Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs

Maurice Roche and Michael Moore

Economics Department Working Paper Series from Department of Economics, National University of Ireland - Maynooth

Abstract: 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.

Keywords: Exchange Rate Puzzles; Forward Foreign Exchange; Habit Persistence (search for similar items in EconPapers)
JEL-codes: F31 F41 G12 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2007
New Economics Papers: this item is included in nep-cba, nep-cfn, nep-ifn and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Journal Article: Solving exchange rate puzzles with neither sticky prices nor trade costs (2010)
Working Paper: Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:may:mayecw:n1750507

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