Exchange rate dynamics, asset market structure and the role of the ...

and foreign intermediate goods in investment goods is set to 1. As there is no clear empirical
evidence on this parameter, I have experimented with several di¤erent values. Our results
are however robust to changing : As is common in the real business cycle literature, such as
Hansen (1985), I set the share of labour in production to 0.64 and assume a 2.5% depreciation
rate of capital per quarter. There is considerable uncertainty regarding the curvature of
the investment adjustment cost function s 00 (:): Christiano, et al (2005), who …rst proposed
this speci…cation interpret 1=s 00 (:) as the elasticity of investment with respect to a 1 percent
temporary increase in the current price of installed capital. Their empirical evidence suggests
a value of s 00 (:) = 2:5. Smets and Wouters (2004), estimate this parameter using Bayesian
techniques in the context of a model of the US economy. Their median estimate is around 6.
Enders and Müller (2008) estimate s 00 (:) in an international real business cycle model, driven
only by productivity shocks. Their estimates are between zero and 0.4. Groth and Kahn
(2007) look at disaggregated data for the UK and the US and for the US …nd a value of of
0.17, much lower than Christiano’s estimate based on aggregate data. Given this uncertainty
in the literature, I have chosen to set to 0.1. This is deliberately small, thus ensuring that
the results of the model are not unduly in‡uenced by a parameter for which the literature
does not have a consistent value. This value of s 00 (:) allows the calibrated model to come
close to matching the relative volatility of investment to GDP. I perform sensitivity analysis
below to ascertain whether the results of this paper are robust to my choice of s 00 (:).
Table 1: Baseline calibration
Preferences = 1=1:01; = 1; h = 1=3;
Final goods tech v = (1 v ) = 0:88; = 2; = 1; ' = (1 ' ) = 1
Intermediate goods =
0:64; = 0:025;
s 00 = 0:1
0:906 0:088
Shocks =
0:088 0:906
V [] = 10 4 0:726 0:187
0:187 0:726
The stochastic process for TFP is taken from the seminal work of Backus et al (1995)
on international real business cycles. The home country in this calibration is assumed to be
the United States. Matrix V [] in Table 1 above shows the variance-covariance matrix of
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