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Microeconomic Sources of Real Exchange Rate Variability

  • Mario J. Crucini
  • Christopher I. Telmer

We provide three sets of variance decompositions on microeconomic international relative price data. The first shows that the overall distribution of absolute deviations from the Law of One Price (LOP) is dominated by cross-sectional variation in long-term averages, not by time-series variation around the long-term averages. The second shows that time-series variation in changes in LOP deviations is dominated by idiosyncratic, goods-specific variation, not by aggregate variation such as that arising from nominal exchange rates. The third shows that time-series and cross-sectional variance are connected across goods. Goods that exhibit high cross-sectional variance also exhibit high time-series variance. Moreover, when this connection is made conditional on the tradeability of a goods, a two-factor structure for the goods-specific cross-section is revealed. We argue that this factor structure, in addition to our other variance decompositions, is informative for the construction of models that can synthesize the micro and macroeconomic behavior of relative prices.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17978.

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Date of creation: Apr 2012
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Handle: RePEc:nbr:nberwo:17978
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  1. Giri, Rahul, 2008. "Local Costs of Distribution, International Trade Costs and Micro Evidence on the Law of One Price," MPRA Paper 11006, University Library of Munich, Germany, revised 31 Sep 2008.
  2. Marios Zachariadis, 2012. "Global Versus Local Shocks in Micro Price Dynamics," 2012 Meeting Papers 66, Society for Economic Dynamics.
  3. Mario Crucini & Chris Telmer & Marios Zachariadis, . "Understanding European Real Exchange Rates," GSIA Working Papers 227, Carnegie Mellon University, Tepper School of Business.
  4. Jean Imbs & Haroon Mumtaz & Morton O. Ravn & Helene Rey, 2002. "PPP Strikes Back: Aggregation and the Real Exchange Rate," NBER Working Papers 9372, National Bureau of Economic Research, Inc.
  5. Mario J Crucini & Mototsugu Shintani, 2002. "Persistence in Law-of-One-Price Deviations: Evidence From Micro-Price Data," NajEcon Working Paper Reviews 506439000000000019, www.najecon.org.
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