International Asset Pricing with Recursive Preferences

Abstract

Focusing on US and UK, we document that both the Backus and Smith (1993) finding -- concerning the low correlation between consumption differentials and exchange rates -- and the forward-premium anomaly -- concerning the tendency of high interest rate currencies to appreciate -- have become more severe through time. After accounting for 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.

Keywords: Recursive preferences, risk-sharing, exchange rate

JEL Classification: C62, F31, G12