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International Price Dispersion in State-Dependent Pricing Models

  • Virgiliu Midrigan

    (Ohio State University)

Studies of disaggregated international price data document a robust, positive relationship between nominal exchange (NER) volatility and the variability of international relative prices. This relationship is interpreted as evidence that sticky prices rather than trade frictions are the source of the large law of one price deviations across locations. This paper shows that an explicitly micro-founded, menu-cost model predicts a hump-shaped rather than a monotonic relationship between relative price and nominal exchange rate volatility. The hump occurs at higher nominal exchange rate volatilities the less tradeable the goods are. We use this implication of the model to identify the size of the physical barriers that separate nations. Ad valorem trade costs as large as 50 percent are necessary for the model to generate the type of international relative price movements observed in the data.

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Paper provided by EconWPA in its series International Finance with number 0511001.

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Length: 49 pages
Date of creation: 01 Nov 2005
Date of revision:
Handle: RePEc:wpa:wuwpif:0511001
Note: Type of Document - pdf; pages: 49
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