Time-Varying Risk, Interest Rates, and Exchange Rates in General Equilibrium

Posted: 25 Jul 2008

See all articles by Fernando Alvarez

Fernando Alvarez

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Andrew Atkeson

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER)

Patrick J. Kehoe

Federal Reserve Bank of Minneapolis - Research Department; University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: March 1, 2006

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.

Keywords: Forward Premium Anomaly, Fama Puzzle, Time-Varying Conditional Variances, Asset Pricing-Puzzle, Segmented Markets, Pricing Kernel

JEL Classification: E43, F3, F31, F41, G12, G15

Suggested Citation

Alvarez, Fernando and Atkeson, Andrew G. and Kehoe, Patrick J., Time-Varying Risk, Interest Rates, and Exchange Rates in General Equilibrium (March 1, 2006). Available at SSRN: https://ssrn.com/abstract=1171795

Fernando Alvarez (Contact Author)

University of Chicago - Department of Economics ( email )

1126 East 59th Street
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Chicago, IL 60637
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773-702-4412 (Phone)
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National Bureau of Economic Research (NBER)

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Andrew G. Atkeson

University of California, Los Angeles (UCLA) - Department of Economics ( email )

Box 951477
Los Angeles, CA 90095-1477
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Patrick J. Kehoe

Federal Reserve Bank of Minneapolis - Research Department ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States
612-204-5525 (Phone)
612-204-5515 (Fax)

University of Minnesota - Twin Cities - Department of Economics ( email )

271 19th Avenue South
Minneapolis, MN 55455
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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