International Financial Market Integration, Asset Compositions, and the Falling Exchange Rate Pass-Through

45 Pages Posted: 19 Jun 2017

See all articles by Almira Enders

Almira Enders

Deutsche Bundesbank

Zeno Enders

University of Heidelberg

Mathias Hoffmann

Deutsche Bundesbank

Date Written: December 2017

Abstract

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 explicitly take into account the interdependence of this decision with the optimal portfolio choice of internationally traded financial assets. Following financial integration, agents use equity, additional to bonds, to hedge against shocks. The resulting optimal portfolio includes a higher share of bonds denominated in foreign currency and impacts the correlation structure of costs and sales in such a way that producers move towards more local-currency pricing. Both predictions are in line with novel empirical evidence.

Keywords: exchange rate pass-through, financial integration, portfolio home bias, international price setting

JEL Classification: F410, F360, F310

Suggested Citation

Enders, Almira and Enders, Zeno and Hoffmann, Mathias, International Financial Market Integration, Asset Compositions, and the Falling Exchange Rate Pass-Through (December 2017). CESifo Working Paper Series No. 6483. Available at SSRN: https://ssrn.com/abstract=2988926

Almira Enders

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Zeno Enders (Contact Author)

University of Heidelberg ( email )

Mathias Hoffmann

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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