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Risk Aversion, Business Volatility and Exchange Rate Regimes in Small Open Economies

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  • Cristian Pardo

    (Department of Economics, Saint Joseph's University, 5600 City Avenue, Philadelphia, PA 19131, USA)

Abstract

This paper explores the effect of asymmetric information and entrepreneurial risk aversion on the dynamics of a small open economy. A private equity premium arises from the optimal contract between a domestic risk-averse borrower and a foreign lender, which, in general equilibrium, helps magnify the effect of shocks over time. In terms of an exchange rate regime comparison, when entrepreneurial risk aversion is considered, shocks are significantly more amplified under fixed than under flexible exchange rates. This result stems from the direct impact of deflation on real wages, which more strongly affects entrepreneur's wealth and hence the private equity premium.

Suggested Citation

  • Cristian Pardo, 2012. "Risk Aversion, Business Volatility and Exchange Rate Regimes in Small Open Economies," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 38(2), pages 167-188.
  • Handle: RePEc:pal:easeco:v:38:y:2012:i:2:p:167-188
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    References listed on IDEAS

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    1. Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2007. "External Constraints on Monetary Policy and the Financial Accelerator," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 295-330, March.
    2. Backus, David K & Kehoe, Patrick J, 1992. "International Evidence of the Historical Properties of Business Cycles," American Economic Review, American Economic Association, vol. 82(4), pages 864-888, September.
    3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    4. Reinhart, Carmen & Calvo, Guillermo, 2000. "When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options," MPRA Paper 6982, University Library of Munich, Germany.
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    Cited by:

    1. Pardo, Cristian, 2012. "Risk aversion and business cycles: An empirical analysis," The Quarterly Review of Economics and Finance, Elsevier, vol. 52(4), pages 413-426.

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