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Exchange Rates: Facts, Policy and Currency Manipulation

Paper Session

Friday, Jan. 5, 2018 10:15 AM - 12:15 PM

Marriott Philadelphia Downtown, Meeting Room 406
Hosted By: Econometric Society

Model-Free International Stochastic Discount Factors

Paula Mirela Sandulescu
University of Lugano & Swiss Finance Institute
Fabio Trojani
University of Geneva
Andrea Vedolin
London School of Economics


We characterize international stochastic discount factors (SDFs) in incomplete markets under various forms of market segmentation. Using 40 years of data on a cross-section of different countries, we estimate model-free SDFs and factorize them into permanent and transitory components. We find that large permanent SDF components help to reconcile the low exchange rate volatility, the exchange rate cyclicality, and the forward premium anomaly. However, under integrated markets, this entails highly volatile and very similar international SDFs. In contrast, segmented markets can generate less volatile and more dissimilar SDFs. We then theoretically study SDFs in segmented markets using a simple model with constrained financiers who intermediate households' demand for international assets. Empirically, we document strong links between international model-free SDFs, Value-at-Risk constraints, and proxies of financial intermediaries' wealth.

Currency Wars or Efficient Spillovers? Or: When Is International Policy Cooperation Useful?

Anton Korinek
Johns Hopkins University


In an interconnected world, national economic policies regularly lead to large international spillover effects, which frequently trigger calls for international policy cooperation. However, the premise of successful cooperation is that there is a Pareto inefficiency, i.e. that there is scope to make some nations better off without hurting others.

This paper presents a first welfare theorem for open economies that defines an efficient benchmark and spells out the conditions that need to be violated to generate inefficiency and scope for cooperation. These are: (i) policymakers act competitively in the international market, (ii) policymakers have sufficient external policy instruments and (iii) international markets are free of imperfections. Importantly, our theorem holds even if each economy suffers from a wide range of domestic market imperfections and targeting problems. We provide examples of current account intervention, monetary policy, fiscal policy, macroprudential policy/capital controls, and exchange rate management and show that the resulting spillovers are Pareto efficient, as long as the three conditions are satisfied. Furthermore, we develop general guidelines for how policy cooperation can improve welfare when the conditions are violated.
JEL Classifications
  • A1 - General Economics