The presence of nontraded goods in our model increases the relative volatility of nominal and real exchange rates relative to the volatility in the model without nontraded goods. An important aspect of the behavior of exchange rates in our model with nontraded goods hinges on the agent's inability to optimally share the risk associated with country-speci¯c shocks to productivity in the nontraded goods sector. In response to a (persistent) positive shock to productivity in this sector, agents wish to consume and invest more. However, higher consumption and investment of tradable goods requires the use (in ¯xed proportions) of both traded intermediate inputs and nontraded inputs. .
