Exchange Rates and Fundamentals:Closing a Two-country Model

Takashi Kano

No 11, UTokyo Price Project Working Paper Series from University of Tokyo, Graduate School of Economics

Abstract: In an influential paper, Engel and West (2005) claim that the near random-walk behavior of nom- inal exchange rates is an equilibrium outcome of a variant of present-value models when economic fundamentals follow exogenous first-order integrated processes and the discount factor approaches one. Subsequent empirical studies further confirm this proposition by estimating a discount factor that is close to one under distinct identification schemes. In this paper, I argue that the unit market discount factor implies the counterfactual joint equilibrium dynamics of random-walk ex- change rates and economic fundamentals within a canonical, two-country, incomplete market model. Bayesian posterior simulation exercises of a two-country model based on post-Bretton Woods data from Canada and the United States reveal difficulties in reconciling the equilibrium random-walk proposition within the two-country model; in particular, the market discount factor is identified as being much lower than one.

Keywords: Exchange rates; Present-value model; Economic fundamentals; Random walk; Two- country model; Incomplete markets; Cointegrated TFPs; Debt elastic risk premium. (search for similar items in EconPapers)
JEL-codes: E31 E37 F41 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2013-09
New Economics Papers: this item is included in nep-cba, nep-int, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
http://www.price.e.u-tokyo.ac.jp/img/researchdata/pdf/p_wp017.pdf (application/pdf)

Related works:
Working Paper: Exchange Rates and Fundamentals: Closing a Two-country Model (2014)
Working Paper: Exchange Rates and Fundamentals: Closing a Two-country Model (2013)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:upd:utppwp:011

Access Statistics for this paper

More papers in UTokyo Price Project Working Paper Series from University of Tokyo, Graduate School of Economics University of Tokyo 702 Faculty of Economics, The University of Tokyo, 7-3-1 Hongo, Bunkyo-ku, Tokyo, 113-0033, Japan. Contact information at EDIRC.
Bibliographic data for series maintained by Yayoi Hatano ().