Creator: Alvarez, Fernando, 1964-, Atkeson, Andrew, and Kehoe, Patrick J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 371 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.
Keyword: Time-Varying Conditional Variances, Forward Premium Anomaly, Pricing Kernel, Segmented Markets, Asset Pricing-Puzzle, and Fama Puzzle Subject (JEL): F41 - Open Economy Macroeconomics, F30 - International Finance: General, G15 - International Financial Markets, E43 - Interest Rates: Determination, Term Structure, and Effects, F31 - Foreign Exchange, and G12 - Asset Pricing; Trading Volume; Bond Interest Rates