Discussion Paper Series, University of Heidelberg, Department of Economics 569
This paper provides an explanation for the observed decline of the exchange rate pass-through into import prices by modeling the effects of ﬁnancial market integration on the optimal choice of the pricing currency in the context of rigid nominal goods prices. Contrary to previous literature, the interdependence of this choice with the optimal portfolio choice of internationally traded ﬁnancial assets is explicitly taken into account. In particular, price setters move towards more local-currency pricing while the debt portfolio includes more foreign assets following increased ﬁnancial integration. Both predictions are in line with novel empirical evidence.
Exchange rate pass-through ﬁnancial integration portfolio home bias international price setting