International Price Dispersion in State-Dependent Pricing Models

Virgiliu Midrigan
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Virgiliu Midrigan: Ohio State University

International Finance from EconWPA

Abstract: Studies of disaggregated international price data document a robust, positive relationship between nominal exchange (NER) volatility and the variability of international relative prices. This relationship is interpreted as evidence that sticky prices rather than trade frictions are the source of the large law of one price deviations across locations. This paper shows that an explicitly micro-founded, menu-cost model predicts a hump-shaped rather than a monotonic relationship between relative price and nominal exchange rate volatility. The hump occurs at higher nominal exchange rate volatilities the less tradeable the goods are. We use this implication of the model to identify the size of the physical barriers that separate nations. Ad valorem trade costs as large as 50 percent are necessary for the model to generate the type of international relative price movements observed in the data.

Keywords: PPP; Law of One Price; menu costs; trade costs (search for similar items in EconPapers)
JEL-codes: E30 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin, nep-ifn, nep-int and nep-mac
Date: 2005-11-01
Note: Type of Document - pdf; pages: 49
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpif:0511001

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