Goods market arbitrage and real exchange rate volatility

This paper studies the economic determinants of real exchange rate volatility within a goods market arbitrage framework. We show that high volatility of the real exchange rate can be explained by relevant real factors such as trade costs, output ratio volatility and intertemporal elasticity of substitution. We also provide empirical evidence to support our model's predictions for real exchange rate volatility. We view our framework as complementary to those that emphasize the role of sticky prices.