Financial Integration, Liquidity and Exchange Rates

41 Pages Posted: 23 Apr 2004 Last revised: 12 Dec 2008

See all articles by Vittorio Grilli

Vittorio Grilli

Independent; National Bureau of Economic Research (NBER)

Nouriel Roubini

New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: August 1989

Abstract

This paper presents a two-country extension of Lucas' (1988) work on the effects of cash-in-advance constraints in asset markets on the pricing of financial assets. The model is one where there exists some degree of separation between the goods markets and the asset markets and money is used for transactions in both markets. The main results of the paper are the following. First, the equilibrium level of the exchange rate depends on the share of money used for asset transactions: a greater share will correspond to a more appreciated exchange rate. Second, under uncertainty, liquidity effects deriving from stochastic shocks to bond creation lead to an "excess" volatility of nominal and real exchange rates even when the "fundamental" value of the exchange rate is constant. Third, capital controls in the form of taxes on foreign asset acquisitions tend to appreciate the exchange rate. Fourth, the maturity structure of the public debt affects the equilibrium exchange rate. In particular, a move towards a longer maturity structure will tend to depreciate the exchange rate.

Suggested Citation

Grilli, Vittorio and Roubini, Nouriel, Financial Integration, Liquidity and Exchange Rates (August 1989). NBER Working Paper No. w3088. Available at SSRN: https://ssrn.com/abstract=283340

Vittorio Grilli

Independent

Ministero del Tesoro
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Nouriel Roubini (Contact Author)

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