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Do Sticky Prices Increase Real Exchange Rate Volatility at the Sector Level?

  • Mario J. Crucini

    ()

    (Department of Economics, Vanderbilt University)

  • Mototsugu Shintani

    ()

    (Department of Economics, Vanderbilt University)

  • Takayuki Tsuruga

    ()

    (Graduate School of Economics, Kyoto University)

We introduce the real exchange rate volatility curve as a useful device to understand the relationship between price stickiness and the fluctuations in Law of One Price deviations. In the presence of both nominal and real shocks, the theory predicts that the real exchange rate volatility curve is a U-shaped function of the degree of price stickiness. Using sector-level US-European real exchange rate data and frequency of price changes, we estimate the volatility curve and find the predominance of real effects over nominal effects. Good-by-good variance decompositions show that the relative contribution of nominal shocks is smaller at the sector level than what previous studies have found at the aggregate level. We conjecture that this is due to significant averaging out of good-specific real microeconomic shocks in the process of aggregation.

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Paper provided by Vanderbilt University Department of Economics in its series Vanderbilt University Department of Economics Working Papers with number 1120.

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Date of creation: Jun 2010
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Handle: RePEc:van:wpaper:1120
Contact details of provider: Web page: http://www.vanderbilt.edu/econ/wparchive/index.html

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