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New Shocks, Exchange Rates and Equity Prices

Author

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  • Pietro Cova
  • Alessandro Rebucci
  • Akito Matsumoto
  • Massimiliano Pisani

Abstract

We study exchange rate and equity price dynamics, in general equilibrium, in the presence of news shocks about future productivity and monetary policy. We identify a condition under which these asset prices become more volatile without affecting the volatility of the underlying processes-a positive correlation between news and current shocks. This condition also explains why persistent underlying processes generate volatile asset prices. In addition, we show that the correlation between exchange rate and equity returns depends critically on the currency denomination of the equity return and the monetary policy reaction to productivity shocks. The model we set up does well at matching second moments of exchange rate and equity returns for major floating currencies.

Suggested Citation

  • Pietro Cova & Alessandro Rebucci & Akito Matsumoto & Massimiliano Pisani, 2008. "New Shocks, Exchange Rates and Equity Prices," IMF Working Papers 08/284, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:08/284
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    References listed on IDEAS

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    6. Monacelli, Tommaso, 2004. "Into the Mussa puzzle: monetary policy regimes and the real exchange rate in a small open economy," Journal of International Economics, Elsevier, pages 191-217.
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    10. Jan J J Groen & Akito Matsumoto, 2004. "Real exchange rate persistence and systematic monetary policy behaviour," Bank of England working papers 231, Bank of England.
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    12. Devereux, Michael B. & Engel, Charles, 2002. "Exchange rate pass-through, exchange rate volatility, and exchange rate disconnect," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 913-940, July.
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    Cited by:

    1. Paul Beaudry & Franck Portier, 2014. "News-Driven Business Cycles: Insights and Challenges," Journal of Economic Literature, American Economic Association, pages 993-1074.
    2. Marcel Fratzscher & Roland Straub, 2009. "Asset Prices and Current Account Fluctuations in G-7 Economies," IMF Staff Papers, Palgrave Macmillan, vol. 56(3), pages 633-654, August.
    3. Fabio Milani & John Treadwell, 2012. "The Effects of Monetary Policy “News” and “Surprises”," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(8), pages 1667-1692, December.

    More about this item

    Keywords

    Exchange rates; External shocks; Equity prices; Economic models; Asset prices; Monetary policy; Floating exchange rates; Productivity; Stock prices; News Shocks; Persistence; exchange rate; money supply; exchange rate volatility;

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