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EXCHANGE RATE DYNAMICS, ASSET MARKET STRUCTURE, AND THE ROLE OF THE TRADE ELASTICITY

Published online by Cambridge University Press:  07 April 2010

Christoph Thoenissen
Christoph Thoenissen*
Affiliation:
Victoria University of Wellington
*
Address correspondence to: Christoph Thoenissen, School of Economics and Finance, Victoria University of Wellington, P.O. Box 600, Wellington, New Zealand; e-mail: [email protected].
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Abstract

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, and 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 that 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.

Keywords

Real Exchange Rate DynamicsIncomplete Financial MarketsBackus–Smith PuzzleExchange Rate PersistenceTrade Elasticity
Type
Articles
Information
Macroeconomic Dynamics , Volume 15 , Issue 1 , February 2011 , pp. 119 - 143
Copyright
Copyright © Cambridge University Press 2010

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