Exchange Rate Determination, Risk Sharing and the Asset Market View

49 Pages Posted: 16 Mar 2012 Last revised: 30 Jan 2013

See all articles by A. Craig Burnside

A. Craig Burnside

Duke University - Department of Economics; University of Glasgow - Department of Economics; National Bureau of Economic Research (NBER)

Jeremy J. Graveline

University of Minnesota - Carlson School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: December 15, 2012

Abstract

Recent research in international finance has equated changes in real exchange rates with differences between the marginal utility growths of representative agents in different economies. The asset market view of exchange rates, encapsulated in this equation, has been used to gain insights into exchange rate determination, foreign exchange risk premia, and international risk sharing. We argue that, in fact, this equation is of limited usefulness. By itself, the asset market view does not identify the economic mechanism that determines the exchange rate. It only holds under complete markets, and even then, it does not generally allow us to identify the marginal utility growths of distinct agents. Moreover, if we allow for incomplete asset markets, measures of agents' marginal utility growths, and international risk sharing, cannot be based on asset market and exchange rate data alone. Instead, we argue that in order to explain how exchange rates are determined, it is necessary to make specific assumptions about preferences, goods market frictions, the assets agents can trade, and the nature of endowments or production.

Keywords: exchange rates, marginal utility, no arbitrage, stochastic discount factors

JEL Classification: F31, G15

Suggested Citation

Burnside, Craig and Graveline, Jeremy J., Exchange Rate Determination, Risk Sharing and the Asset Market View (December 15, 2012). AFA 2013 San Diego Meetings Paper; Economic Research Initiatives at Duke (ERID) Working Paper No. 139. Available at SSRN: https://ssrn.com/abstract=2023041 or http://dx.doi.org/10.2139/ssrn.2023041

Craig Burnside (Contact Author)

Duke University - Department of Economics ( email )

213 Social Sciences Building
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Durham, NC 27708-0204
United States

University of Glasgow - Department of Economics

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jeremy J. Graveline

University of Minnesota - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States
612-626-7817 (Phone)

HOME PAGE: http://www.tc.umn.edu/~jeremy/

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