Why Are Exchange Rates So Smooth? A Household Finance Explanation

YiLi Chien, Hanno Lustig and Kanda Naknoi

No 2015-39, Working Papers from Federal Reserve Bank of St. Louis

Abstract: Empirical moments of asset prices and exchange rates imply that pricing kernels are almost perfectly correlated across countries. Otherwise, observed real exchange rates would be too smooth for high Sharpe ratios. However, the cross country correlation among macro fundamentals is weak. We reconcile these facts in a two-country stochastic growth model with heterogeneous households and a home bias in consumption. In our model, only a small fraction of households trade domestic and foreign equities. We show that this mechanism can quantitatively account for the smoothness of exchange rates in the presence of volatile pricing kernels and weakly correlated macro fundamentals.

Keywords: Asset pricing; Market segmentation; Exchange rates; International risk sharing (search for similar items in EconPapers)
JEL-codes: F10 F31 G12 G15 (search for similar items in EconPapers)
Date: 2015-11-27
New Economics Papers: this item is included in nep-dge, nep-ifn and nep-opm
Note: Previous title: Why Are Exchange Rates So Smooth? A Segmented Asset Markets Explanation
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Citations: View citations in EconPapers (4)

Published in Journal of Monetary Economics

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Related works:
Journal Article: Why are exchange rates so smooth? A household finance explanation (2020)
Working Paper: Why Are Exchange Rates So Smooth? A Household Finance Explanation (2017)
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DOI: 10.20955/wp.2015.039

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