How Can Asset Prices Value Exchange Rate Wedges?

Karen Lewis and Edith Liu

No 2022-075, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

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: Exchange rates and foreign exchange; Asset prices; Financial integration; Social costs (search for similar items in EconPapers)
JEL-codes: F30 F31 F41 G10 G15 (search for similar items in EconPapers)
Pages: 77 p.
Date: 2022-11-07
New Economics Papers: this item is included in nep-ifn and nep-opm
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https://www.federalreserve.gov/econres/feds/files/2022075pap.pdf (application/pdf)

Related works:
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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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2022-75

DOI: 10.17016/FEDS.2022.075

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