Risk Sharing in International Economies and Market Incompleteness
American Finance Association Meeting 2016
Posted: 16 Aug 2014 Last revised: 30 Sep 2018
Date Written: September 11, 2016
Abstract
We develop an incomplete markets framework to synthesize domestic and foreign stochastic discount factors (SDFs) that are consistent with limited international risk sharing. The fundamental departure in our paper is that exchange rate growth need not equal the ratio of SDFs, and we develop a restriction that precludes “good deals” in international economies with incomplete markets. Our innovation is to study an incomplete markets problem that is consistent with SDFs that (i) are nonnegative, (ii) correctly price returns, and (iii) disallow “good deals.”
Keywords: International risk sharing, incomplete markets, exchange rates, high (low) interest rates, carry trade
JEL Classification: G12, G13
Suggested Citation: Suggested Citation