International Financial Market Integration, Asset Compositions, and the Falling Exchange Rate Pass-Through
43 Pages Posted: 21 Jun 2016
Date Written: 2015
This paper provides an explanation for the observed decline of the exchange rate pass-through into import prices by modeling the effects of financial market integration on the optimal choice of the pricing currency in the context of rigid nominal goods prices. Contrary to previous literature, we take the interdependence of this choice with the optimal portfolio choice of internationally traded financial assets explicitly into account. In particular, price setters move towards more localcurrency pricing and portfolios include more foreign debt assets following increased financial integration. Both predictions are in line with novel empirical evidence.
Keywords: exchange rate pass-through, financial integration, portfolio home bias, international price setting
JEL Classification: F41, F36, F31
Suggested Citation: Suggested Citation