Solving Exchange Rates Puzzles with neither Sticky Prices nor Trade Costs

Roche, Dr Maurice J. and Moore, Michail (2007) Solving Exchange Rates Puzzles with neither Sticky Prices nor Trade Costs. UNSPECIFIED. (Unpublished)

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We present a simple framework in which both the exchange rates disconnect and forward bias puzzles are simultaneously resolved. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habit persistence is modeled using Campbell Cochrane preferences with ‘deep’ habits. By deep habits, we mean habits defined over goods rather than countries. The model is simulated using the artificial economy methodology. It offers a neo-classical explanation of the Meese-Rogoff puzzle and mimics the failure of fundamentals to explain nominal exchange rates in a linear setting. Finally, the model naturally generates the negative slope in the standard forward market regression.

Item Type: Other
Additional Information: JEL classification: F31; F41; G12
Keywords: Exchange Rate Puzzles; Forward Foreign Exchange; Habit Persistence
Academic Unit: Faculty of Social Sciences > Economics, Finance and Accounting
Item ID: 532
Depositing User: Ms Sandra Doherty
Date Deposited: 30 May 2007
Refereed: No

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