We show that a flex-price two-sector open economy DSGE model can explain the poor degree of international risk sharing and exchange rate disconnect. We use a suite of model evaluation measures and examine the role of (1) traded and non-traded sectors; (2) financial market incompleteness; (3) preference shocks; (4) deviations from UIP condition for the exchange rates; and (5) creditor status in net foreign assets. We find that there is a good case for both traded and non-traded productivity shocks as well as UIP deviations in explaining the puzzles.
|Place of Publication||St. Andrews|
|Publisher||Centre for Dynamic Macroeconomic Analysis|
|Publication status||Published - 2008|
|Name||CDMA Working Paper Series|
- current account dynamics
- real exchange rates
- financial frictions
- incomplete markets
Bhattacharjee, A., Chadha, J. S., & Sun, Q. (2008). Productivity, preferences and UIP deviations in an open economy business cycle model. (CDMA Working Paper Series). Centre for Dynamic Macroeconomic Analysis.