The Equilibrium Approach to Exchange Rates: Theory and Tests / Prakash Apte, Piet Sercu, Raman Uppal.

Format:

Book

Author/Creator:

Apte, Prakash.

Contributor:

National Bureau of Economic Research.

Sercu, Piet.

Uppal, Raman.

Series:

Working Paper Series (National Bureau of Economic Research) no. w5748.

NBER working paper series no. w5748

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

The Equilibrium Approach to Exchange Rates

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1996.

Summary:

We characterize the equilibrium exchange rate in a general equilibrium economy without imposing strong restrictions on the output processes, preferences, or commodity market imperfections. The nominal exchange rate is determined by differences in initial wealths the currencies of richer countries tend to be overvalued by PPP standards and by differences of marginal indirect utilities of total nominal spending. Changes in the exchange rate mirror differences in growth rates of real spending weighted by relative risk-aversion (which can be time-varying and can differ across countries), and in the case of non-homothetic utility functions, differences in inflation rates computed from marginal spending weights. Thus, standard regression or cointegration tests of PPP suffer from missing-variables biases and ignore variations in risk aversions across countries and over time. We also present cointegration tests of the version of the model with constant relative risk aversion (CRRA) and homothetic preferences. When nominal spending is given an independent role (next to prices) in the short-term dynamics, both PPP and the CRRA model become acceptable.

Notes:

Print version record

September 1996.