Heterogeneity and Volatility Puzzles in International Finance
40 Pages Posted: 21 Feb 2009 Last revised: 24 Jan 2011
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Heterogeneity and Volatility Puzzles in International Finance
Date Written: February 19, 2009
Abstract
We develop an equilibrium model in a two-country, two-good, pure exchange economy in which investors with logarithmic utility functions have heterogeneous beliefs about exogenously given output or endowment processes. We obtain closed-form representations of real exchange rate and of stock prices. We show that heterogeneous beliefs, together with heterogeneous preferences make the volatility of real exchange rates and of stocks exhibit some properties that have been well documented in the empirical literature. These properties include the high volatility of both real exchange rates and stocks compared with that of economic fundamentals, the high correlation of stocks during periods of volatile markets. The model can also generate the clustering of the volatility of foreign exchange rate and stocks if the differences of beliefs are clustering.
Keywords: International Finance, Asset Pricing, Exchange Rate, Heterogeneous Beliefs, Heterogeneous Preferences, Excess Volatility, Correlation of Stock Markets
JEL Classification: D51, D84, G12, G15, F31, F36
Suggested Citation: Suggested Citation
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