IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

International asset markets and real exchange rate volatility

Author Info

  • Martin Bodenstein

Abstract

The real exchange rate is very volatile relative to major macroeconomic aggregates and its correlation with the ratio of domestic over foreign consumption is negative (Backus-Smith puzzle). These two observations constitute a puzzle to standard international macroeconomic theory. This paper develops a two country model with complete asset markets and limited enforcement for international financial contracts that provides a possible explanation of these two puzzles. The model performs poorly with respect to asset pricing. However, with limited enforcement for both domestic and international financial contracts, the model's asset pricing implications are brought into line with the empirical evidence, albeit at the expense of raising real exchange rate volatility.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.federalreserve.gov/pubs/ifdp/2006/884/default.htm
Download Restriction: no
File URL: http://www.federalreserve.gov/pubs/ifdp/2006/884/ifdp884.pdf
Download Restriction: no

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 884.

as
in new window

Length:
Date of creation: 2006
Date of revision:
Handle: RePEc:fip:fedgif:884
Contact details of provider: Postal: 20th Street and Constitution Avenue, NW, Washington, DC 20551
Web page: http://www.federalreserve.gov/
More information through EDIRC

Order Information: Web: http://www.federalreserve.gov/pubs/ifdp/order.htm

Keywords: Foreign exchange rates;

Other versions of this item:

Find related papers by JEL classification:
  • F31 - International Economics - - International Finance - - - Foreign Exchange
  • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

This paper has been announced in the following NEP Reports:

References listed on IDEAS
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.:

as in new window
  1. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers 445, Federal Reserve Bank of Minneapolis.
  2. Fernando Alvarez & Urban J. Jermann, . "Quantitative Asset Pricing Implications of Endogenous Solvency Constraints," Rodney L. White Center for Financial Research Working Papers 10-99, Wharton School Rodney L. White Center for Financial Research.
  3. Patrick J. Kehoe & Fabrizio Perri, 2002. "International Business Cycles with Endogenous Incomplete Markets," Econometrica, Econometric Society, vol. 70(3), pages 907-928, May.
  4. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
  5. Christian Broda & David Weinstein, 2004. "Globalization and the gains from variety," Staff Reports 180, Federal Reserve Bank of New York.
  6. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
  7. Hanno Lustig & Yi-Li Chien, 2005. "The Market Price of Aggregate Risk and the Wealth Distribution," NBER Working Papers 11132, National Bureau of Economic Research, Inc.
  8. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," NBER Working Papers 7869, National Bureau of Economic Research, Inc.
  9. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2004. "International risk-sharing and the transmission of productivity shocks," Working Paper Series 0308, European Central Bank.
  10. Matthias Messner & Nicola Pavoni, 2004. "On the Recursive Saddle Point Method," Levine's Bibliography 122247000000000050, UCLA Department of Economics.
  11. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, vol. 35(3-4), pages 297-316, November.
  12. Heathcote, Jonathan & Perri, Fabrizio, 1999. "Financial Autarky and International Business Cycles," SSE/EFI Working Paper Series in Economics and Finance 320, Stockholm School of Economics, revised 30 Apr 2000.
  13. repec:cas:wpaper:cas_rn_2007_7 is not listed on IDEAS
  14. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-87, June.
  15. Marcet, A. & Marimon, R., 1998. "Recursive Contracts," Economics Working Papers eco98/37, European University Institute.
  16. Brandt, Michael W. & Cochrane, John H. & Santa-Clara, Pedro, 2006. "International risk sharing is better than you think, or exchange rates are too smooth," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 671-698, May.
  17. David Backus & Silverio Foresi & Chris Telmer, 1996. "Affine Models of Currency Pricing," New York University, Leonard N. Stern School Finance Department Working Paper Seires 96-9, New York University, Leonard N. Stern School of Business-.
  18. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International Business Cycles: Theory and Evidence," Working Papers 93-21, New York University, Leonard N. Stern School of Business, Department of Economics.
  19. Gianluca Benigno & Christoph Theonissen, 2006. "Consumption and real exchange rates with incomplete markets and non-traded goods," LSE Research Online Documents on Economics 3758, London School of Economics and Political Science, LSE Library.
  20. Burstein, Ariel T. & Neves, Joao C. & Rebelo, Sergio, 2003. "Distribution costs and real exchange rate dynamics during exchange-rate-based stabilizations," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1189-1214, September.
  21. Lewis, Karen K, 1996. "What Can Explain the Apparent Lack of International Consumption Risk Sharing?," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 267-97, April.
  22. Riccardo Colacito & Mariano M. Croce, 2011. "Risks for the Long Run and the Real Exchange Rate," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 153 - 181.
  23. Ariel Burstein & Martin Eichenbaum & Sergio Rebelo, 2004. "Large Devaluations and the Real Exchange Rate," RCER Working Papers 513, University of Rochester - Center for Economic Research (RCER).
  24. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  25. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 225-62, April.
  26. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  27. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
  28. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August.
Full references (including those not matched with items on IDEAS)

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

as in new window


Cited by:

  1. 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.
  2. Nuntramas, Phacharaphot, 2011. "Revisiting the consumption-real exchange rate anomaly in a model with non-traded goods," Journal of International Money and Finance, Elsevier, vol. 30(3), pages 428-447, April.
  3. Matthew Canzoneri & Robert Cumby & Behzad Diba, 2013. "Addressing International Empirical Puzzles: the Liquidity of Bonds," Open Economies Review, Springer, vol. 24(2), pages 197-215, April.
  4. Jón Steinsson, 2008. "The Dynamic Behavior of the Real Exchange Rate in Sticky Price Models," NBER Working Papers 13910, National Bureau of Economic Research, Inc.
  5. Michael B. Devereux & Gregor W. Smith & James Yetman, 2009. "Consumption and Real Exchange Rates in Professional Forecasts," Working Papers 1195, Queen's University, Department of Economics.
  6. Andrés Sagner, 2010. "Implied Probability Distribution in Financial Options," Working Papers Central Bank of Chile 597, Central Bank of Chile.
  7. M. Hadzi-Vaskov, 2008. "Does the nominal exchange rate explain the Backus-Smith puzzle? evidence from the Eurozone," Working Papers 07-32, Utrecht School of Economics.
  8. Donadelli, Michael & Paradiso, Antonio, 2014. "Does financial integration affect real exchange rate volatility and cross-country equity market returns correlation?," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 206-220.
  9. A. Craig Burnside & Jeremy J. Graveline, 2012. "On the Asset Market View of Exchange Rates," NBER Working Papers 18646, National Bureau of Economic Research, Inc.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Access and download statistics

When requesting a correction, please mention this item's handle: RePEc:fip:fedgif:884. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kris Vajs)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.