Abstract
This paper develops a stochastic model of temporary stabilization of prices when the exchange rate acts as a nominal anchor. The model explicitly recognizes the uncertainty in the expected dynamics of both the devaluation rate and the labor income. Under this framework, the expectations of devaluation are driven by a mixed diffusion-jumps process, and future labor income is governed by a geometric Btownian motion. It is assumed that a contingent claims market does not exist to hedge against both devaluation and adverse fluctuations in future labor income, in this way the financial markets are incomplete. The dynamics of the consumption and portfolio decisions when a stabilization program is implemented is also examined. Finally, the effects of exogenous shocks on the expectations of devaluation and labor income are assessed in terms of economic welfare.
| Translated title of the contribution | Stabilization of prices and uncertain labor income: A estochastic approach |
|---|---|
| Original language | Spanish |
| Pages (from-to) | 45-69 |
| Number of pages | 25 |
| Journal | Investigacion Economica |
| Volume | 65 |
| Issue number | 256 |
| State | Published - Apr 2006 |
| Externally published | Yes |