Risks for the Long-Run and the Real Exchange Rate

34 Pages Posted: 14 Mar 2008 Last revised: 3 Oct 2012

See all articles by Ric Colacito

Ric Colacito

University of North Carolina Kenan-Flagler Business School; NBER

Mariano (Max) Massimiliano Croce

Finance Department, Bocconi University; Centre for Economic Policy Research (CEPR)

Date Written: December 28, 2010

Abstract

We propose an equilibrium model that can explain a wide range of international finance puzzles, including the high correlation of international stock markets despite the lack of correlation of fundamentals. We conduct an empirical analysis of our model, which combines cross-country-correlated long-run risk with Epstein and Zin (1989) preferences, using US and UK data and show that it successfully reconciles international prices and quantities, thereby solving the international equity premium puzzle. These results provide evidence suggesting a link between common long-run growth perspectives and exchange rate movements.

Keywords: Exchange rates, international financial markets, long-run risks

JEL Classification: G12, G15, F31

Suggested Citation

Colacito, Riccardo and Croce, Mariano Massimiliano, Risks for the Long-Run and the Real Exchange Rate (December 28, 2010). Journal of Political Economy, Vol. 119, No. 1, 2011, Available at SSRN: https://ssrn.com/abstract=1105496

Riccardo Colacito (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

HOME PAGE: http://drric.web.unc.edu/

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Mariano Massimiliano Croce

Finance Department, Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

HOME PAGE: http://sites.google.com/view/mmcroce/home

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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