An Intermediation-Based Model of Exchange Rates
58 Pages Posted: 6 Mar 2018 Last revised: 1 Sep 2020
Date Written: June 5, 2018
We develop a general equilibrium model with intermediaries at the heart of international financial markets. Global intermediaries bargain with households and extract rents for providing access to foreign claims. The behavior of intermediaries, by tilting state prices, breaks monetary neutrality and generates an explicit, non-linear risk structure in exchange rates. Despite having zero net positions, intermediaries significantly distort exchange rate dynamics, affecting both the magnitude and sign of the response of exchange rates to shocks. In particular, our model is able to produce patterns that are both qualitatively and quantitatively consistent with several well-known exchange rate puzzles.
Keywords: Financial Intermediation, Exchange Rates, Currency Crashes, Uncovered Interest Parity, Covered Interest Parity
JEL Classification: E44, E52, F31, F33, G13, G15, G23
Suggested Citation: Suggested Citation