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The origin of the law of one price deviations: Insights from the good-level real exchange rate volatility

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  • Nakamura, Fumitaka

Abstract

What is the origin of the law of one price deviation? To address this issue, this paper exploits the properties of good-level real exchange rate (RER) volatility; nominal (real) shocks predict the positive (negative) correlation between price stickiness and volatility. Using the US and 25 European countries, we estimate the contribution of each shock based on a two-country model in local currency pricing and the empirical analysis. The results indicate that the weighted average contribution of nominal shocks to the overall good-level RER volatility is 71%.

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  • Nakamura, Fumitaka, 2022. "The origin of the law of one price deviations: Insights from the good-level real exchange rate volatility," Journal of International Money and Finance, Elsevier, vol. 128(C).
    • Handle: RePEc:eee:jimfin:v:128:y:2022:i:c:s0261560622001206
    DOI: 10.1016/j.jimonfin.2022.102717
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    More about this item

    Keywords

    Real exchange rate; The law of one price; Local currency pricing;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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