Essays in international money and finance

Three essays compose the dissertation. In the first essay, entitled "Interest Rate Rules, Endogenous Fluctuations and Chaotic Dynamics in Open Economies" (joint with Luis-Felipe Zanna), we study the consequences for global equilibrium determinacy of implementing active interest rate rules (i.e. whereby the nominal interest rate responds more than proportionally to changes in inflation) in flexible-price open economies. We show that conditions under which these rules generate aggregate instability by inducing cyclical and chaotic equilibrium dynamics depend on particular characteristics of open economies such as the degree of (trade) openness and the degree of exchange rate pass-through. We find that a forward-looking rule is more prone to induce endogenous cyclical and chaotic dynamics the more open the economy and the higher the degree of exchange rate pass-through. The results persist under a contemporaneous rule, as well as for different degrees of international financial markets completeness. The second essay, entitled "Monetary Policy Rules and Indeterminacy in Dollarized Open Economies", studies the implications of both an interest rate and a constant money growth rule in a small open economy which is subject to currency substitution. We show that equilibrium determinacy depends not only on the policy parameters but also on the degree of dollarization, the complementarity between the domestic and the foreign currency, the degree of international capital mobility and the extent of network externalities in the use of the foreign currency. The third essay, entitled "Real Exchange Rate Mean Reversion and International Portfolio Allocation" (joint with Marcos Buscaglia), assesses whether mean reversion in real exchange rates (RER) can induce horizon effects in international portfolio allocation. We estimate and introduce a long memory (ARFIMA) RER model into an optimal portfolio allocation framework where a representative investor can access domestic and international stocks. Our results show that there are significant horizon effects for the buy and hold investor, and that they depend upon the initial value of the RER compared to its long run value. Horizon effects disappear for the optimal rebalancing case. We argue that intertemporal hedging demands for foreign stocks are small given the low correlation between realized and expected returns.