Journal Article

Asset Prices and Exchange Rates

Anna Pavlova and Roberto Rigobon

in The Review of Financial Studies

Published on behalf of The Society for Financial Studies

Volume 20, issue 4, pages 1139-1180
Published in print July 2007 | ISSN: 0893-9454
Published online January 2007 | e-ISSN: 1465-7368 | DOI: https://dx.doi.org/10.1093/revfin/hhm008
Asset Prices and Exchange Rates

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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: G12; G15; F31; F36

Journal Article.  19601 words.  Illustrated.

Subjects: Economics ; International Financial Markets ; International Finance

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