Solving exchange rate puzzles with neither sticky prices nor trade costs

Michael Moore and Maurice Roche

Journal of International Money and Finance, 2010, vol. 29, issue 6, 1151-1170

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 along the lines of the work of Ravn, Schmitt-Grohe and Uribe. 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)
Date: 2010
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Citations: View citations in EconPapers (32)

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Related works:
Working Paper: Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs (2009)
Working Paper: Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:29:y:2010:i:6:p:1151-1170

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