Information Heterogeneity and the Role of Foreign Exchange

In this paper we introduce information heterogeneity in the FX market in line with Bacchetta and Wincoop (2006) in attempt to extend their results to a DSGE framework. We show that the introduction of information heterogeneity, in the shape of both dispersed information about fundamentals and non-fundamental based shocks, generates a magnification effect that can help obtaining a better approximation to the empirical moments. Also, FX intervention can improve the connection between the exchange rate and its fundamentals. Finally, in the methodological front, we extend the procedure proposed by Townsend (1983) to solve dynamic stochastic general equilibrium (DSGE) models with heterogeneous expectations.