Year of Graduation
Exchange Rate Dynamics in General Equilibrium Models
The main problems of open economy modeling is real exchange rate high volatility and persistence, as well as the lack of correlation with the relative consumption. Theoretical models fails to predict these properties. There is a trade-off between prediction of volatility and persistence (with perfect financial markets) and correlation of real exchange rate with relative consumption (with imperfect financial markets). This paper shows that inclusion of non-ricardian households in perfect financial markets framework provides a significant reduction in correlation while the volatility and persistence rise. Thus, this hypothesis can improve the predictive ability of the stochastic model as far as all three main characteristics of the real exchange rate are concerned.