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Risk and Exchange Rates

  • Maurice Obstfeld
  • Kenneth Rogoff

This paper develops an explicitly stochastic new open economy macroeconomics' model, which can potentially be used to explore the qualitative and quantitative welfare differences between alternative exchange rate regimes. A crucial feature is that we do not simplify by assuming certainty equivalence for producer price setting behavior. Our framework also provides a sticky-price alternative to Lucas's (1982) exchage rate risk premium model. We show that the level risk premium' in the exchage rate is potentially quite large and may be an important missing fundamental in empirical exchange rate equations. As a byproduct analysis also suggests an intriguing possible explanation of the forward premium puzzle.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6694.

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Date of creation: Aug 1998
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Publication status: published as Helpman, Elhanan and Efraim Sadka (eds.) Contemporary Economic Policy: Essays in Honor of Assaf Razin. Cambridge University Press, 2003.
Handle: RePEc:nbr:nberwo:6694
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  1. 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.
  2. Miles S. Kimball, 1995. "The Quantitative Analytics of the Basic Neomonetarist Model," NBER Working Papers 5046, National Bureau of Economic Research, Inc.
  3. Alesina, Alberto & Summers, Lawrence H, 1993. "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 151-62, May.
  4. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, March.
  5. Frankel, Jeffrey A. & Meese, Richard, 1987. "Are Exchange Rates Excessively Variable?," Department of Economics, Working Paper Series qt18n4c5f6, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  6. Krugman, P., 1993. "What Do We Need to Know About the International Monetary System?," Princeton Studies in International Economics 190, International Economics Section, Departement of Economics Princeton University,.
  7. Richard Meese & Kenneth Rogoff, 1983. "The Out-of-Sample Failure of Empirical Exchange Rate Models: Sampling Error or Misspecification?," NBER Chapters, in: Exchange Rates and International Macroeconomics, pages 67-112 National Bureau of Economic Research, Inc.
  8. Flood, R.P. & Rose, A.K., 1992. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," Papers 529, Stockholm - International Economic Studies.
  9. Edward L. Whalen, 1966. "A Rationalization of the Precautionary Demand for Cash," The Quarterly Journal of Economics, Oxford University Press, vol. 80(2), pages 314-324.
  10. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
  11. Lewis, Karen K., 1995. "Puzzles in international financial markets," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 37, pages 1913-1971 Elsevier.
  12. Obstfeld, Maurice & Stockman, Alan C., 1985. "Exchange-rate dynamics," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 18, pages 917-977 Elsevier.
  13. Engel, Charles, 1992. "On the foreign exchange risk premium in a general equilibrium model," Journal of International Economics, Elsevier, vol. 32(3-4), pages 305-319, May.
  14. Obstfeld, Maurice, 1998. " Open-Economy Macroeconomics: Developments in Theory and Policy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 100(1), pages 247-75, March.
  15. Baxter, M. & Stockman, A.C., 1988. "Business Cycles And The Exchange Rate System: Some International Evidence," RCER Working Papers 140, University of Rochester - Center for Economic Research (RCER).
  16. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare and Macroeconomic Interdependence," The Quarterly Journal of Economics, Oxford University Press, vol. 116(2), pages 421-445.
  17. Andrew B. Abel, 1988. "Stock Prices Under Time-Varying Dividend Risk: An Exact Solution In An Infinite-Horizon General Equilibrium Model," NBER Working Papers 2621, National Bureau of Economic Research, Inc.
  18. Mussa, Michael, 1986. "Nominal exchange rate regimes and the behavior of real exchange rates: Evidence and implications," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 117-214, January.
  19. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  20. Hodrick, Robert J., 1989. "Risk, uncertainty, and exchange rates," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 433-459, May.
  21. Merton H. Miller & Daniel Orr, 1966. "A Model of the Demand for Money by Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 80(3), pages 413-435.
  22. Lars E.O. Svensson & Sweder van Wijnbergen, 1987. "Excess Capacity, Monopolistic Competition, and International Transmission of Monetary Disturbances," NBER Working Papers 2262, National Bureau of Economic Research, Inc.
  23. Baxter, Marianne & Stockman, Alan C., 1989. "Business cycles and the exchange-rate regime : Some international evidence," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 377-400, May.
  24. Lars E. O. Svensson, 1986. "Sticky Goods Prices, Flexible Asset Prices, Monopolistic Competition, and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 53(3), pages 385-405.
  25. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
  26. Svensson, Lars E. O., 1985. "Currency prices, terms of trade, and interest rates: A general equilibrium asset-pricing cash-in-advance approach," Journal of International Economics, Elsevier, vol. 18(1-2), pages 17-41, February.
  27. Rankin, Neil, 1998. "Nominal rigidity and monetary uncertainty in a small open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 22(5), pages 679-702, May.
  28. Stephen M. Goldfeld, 1973. "The Demand for Money Revisited," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 4(3), pages 577-646.
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