This paper extends Dornbusch’s overshooting model by proposing a generalized interest parity condition (GIP), which captures a sluggish adjustment on the asset market. The exchange rate model under the GIP is able to reproduce the delayed overshooting and the hump-shaped response to monetary shocks of both nominal and real exchange rates. Furthermore, we present empirical results for OECD member countries which fit the theoretical predictions.
HYUNJOO, R. et TERRA, C. (2015). Exchange Rate Dynamics under Financial Market Frictions.