Stock Markets and the Real Exchange Rate: An Intertemporal Approach, Issues 2003-2109
The paper presents an N-country model with stock markets, in which a closed-form solution for the real exchange rate is derived. Risky asset prices and allocation of risky assets among countries are determined endogenously. Such a framework allows an analysis of how fundamental parameters, such as the variance and covariance of the risky assets or demographic variables, affect the real exchange rate. The predictions of the model are contrasted with the Balassa-Samuelson effect. A new transmission channel of the real exchange rate for parameters such as income on net foreign assets, risk aversion, and risk-hedging opportunities is also explored.
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Real Exchange Rate in an Intertemporal NCountry Model with Incomplete Markets
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Appendix Balassa-Samuelson effect ceteris paribus closed-form solution consequence country h country's determined endogenously dividends innovation endowment innovation equilibrium asset prices European Central Bank excess financial gains exchange rate volatility expected excess returns exponential utility function financial excess gains foreign assets foreign position form an incomplete framework fundamental parameters future endowments gross income higher real exchange incomplete market JxJ diagonal matrix lower exchange rates lower real exchange market-clearing Mercereau 2003 number of risky numeraire past financial investment portfolio allocations portfolio holdings precautionary savings premium exploitation risk present discounted value price of nontradables prices and portfolio Proof Proposition rate is derived real exchange rate relative productivity advantage representative agent revenue on past risk premium exploitation risk-averse countries risk-free bond risk-hedging benefits risk-hedging opportunities risky asset prices stock markets Structural risk cost tradables and nontradables tradables is larger transmission channel U.S. dollar variables variance and covariance Variance-covariance matrix vector wealth effect