Asset Prices and Exchange Rates

45 Pages Posted: 27 Dec 2004

See all articles by Anna Pavlova

Anna Pavlova

London Business School; Centre for Economic Policy Research (CEPR)

Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Multiple version iconThere are 4 versions of this paper

Date Written: April 2006

Abstract

In this paper we study the implications of introducing demand shocks and trade in goods into an otherwise standard international asset pricing model. Trade in goods gives rise to an additional channel of international propagation - through the terms of trade - absent in traditional single-good asset pricing models. The inclusion of demand shocks helps overturn many unrealistic implications of existing international finance models in which productivity shocks are the sole source of uncertainty. Our model generates a rich set of implications on how stock, bond, and foreign exchange markets co-move. We solve the model in closed-form, which yields a system of equations that can be readily estimated empirically. Our estimation validates the main predictions of the theory.

Keywords: International finance, asset pricing, exchange rate, terms of trade, international transmission

JEL Classification: G12, G15, F31, F36

Suggested Citation

Pavlova, Anna and Rigobon, Roberto, Asset Prices and Exchange Rates (April 2006). MIT Sloan Working Paper No. 4322-03, AFA 2005 Philadelphia Meetings, Available at SSRN: https://ssrn.com/abstract=420524 or http://dx.doi.org/10.2139/ssrn.420524

Anna Pavlova (Contact Author)

London Business School ( email )

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HOME PAGE: http://https://www.anna-pavlova.co.uk/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-447
Cambridge, MA 02142
United States
617-258-8374 (Phone)
617-258-6855 (Fax)

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