On the Foreign-Exchange Risk Premium in Sticky-Price General Equilibrium Models

Charles Engel

No 7067, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper investigates the behavior of the foreign exchange risk premium in two recent two-country intertemporal-optimizing general equilibrium models with sticky nominal prices: Obstfeld-Rogoff (1998) and Devereux-Engel (1998). The foreign exchange risk premium in any general equilibrium model arises from the correlation of the exchange rate with consumption. In flexible price models, that requires correlation of monetary and output supply shocks. In sticky-price models, the correlation arises endogenously because monetary shocks cause output and consumption to change. The size of the risk premium depends on how prices are set (in producers' currencies versus consumers' currencies), and on the form of the money demand function. In some cases, the risk premium generated by the model is quite large.

JEL-codes: F3 F4 (search for similar items in EconPapers)
Date: 1999-04
New Economics Papers: this item is included in nep-dge, nep-ifn and nep-mon
Note: AP IFM
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Citations: View citations in EconPapers (23)

Published as Isard, Peter, Assaf Razin and Andrew Rose (eds.) International Finance and Financial Crises: Essays in Honor of Robert P. Flood, Jr. Kluwer Academic Publishers, 1999.
Published as International Tax and Public Finance, Vol. 6 (1999): 491-505.

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Journal Article: On the Foreign Exchange Risk Premium in Sticky-Price General Equilibrium Models (1999)
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