Essays on International Finance

I study the exchange rate disconnect puzzle in a two-country DSGE framework that features a financial intermediation sector. An intermediary is subject to two types of financing constraints: 1. a segmented deposit market restricted to local households, and 2. a balance-sheet constraint. These two constraints drive a wedge between marginal decisions of home and foreign intermediaries, which in turn, breaks the link between exchange rates and consumption differences in the Backus-Smith relationship. In contrast to traditional models which find a tight link between exchange rate growth and the consumption growth rate differential, the calibrated model produces a correlation of around -0.16, reconciling the model with the empirical evidence. ∗Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh PA 15213. e-mail: [email protected]. †I am extremely grateful to my committee members, Burton Hollifield, Nicolas Petrosky-Nadeau, Chris Telmer, and Sevin Yeltekin, for their invaluable advices and kind support. I am also indebted to Chris Telmer for his guidance throughout my graduate study.