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Time-varying risk, interest rates, and exchange rates in general equilibrium

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  • Fernando Alvarez
  • Andrew Atkeson
  • Patrick J. Kehoe

Abstract

Under mild assumptions, the data indicate that fluctuations in nominal interest rate differentials across currencies are primarily fluctuations in time-varying risk. This finding is an immediate implication of the fact that exchange rates are roughly random walks. If most fluctuations in interest differentials are thought to be driven by monetary policy, then the data call for a theory which explains how changes in monetary policy change risk. Here we propose such a theory based on a general equilibrium monetary model with an endogenous source of risk variation - a variable degree of asset market segmentation.

Suggested Citation

  • Fernando Alvarez & Andrew Atkeson & Patrick J. Kehoe, . "Time-varying risk, interest rates, and exchange rates in general equilibrium," Staff Report, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:371
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    References listed on IDEAS

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    Cited by:

    1. Faust, Jon & Rogers, John H. & Wang, Shing-Yi B. & Wright, Jonathan H., 2007. "The high-frequency response of exchange rates and interest rates to macroeconomic announcements," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1051-1068, May.
    2. Andrew Atkeson & Patrick J. Kehoe, 2009. "On the Need for a New Approach to Analyzing Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 2008, Volume 23, pages 389-425, National Bureau of Economic Research, Inc.
    3. Tarek Alexander Hassan, 2010. "Country Size, Currency Areas, and International Asset Returns," 2010 Meeting Papers 365, Society for Economic Dynamics.
    4. Fabio Ghironi & Karen K. Lewis, 2011. "Equity Sales and Manager Efficiency Across Firms and the Business Cycle," IMES Discussion Paper Series 11-E-07, Institute for Monetary and Economic Studies, Bank of Japan.
    5. Philippe Bacchetta & Eric Van Wincoop, 2006. "Incomplete information processing: a solution to the forward discount puzzle," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
    6. Monika Piazzesi & Martin Schneider, 2007. "Equilibrium Yield Curves," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 389-472, National Bureau of Economic Research, Inc.
    7. Tarek A. Hassan, 2013. "Country Size, Currency Unions, and International Asset Returns," Journal of Finance, American Finance Association, vol. 68(6), pages 2269-2308, December.
    8. Perron, Pierre & Wada, Tatsuma, 2009. "Let's take a break: Trends and cycles in US real GDP," Journal of Monetary Economics, Elsevier, vol. 56(6), pages 749-765, September.
    9. Tarek A Hassan & Rui C Mano, 2019. "Forward and Spot Exchange Rates in a Multi-Currency World," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 134(1), pages 397-450.
    10. repec:onb:oenbwp:y::i:154:b:1 is not listed on IDEAS
    11. David Backus & Mikhail Chernov & Ian Martin, 2011. "Disasters Implied by Equity Index Options," Journal of Finance, American Finance Association, vol. 66(6), pages 1969-2012, December.
    12. Andrew Atkeson & Patrick J. Kehoe, . "On the need for a new approach to analyzing monetary policy," Staff Report, Federal Reserve Bank of Minneapolis.
    13. Fernando Alvarez & Andrew Atkeson & Patrick J. Kehoe, . "If exchange rates are random walks, then almost everything we say about monetary policy is wrong," Staff Report, Federal Reserve Bank of Minneapolis.
    14. Fernando Alvarez & Andrew Atkeson & Chris Edmond, 2008. "Sluggish responses of prices and inflation to monetary shocks in an inventory model of money demand," Staff Report, Federal Reserve Bank of Minneapolis.
    15. Fernando Alvarez & Andrew Atkeson & Patrick J. Kehoe, 2008. "If exchange rates are random walks, then almost everything we say about monetary policy is wrong," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Jul, pages 2-9.
    16. Christopher J. Gust & J. David López-Salido, 2009. "Portfolio inertia and the equity premium," International Finance Discussion Papers 984, Board of Governors of the Federal Reserve System (U.S.).
    17. Eichenbaum, Martin & Rebelo, Sérgio & Burnside, Craig & Kleshchelski, Isaac, 2006. "The Returns to Currency Speculation," CEPR Discussion Papers 5883, C.E.P.R. Discussion Papers.
    18. Maurice J. Roche & Michael J. Moore, 2010. "For Rich or for Poor: When does Uncovered Interest Parity Hold?," Working Papers 015, Toronto Metropolitan University, Department of Economics.

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