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Exchange rate dynamics, asset market structure and the role of the trade elasticity

  • Christoph Thoenissen

    ()

This paper shows that a canonical flexible price international real business cycle model with incomplete financial markets can address the exchange rate volatility puzzle, the exchange rate persistence puzzle, the consumption real exchange rate anomaly, as well as the quantity anomaly. Crucial for the success of the model is the choice of the elasticity of substitution between home and foreign produced goods. The paper shows that the range of this parameter which allows the model to address these international macroeconomics anomalies is very narrow. Furthermore, the paper highlights an anomalous relationship between real exchange rate persistence and the elasticity of substitution between home and foreign-produced goods.

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File URL: http://www.st-andrews.ac.uk/economics/CDMA/papers/wp0803.pdf
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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200803.

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Date of creation: 15 Jan 2008
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Handle: RePEc:san:cdmawp:0803
Contact details of provider: Postal: School of Economics and Finance, University of St. Andrews, Fife KY16 9AL
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Web page: http://www.st-andrews.ac.uk/cdma
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  1. Parantap Basu & Christoph Thoenissen, 2007. "Investment Frictions and the Relative Price of Investment Goods in an Open Economy Model," CDMA Working Paper Series 200704, Centre for Dynamic Macroeconomic Analysis, revised 15 Aug 2007.
  2. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2008. "International Risk Sharing and the Transmission of Productivity Shocks," Review of Economic Studies, Oxford University Press, vol. 75(2), pages 443-473.
  3. Benigno, Gianluca & Thoenissen, Christoph, 2008. "Consumption and real exchange rates with incomplete markets and non-traded goods," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 926-948, October.
  4. 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.
  5. 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.
  6. 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.
  7. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  8. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 121-149, 02.
  9. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
  10. Alan C. Stockman & Linda L. Tesar, 1991. "Tastes and technology in a two-country model of the business cycle: explaining international co-movements," Working Paper 9019, Federal Reserve Bank of Cleveland.
  11. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  12. Harold L. Cole & Maurice Obstfeld, 1989. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
  13. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2006. "Productivity, External Balance and Exchange Rates: Evidence on the Transmission Mechanism among G7 Countries," CEPR Discussion Papers 5853, C.E.P.R. Discussion Papers.
  14. King, Robert G & Watson, Mark W, 1998. "The Solution of Singular Linear Difference Systems under Rational Expectations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 1015-26, November.
  15. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March.
  16. Enders, Zeno & Müller, Gernot J., 2009. "On the international transmission of technology shocks," Journal of International Economics, Elsevier, vol. 78(1), pages 45-59, June.
  17. Martin Bodenstein, 2006. "Closing open economy models," International Finance Discussion Papers 867, Board of Governors of the Federal Reserve System (U.S.).
  18. Lucrezia Reichlin & Kenneth West, 2008. "NBER International Seminar on Macroeconomics 2006," NBER Books, National Bureau of Economic Research, Inc, number reic08-1, June.
  19. 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.
  20. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
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