Stock Markets and Real Exchange Rate: An Intertemporal Approach
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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analysis Balassa-Samuelson effect ceteris paribus closed-form solution consequence consumption volatility countries with larger country h covariance dividends innovation endowment innovation equilibrium asset prices European Central Bank excess financial gains exchange rate volatility expected excess returns exponential utility function expression financial excess gains foreign assets foreign position framework fundamental parameters future endowments hedging risk premium higher real exchange i+1 k=l incomplete market Jx1 vector JxJ diagonal matrixes lower exchange rates lower real exchange market-clearing past financial investment portfolio allocations portfolio holdings Precautionary Saving present discounted value prices and portfolio Proof see Appendix Proposition real exchange rate relative productivity advantage representative agent revenue on past risk aversion risk hedging risk risk premium exploitation risk-averse countries risk-free bond risk-hedging benefits risk-hedging opportunities risky asset prices stock market Structural risk cost t+i-l tradables and nontradables transmission channel U.S. dollar value of future variables variance and covariance Variance-covariance matrix