles: Two Symptoms of the Same Illness?," Economics Working Papers (Ensaios Economicos da EPGE) 743, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  7. Punnoose Jacob & Gert Peersman, 2012. "Dissecting the dynamics of the US trade balance in an estimated equilibrium model," Working Paper Research, National Bank of Belgium 226, National Bank of Belgium.

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