International Asset Pricing with Recursive Preferences

Abstract

Focusing on data from the US and UK, we document that both the anomaly identified by Backus and Smith (1993), which concerns the low correlation between consumption differentials and exchange rates, and the forward-premium anomaly, which concerns the tendency of high interest rate currencies to appreciate, have become more severe over time. Taking into account different capital mobility regimes, we show that these anomalies turn into general equilibrium regularities in a two-country and two-good economy with Epstein and Zin (1989) preferences, frictionless markets, and correlated long-run growth prospects.

JEL Classification: C62, F31, G12