Risks for the Long-Run and the Real Exchange Rate
34 Pages Posted: 14 Mar 2008 Last revised: 3 Oct 2012
Date Written: December 28, 2010
We propose an equilibrium model that can explain a wide range of international finance puzzles, including the high correlation of international stock markets despite the lack of correlation of fundamentals. We conduct an empirical analysis of our model, which combines cross-country-correlated long-run risk with Epstein and Zin (1989) preferences, using US and UK data and show that it successfully reconciles international prices and quantities, thereby solving the international equity premium puzzle. These results provide evidence suggesting a link between common long-run growth perspectives and exchange rate movements.
Keywords: Exchange rates, international financial markets, long-run risks
JEL Classification: G12, G15, F31
Suggested Citation: Suggested Citation