An Intermediation-Based Model of Exchange Rates
85 Pages Posted: 6 Mar 2018 Last revised: 5 Sep 2018
Date Written: June 5, 2018
We develop a general equilibrium model with intermediaries at the heart of international financial markets. In our model, intermediaries bargain with their customers and extract rents for providing access to foreign claims. The behavior of intermediaries, by tilting state prices, generates an explicit, non-linear risk structure in exchange rates. We show how this endogenous risk structure helps explain a number of anomalies in foreign exchange and international capital markets, including the safe haven properties of exchange rates and the breakdown of covered interest parity.
Keywords: exchange rates, dollar, covered interest parity deviations, currency skew, currency crashes
JEL Classification: E44, E52, F31, F33, G13, G15, G23
Suggested Citation: Suggested Citation