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 (i) traded and non-traded sectors; (ii) financial market incompleteness; (iii) preference shocks; (iv) deviations from UIP condition for the exchange rates; and (v) 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||Scottish Institute for Research in Economics|
|Publication status||Published - 2008|
|Name||SIRE Discussion Papers|
- current account dynamics
- real exchange rates
- incomplete markets
- financial frictions
Bhattacharjee, A., Sun, Q., & Chadha, J. S. (2008). Productivity, preferences and UIP deviations in an open economy business cycle model. (SIRE Discussion Papers). Scottish Institute for Research in Economics.