Skip to main content

Time-Varying Risk, Interest Rates, and Exchange Rates in General Equilibrium

Staff Report 371 | Published September 1, 2007

Download PDF

Authors

Patrick J. Kehoe Monetary Advisor
Andrew Atkeson Consultant
Fernando Alvarez Consultant
Time-Varying Risk, Interest Rates, and Exchange Rates in General Equilibrium

Abstract

Under mild assumptions, the data indicate that fluctuations in nominal interest rate differentials across currencies are primarily fluctuations in time-varying risk. This finding is an immediate implication of the fact that exchange rates are roughly random walks. If most fluctuations in interest differentials are thought to be driven by monetary policy, then the data call for a theory which explains how changes in monetary policy change risk. Here we propose such a theory based on a general equilibrium monetary model with an endogenous source of risk variation—a variable degree of asset market segmentation.




Published in: _Review of Economic Studies_ (Vol. 76, No. 3, July 2009, pp. 851-878) https://doi.org/10.1111/j.1467-937X.2009.00537.x.