Market Incompleteness and Exchange Rate Spill-over
45 Pages Posted: 8 Jun 2021 Last revised: 11 Jan 2023
There are 2 versions of this paper
Market Incompleteness and Exchange Rate Spill-over
Market Incompleteness and Exchange Rate Spill-Over
Date Written: June 7, 2021
Abstract
I develop a general characterization of the effect that market incompleteness has on exchange rate dynamics. On the one hand, it weakens the pass-through from a country's marginal utility shocks to its own exchange rate movements; on the other hand, it gives rise to additional variations in exchange rates and propagates one country's marginal utility shocks to other countries' exchange rate movements. This novel international spill-over effect gives rise to both exchange rate disconnect from local fundamentals and exchange rate comovements in the cross-section of currencies, offering a novel channel for understanding these salient features of exchange rate behaviors.
Keywords: Incomplete Markets, Exchange Rate Disconnect, Common Currency Factors
JEL Classification: F31, F44, G15
Suggested Citation: Suggested Citation