Exchange Rates Dynamics with Long-Run Risk and Recursive Preferences

Robert Kollmann ()

Working Papers ECARES from ULB -- Universite Libre de Bruxelles

Abstract: Standard macro models cannot explain why real exchange rates are volatile anddisconnected from macro aggregates. Recent research argues that models with persistentgrowth rate shocks and recursive preferences can solve that puzzle. I show that this resultis highly sensitive to the structure of financial markets. When just a bond is tradedinternationally, then long-run risk generates insufficient exchange rate volatility. A longrunrisk model with recursive-preferences can generate realistic exchange rate volatility,if all agents efficiently share their consumption risk by trading in complete financialmarkets; however, this entails massive international wealth transfers, and excessiveswings in net foreign asset positions. By contrast, a long-run risk, recursive-preferencesmodel in which only a fraction of households trades in complete markets, while theremaining households lead hand-to-mouth lives, can generate realistic exchange rate andexternal balance volatility.

Keywords: exchange rate; long-run risk; recursive preferences; complete financial markets; financial frictions; international risk sharing (search for similar items in EconPapers)
JEL-codes: F31 F36 F41 F43 (search for similar items in EconPapers)
Pages: 27 p.
Date: 2014-11
New Economics Papers: this item is included in nep-dge, nep-opm and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Published by:

Downloads: (external link)
https://dipot.ulb.ac.be/dspace/bitstream/2013/1771 ... OLLMANN-Exchange.pdf 2014-49-KOLLMANN-Exchange (application/pdf)

Related works:
Journal Article: Exchange Rates Dynamics with Long-Run Risk and Recursive Preferences (2015)
Working Paper: Exchange Rates Dynamics with Long-Run Risk and Recursive Preferences (2014)
Working Paper: Exchange Rates Dynamics with Long-Run Risk and Recursive Preferences (2014)
Working Paper: Exchange rates dynamics with long-run risk and recursive preferences (2014)
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:eca:wpaper:2013/177116

Ordering information: This working paper can be ordered from
http://hdl.handle.ne ... lb.ac.be:2013/177116

Access Statistics for this paper

More papers in Working Papers ECARES from ULB -- Universite Libre de Bruxelles Contact information at EDIRC.
Bibliographic data for series maintained by Benoit Pauwels ().