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Shocks and Exchange Rates in Small Open Economies

Author

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  • Vito Cormun
  • Pierre De Leo

Abstract

We separately identify domestic and external sources of exchange rate fluctuations in a large sample of small open economies (SOEs). We find that external shocks lead to large and predictable deviations from uncovered interest parity (UIP), while domestic shocks do not. Additionally, external shocks are linked to fluctuations in global risk aversion and US macroeconomic aggregates. We present an SOE model that rationalizes these facts. In the model, global risk aversion shocks drive exchange rate fluctuations, and a country's net external position governs their transmission. We provide evidence that a country's response to external shocks depends on its external position.

Suggested Citation

  • Vito Cormun & Pierre De Leo, 2026. "Shocks and Exchange Rates in Small Open Economies," American Economic Journal: Macroeconomics, American Economic Association, vol. 18(2), pages 457-485, April.
    • Handle: RePEc:aea:aejmac:v:18:y:2026:i:2:p:457-85
    DOI: 10.1257/mac.20220150
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    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • O19 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - International Linkages to Development; Role of International Organizations

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