Dynamics of Real Exchange Rates and Trade Balance In The Presence of Heterogeneous Preferences and Incomplete Financial Markets

Geun Mee Ahn and Young-jae Kim
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Geun Mee Ahn: Kangwon University
Young-jae Kim: Pusan National University

Korean Economic Review, 2005, vol. 21, 213-235

Abstract: When agents across countries have home-biased preferences in a world of incomplete financial markets, an increase in the relative price of home-produced goods resulted from a permanent adverse home output shock makes the cost of living of home agents higher than that of foreign agents, reducing home relative consumption. Intertemporal utility maximizng agents with the degree of relative risk aversion greater than unity in the CES utility function would like to smooth their relative consumption by reducing exports and increasing imports, resulting in trade deficit.

Keywords: heterogeneous preferences; incomplete financial markets; relative cost of living; real exchange rates; relative consumption; trade balance (search for similar items in EconPapers)
JEL-codes: E58 E61 F33 F41 F42 (search for similar items in EconPapers)
Date: 2005
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