International capital markets structure, preferences and puzzles : the US-China case

Caporale, Guglielmo Maria and Donadelli, Michael and Varani, Alessia (2014) International capital markets structure, preferences and puzzles : the US-China case. Centre for International Capital Markets discussion papers, 2014 (04). pp. 1-30. ISSN 1749-3412

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Abstract

A canonical two country-two good model with standard preferences does not address three classic international macroeconomic puzzles as well as two well-known asset pricing puzzles. Specifically, under financial autarky, it does not account for the high real exchange rate (RER) volatility relative to consumption volatility (RER volatility puzzle), the negative RER-consumption differentials correlation (Backus-Smith anomaly), the relatively low cross-country consumption correlation (consumption correlation puzzle), the low risk-free rate (risk-free rate puzzle) and the high equity risk premium (equity premium puzzle) in the data. In this paper, we show that instead a two country-two good model with recursive preferences, international complete markets and correlated long-run innovations can address all five puzzles for a relatively large range of parameter values, specifically in the case of the US and China. Therefore, in contrast to other IBC models, its performance does not rely on any financial market imperfections.

Item Type: Article
Uncontrolled Keywords: Centre for International Capital Markets discussion papers; CICM discussion papers; financial autarky; complete markets; long-run risk; anomalies
Subjects: 300 Social sciences > 330 Economics
Department: Guildhall School of Business and Law
Depositing User: Mary Burslem
Date Deposited: 16 Apr 2015 11:35
Last Modified: 17 Apr 2015 09:38
URI: http://repository.londonmet.ac.uk/id/eprint/370

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