Exchange rates in the standard macro-finance model with a representative agent are counter-cyclical. The reason is that exchange rates are equal to the ratio of marginal utilities of consumption of the representative investor in each country. This prediction is counterfactual: across a variety of countries, (real) exchange rates are, on average, positively correlated with output and consumption growth. We provide a model in which the cyclical behavior of exchange rates varies with the source of the economic shocks. A key feature of our model is incomplete markets, which introduces a wedge between consumption and the marginal utility of the average investor. We introduce a minimal deviation from the standard endowment economy model of exchange rate depreciation: in a boom, new trees are created, but they are randomly distributed to a small part of the population. As a result, the marginal utility of the average investor can rise, leading to an appreciation of the real exchange rate. Our calibrated model does a good job replicating key features of the data, specifically, the joint dynamics of exchange rates, stock returns, real output and consumption growth, and trade flows. 

Research Paper Link：A Model of Pro-Cyclical Exchange Rates