Does Exchange Rate Risk Matter for Welfare?, Issue 9900
National Bureau of Economic Research, 2003 - Foreign exchange rates - 28 pages
Volatility in exchange rates is a prominent feature of open economies, a fact which has motivated elaborate attempts in many countries at exchange rate management. This paper analyzes quantitatively the welfare effects of exchange rate risk in a general two-country environment. It finds that the effects of uncertainty tend to be small for the types of simplified cases considered in past literature. But it identifies other cases, not considered previously, in which these effects can be significantly larger. These include habit persistence, where agents are more sensitive to risk, and also incomplete asset market structures which allow for asymmetries between countries. The latter case suggests that countries which are hosts to an international reserve currency, such as the U.S. or members of the euro zone, may accrue.
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Asymmetric Asset Market Bacchetta benchmark model Benigno bond business cycle calibrated changes compute consumption and leisure deterministic steady Devereux and Engel difference between stochastic effects of exchange effects of risk equilibrium equity premium puzzle exchange rate regime exchange rate risk exchange rate variability fixed exchange rate flexible exchange rate foreign assets foreign country foreign currency forward contracts habit persistence hedge against exchange home and foreign home country implies instructions inside interest rate interest rate parity investment Kollmann large welfare effects literature markup monetary shocks money demand shocks Nash equilibrium NBER Working Papers Obstfeld and Rogoff optimal policy rule output papers in hard parameter Partial Subscription percent of steady price setting quantitatively reserve currency result risk aversion Standard deviations steady state consumption sticky price stochastic steady technology shocks trade volume two-country model u-mean u-overall U.S. dollar unconditional expectations unit root utility function variance welfare costs Wincoop WtHt