Asset Prices and Exchange Rates

Posted: 7 Aug 2006

See all articles by Anna Pavlova

Anna Pavlova

London Business School; Centre for Economic Policy Research (CEPR)

Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

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Abstract

We study the implications of introducing demand shocks and trade in goods into an otherwise standard international asset pricing model. Trade in goods gives rise to an additional channel of international propagation - through the terms of trade - absent in traditional single-good models. The inclusion of demand shocks helps overturn many unrealistic implications of existing international finance models in which productivity shocks are the sole source of uncertainty. Our model generates a rich set of implications on how stock, bond, and foreign exchange markets co-move. We solve the model in closed-form, which yields a system of equations that can be readily estimated empirically. Our estimation validates the main predictions of the theory.

Keywords: International finance, asset pricing, exchange rate, terms of trade, international transmission

JEL Classification: G12, G15, F31, F36

Suggested Citation

Pavlova, Anna and Rigobon, Roberto, Asset Prices and Exchange Rates. Review of Financial Studies, Vol. 20, pp. 1139-1181, 2007, Available at SSRN: https://ssrn.com/abstract=922505

Anna Pavlova (Contact Author)

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Centre for Economic Policy Research (CEPR)

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Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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National Bureau of Economic Research (NBER) ( email )

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