How Can Asset Prices Value Exchange Rate Wedges?

Karen Lewis and Edith Liu

No 17596, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: When available financial securities allow investors to optimally diversify risk across countries, standard theory implies that exchange rates should reflect this behavior. However, exchange rates observed in the data deviate from these predictions. In this paper, we develop a framework to value the welfare costs of these exchange rate wedges, as disciplined by asset returns. This framework applies to a general class of asset pricing and exchange rate models. We further decompose the value of these wedges into components, showing that the ability of goods markets to respond to financial markets through exchange rate adjustment has significant implications for welfare.

Keywords: International spillovers; Incomplete and complete markets (search for similar items in EconPapers)
JEL-codes: F30 F31 F41 G10 G15 (search for similar items in EconPapers)
Date: 2022-10
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Working Paper: How Can Asset Prices Value Exchange Rate Wedges? (2022)
Working Paper: How Can Asset Prices Value Exchange Rate Wedges? (2022)
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