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Currency Portfolios and Currency Exchange in a Search Economy

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  • Waller, Christopher Jude
  • Craig, Ben R.

Abstract

We develop a dual currency search model to study equilibrium currency exchange and the determination of nominal exchange rates. Agents hold portfolios consisting of two distinct currencies. We study equilibria in which the two currencies are identical and equilibria in which the two currencies differ according to their relative purchasing power risk. We use numerical methods to solve for the steady-state distributions of currency portfolios, nominal exchange rates and value functions. When one of the currencies is 'risky', equilibria exist in which the safe currency trades for multiple units of the risky currency with the observed ratio being the nominal exchange rate. However, due to the decentralized trading environment, we obtain a steady state distribution of nominal exchange rates. The mean and variance of the nominal exchange rate distribution are based on the fundamentals of the model and change in predictable ways when the fundamentals change.

Suggested Citation

  • Waller, Christopher Jude & Craig, Ben R., 2001. "Currency Portfolios and Currency Exchange in a Search Economy," Discussion Paper Series 1: Economic Studies 2001,15, Deutsche Bundesbank.
    • Handle: RePEc:zbw:bubdp1:4160
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    References listed on IDEAS

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    1. Berentsen, Aleksander & Molico, Miguel & Wright, Randall, 2002. "Indivisibilities, Lotteries, and Monetary Exchange," Journal of Economic Theory, Elsevier, vol. 107(1), pages 70-94, November.
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    4. Miguel Molico, 2006. "The Distribution Of Money And Prices In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 701-722, August.
    5. Green, Edward J. & Zhou, Ruilin, 1998. "A Rudimentary Random-Matching Model with Divisible Money and Prices," Journal of Economic Theory, Elsevier, vol. 81(2), pages 252-271, August.
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    7. John Kareken & Neil Wallace, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 96(2), pages 207-222.
    8. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
    9. Christopher J. Waller & Elisabeth S. Curtis, 2003. "Currency restrictions, government transaction policies and currency exchange," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 21(1), pages 19-42, January.
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    12. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-141, February.
    13. Kiyotaki, Nobuhiro & Wright, Randall, 1993. "A Search-Theoretic Approach to Monetary Economics," American Economic Review, American Economic Association, vol. 83(1), pages 63-77, March.
    14. Li, Victor E, 1995. "The Optimal Taxation of Fiat Money in Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(4), pages 927-942, November.
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    Cited by:

    1. Camera, Gabriele & Craig, Ben & Waller, Christopher J., 2004. "Currency competition in a fundamental model of money," Journal of International Economics, Elsevier, vol. 64(2), pages 521-544, December.
    2. Craig, Ben & Waller, C.J.Christopher J., 2004. "Dollarization and currency exchange," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 671-689, May.

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