Risk and Exchange Rates

49 Pages Posted: 12 Nov 1998 Last revised: 14 May 2000

See all articles by Maurice Obstfeld

Maurice Obstfeld

University of California, Berkeley; Peterson Institute for International Economics; National Bureau of Economic Research; Centre for Economic Policy Research

Kenneth Rogoff

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

Date Written: August 1998

Abstract

This paper develops an explicitly stochastic new open economy macroeconomics' model, which can potentially be used to explore the qualitative and quantitative welfare differences between alternative exchange rate regimes. A crucial feature is that we do not simplify by assuming certainty equivalence for producer price setting behavior. Our framework also provides a sticky-price alternative to Lucas's (1982) exchage rate risk premium model. We show that the level risk premium' in the exchage rate is potentially quite large and may be an important missing fundamental in empirical exchange rate equations. As a byproduct analysis also suggests an intriguing possible explanation of the forward premium puzzle.

Suggested Citation

Obstfeld, Maurice and Rogoff, Kenneth S., Risk and Exchange Rates (August 1998). NBER Working Paper No. w6694. Available at SSRN: https://ssrn.com/abstract=122308

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