Home bias and the persistence of real exchange rates

This paper investigates the half-life of real exchange rates after taking into account the impact of home bias. Empirical results indicate that the half-life of real exchange rates is in the range of 1.5 to 2 years for four out of five countries after controlling the impact of home bias. These results support Obstfeld and Rogoff's (2000, NBER Macroeconomics Annual) view that home bias is crucial in explaining the PPP puzzle.

Research Highlights► This paper investigates the half-life of real exchange rates after controlling the impact of home bias. ► The time-varying home bias is estimated through Kalman filter and the local projection method is applied to construct the impulse responses function of a shock on real exchange rates. ► Empirical results indicate that the half-life of real exchange rates is in the range of 1.5 to 2 years for four out of five countries after controlling the impact of home bias.