Model-Free International Stochastic Discount Factors
43 Pages Posted: 16 Nov 2017 Last revised: 21 Nov 2018
Date Written: April 20, 2018
We characterize model-free international stochastic discount factors (SDFs) and unspanned FX risks under different degrees of market segmentation. While estimated SDFs perfectly match international macro-finance puzzles, properties of SDFs and unspanned FX risks vary starkly across market structures: In integrated markets SDFs are highly volatile and both SDFs and unspanned risks are almost perfectly comoving, but segmented markets feature less correlated uninsurable risks and less volatile and correlated SDFs. We interpret this evidence through the lens of an economy where constrained intermediaries supply insurance-like contracts that hedge unspanned FX risks to households.
Keywords: stochastic discount factor, exchange rates, market segmentation, financial intermediaries
JEL Classification: F31, G12
Suggested Citation: Suggested Citation