17 Pages Posted: 27 Oct 2008 Last revised: 30 Oct 2008
Date Written: July 5, 2008
The aim of this paper is to develop a framework for asset pricing in a continuous time general equilibrium model for a two country Lucas type economy. The model assumes that the output in the two countries follows a jump-diffusion stochastic process characterized by constant growth rates and volatilities and by log-normal amplitude of the jumps. Using this specification we deduce the fundamental evaluation equations for financial assets as well as a formula for the price of exchange rate options in this economy.
Keywords: general equilibrium model, two-country Lucas economy, exchange rate, asset pricing, exchange rate options, jump-diffusion
JEL Classification: C02, C61, D50, G12, G13
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