Exchange Rates and Fundamentals : Closing a Two-country Model

In an influential paper, Engel and West (2005) claim that the near random-walk behavior of nominal exchange rates is an equilibrium outcome of a variant of present-value models when economic fundamentals follow exogenous rst-order integrated processes and the discount factor approaches one. Subsequent empirical studies further con rm this proposition by estimating a discount factor that is close to one under distinct identi cation schemes. In this paper, I argue that the unit market discount factor implies the counterfactual joint equilibrium dynamics of random-walk exchange rates and economic fundamentals within a canonical, two-country, incomplete market model. Bayesian posterior simulation exercises of a two-country model based on post-Bretton Woods data from Canada and the United States reveal difficulties in reconciling the equilibrium random-walk proposition within the two-country model; in particular, the market discount factor is identi ed as being much lower than one.2012～2016年度科学研究費補助金[基盤研究(S)]「長期デフレの解明」(研究代表者 東京大学経済学研究科・渡辺努, 課題番号：24223003