A. Pricing-to-Market and Deviations from Law of One Price

Understanding International Prices: Customers as Capital (with Jaromir B. Nosal)

ABSTRACT: The paper develops a new theory of pricing-to-market driven by marketing and bargaining frictions. Our key innovation is a capital theoretic model of marketing in which relations with customers are valuable. In our model, producers search and form long-lasting relations with their customers, and marketing helps overcome the search frictions involved in forming such matches. Costly matching leads to a bilateral monopoly problem and bargaining. When framed into an international business cycle theory, our model of marketing can account for observations that are a puzzle for a large class of theories: (i) pricing-to-market, (ii) positive correlation of aggregate real export and real import prices, (iv) excess volatility of the real exchange rate over the terms of trade, and (iv) low short-run and high long-run price elasticity of international trade flows. The behavior of quantities is shown to be on par with standard international business cycle theories that in contrast to our model assume low intrinsic elasticity of substitution between domestic and foreign goods.

 Slides      Technical Appendix        Data files

Trade Intensity and Real Exchange Rate Volatility (with Jaromir B. Nosal)

ABSTRACT: Countries which trade intensively with each other tend to have less volatile bilateral real exchange rates. In addition, the decomposition of the real exchange rate volatility shows that in such cases a larger portion of its volatility comes from variations in the relative price of tradable to non-tradable goods. This paper proposes a theory which accounts for this observation. The key innovation is that the producers face a friction to expand to a larger market. This feature is incorporated into a framework in which domestic and foreign tradable goods are intrinsically close substitutes. The model implies smaller deviations from the law of one price for tradable goods when the domestic country producers hold a larger market share in the foreign partner country. As a result, consistent with the data, more intensive trade relations between countries are associated with a lower volatility of the real exchange rate for tradable goods, lower overall real exchange rate volatility, and a higher fraction of its volatility accounted for by the volatility of the relative price of non-tradable goods to tradable goods.
 

B. International Transmission of Business Cycles

Long-Run Price Elasticity of Trade and the Trade-Comovement Puzzle (with Jaromir B. Nosal)

ABSTRACT: Recent studies have found significant support for the positive link between bilateral trade intensity and business cycle comovement of output and TFP in a cross-section of industrialized country pairs. Since this feature of the data is not reproduced by the workhorse model of international business cycle, it is referred to as the trade-comovement puzzle. In this paper, we show that the puzzle is very much related to the failure of the standard theory to account for the high long-run price elasticity of trade flows. We do so by enriching the standard theory with frictions of building market shares and establishing trade relations which generate low short-run price elasticity of trade coexisting with the high long-run price elasticity. We show that when the low short-run elasticity is generated by explicitly modeled frictions of building market shares, the theory can account for 50% and 78% of the trade-comovement relation in the data for output and TFP, respectively.

Slides

C. Aggregate Implications of Personal Bankruptcy Provisions

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