Working Paper

Exchange-rate puzzles in a model with arbitrage.

Abstract: This paper documents the implications of arbitrage costs on the behavior of exchange rates in an open-economy liquidity model. The main motivation behind the paper is the growing evidence that the well-documented departures from purchasing power parity are due to a failure of the law of one price. The paper quantifies the importance of arbitrage costs for the variability, persistence, and autocorrelation of real and nominal exchange rates and compares the results with those of a model with nominal rigidities and firms pricing to market; second, the paper studies the impact of currency risk due to the failure of the law of one price on uncovered interest parity.

Keywords: Foreign exchange rates; Arbitrage;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2000

Number: 00-11