Essays on asset markets in international economics: Human capital and foreign exchange.

Abstract

This dissertation consists of three essays that examine issues in international asset markets for human capital and foreign exchange in the context of models of representative agents with optimizing behavior. The response of the relative wages of skilled workers to shocks in the terms of trade is examined in the context of a small, open economy with a comparative advantage in skill-intensive goods. It is shown that the long-run response of the relative wage will be smaller than the initial response to a real exchange rate shock. Impulse response functions are estimated for data from the United States and some support is found for the hypothesis that relative wages display overshooting behavior in response to real exchange rate shocks. Next, the divergence in growth rates of economies is examined in the context of a two sector growth model with physical capital and human capital. It is shown that when there are positive externalities in human capital production associated with the skill level in the economy, divergence in growth rates can occur and that government policy can potentially boost economic growth. Third, the observed forward premium puzzle in foreign exchange markets is shown to be consistent with the uncovered interest parity condition. A simultaneous equation system describing a small open economy with an active monetary policy regime is set up to show that the single equation test of the unbiasedness hypothesis may be inappropriate. Markov regime-switching estimates and tests are conducted for data from the dollar-yen and dollar-deutschemark markets at monthly frequency. The evidence supports the existence of two regimes in both markets marked by different volatilities, and by regime-shift dates that can be identified with shifts in monetary policy. The coefficient estimates for the relation between the forward premium and next-period change in the spot exchange rate are more precise in the low-volatility regimes.