Working Paper: NBER ID: w17277
Authors: Francois Gourio; Michael Siemer; Adrien Verdelhan
Abstract: Recent work in international finance suggests that the forward premium puzzle can be accounted for if (1) aggregate uncertainty is time-varying, and (2) countries have heterogeneous exposures to a world aggregate shock. We embed these features in a standard two-country real business cycle framework, and calibrate the model to match the differences between low and high interest rates countries. Unlike traditional real business cycle models, our model generates volatile exchange rates, a large currency forward premium, "excess comovement'' of asset prices relative to quantities, and an imperfect correlation between relative consumption growth and exchange rates. Our model implies, however, that high interest rate countries have smoother quantities, equity returns and interest rates than low interest rate countries, contrary to the data.
Keywords: international finance; risk cycles; real business cycle; exchange rates; asset pricing
JEL Codes: E32; E44; F31; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in the probability of a global disaster (Q54) | decline in investment (E22) |
| decline in investment (E22) | recession characterized by falling output and employment (E32) |
| increase in the probability of a global disaster (Q54) | recession characterized by falling output and employment (E32) |
| variations in disaster risk (H84) | changes in risk premia and asset valuations (G19) |
| disaster risk influences macroeconomic dynamics and asset pricing (E44) | observed data alignment (Y10) |
| high interest rate countries (F34) | smoother quantities and equity returns than low interest rate countries (G15) |
| variations in disaster risk (H84) | equity return volatility (G17) |