An Intermediation-Based Model of Exchange Rates
52 Pages Posted: 30 Oct 2018
Date Written: September 13, 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: financial intermediation, exchange rates, safe haven, covered interest
JEL Classification: E44, E52, F31, F33, G13, G15, G23
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