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: Fama Puzzle, Asset Pricing-Puzzle, Segmented Markets, Pricing Kernel, Time-Varying Conditional Variances, and Forward Premium Anomaly Subject (JEL): G15 - International Financial Markets, F31 - Foreign Exchange, F41 - Open Economy Macroeconomics, F30 - International Finance: General, E43 - Interest Rates: Determination, Term Structure, and Effects, and G12 - Asset Pricing; Trading Volume; Bond Interest Rates