Chang, Yanqin (2006): How a small open economy's asset are priced by heterogeneous international investors.
Download (609kB) | Preview
We study how a small open economy’s assets are prices by heterogeneous international investors. We initially decompose the asset pricing issue into separate studies of its two ingredients: the asset’s ex post return and the investors’ stochastic discount factor. The ex post asset return is examined in a small open economy RBC model featuring adjustment cost in investment. We derive an approximate closed-form solution for the ex post asset return using the Campbell (1994) log-linear technique. The international investors’ stochastic discount factor is taken as given by this small open economy. To examine the international investors’ stochastic discount factor, general equilibrium analysis is called in. We do this by setting up a world economy model. In the world economy model, the production side features a world representative firm which produce the world aggregate output consumed as world aggregate consumption; the consumer side features heterogeneous international investors from N countries in a sense that there are exogenous consumption distribution shocks and the price variation across countries. The shock affects the cross-sectional distribution of consumption goods among international investors but won’t affect the world aggregate level. The market stochastic discount factor hence is derived as a function of the world aggregate consumption growth, the world aggregate price growth and the cross-sectional variances and covariance terms of individual consumption growth and price growth. We then derive the closed-form solutions for asset prices by substituting the two ingredients, the asset’s ex post return from small open economy model and the investors’ stochastic discount factor from a general equilibrium world economy model, into the basic asset pricing formulas. Our model generates a risk premium for a small economy’s asset that tends to be low when the global economy is robust and to soar when global economy experiences a downturn. The main reason behind this is our assumption of heterogeneity across international investors. We also study the capital accumulation and capital loss/gain channels and explore their asset pricing implications. Our major finding is: For a small country that conducts fierce capital accumulation, our model predicts that its risk premium will fluctuate less broadly than one that conducts little capital accumulation.
|Item Type:||MPRA Paper|
|Original Title:||How a small open economy's asset are priced by heterogeneous international investors|
|Subjects:||F - International Economics > F3 - International Finance > F34 - International Lending and Debt Problems
G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates
|Depositing User:||Yanqin Chang|
|Date Deposited:||22. Oct 2006|
|Last Modified:||12. Feb 2013 09:09|
1. Abel, A. B., 1990, Asset prices under habit formation and catching up with the Joneses, American Economic Review Paper and Proceedings, 80, 38-42. 2. Abel, A. B., 1999, Risk premia and term premia in general equilibrium, Journal of Monetary Economics, 43, 3-33. 3. Arellano, C., and E. Mendoza, 2002, Credit frictions and “sudden stops” in small open economies: an equilibrium business cycle framework for emerging market crises, NBER working paper, No. w8880. 4. Atkeson, A., and T. Bayoumi, 1993, Do private capital markets insure regional risk? Evidence from Europe and the United States, Open Economics Review, 4 (3), 303-324. 5. Backus, D. K., P. J. Kehoe, and F. E. Kydland, 1992, International real business cycles, Journal of Political Economy, 100, 745-775. 6. Barberis, N., M. Huang and T. Santos, 2001, Prospect theory and asset prices, Quarterly Journal of Economics, 116, 1-53. 7. Bayoumi, T., and M. W. Klein, 1995, A provincial view of capital mobility, International Monetary Fund Staff Papers, 44 (4), 534-556. 8. Benartzi, S., and R. Thaler, 1995, Myopic loss aversion and the equity premium puzzle, Quarterly Journal of Economics, 110, 73-92. 9. Boldrin, M., L. J. Christiano and J. Fisher, 2001, Habit persistence, asset returns, and the business cycle, American Economic Review, 91, 149-166. 10. Calvo, G.A., C. Reinhart, 2000: When capital inflows come to a sudden stop: consequences and policy options, in P. Kenen, A. Swoboda, eds, Key issues in reform of the international monetary and financial system, Washington D.C., International Monetary Fund, 175-201. 11. Campbell, J. Y., 1994, Inspecting the mechanism: an analytical approach to the stochastic growth model, Journal of Monetary Economics, 33, 463-506. 12. Campbell, J. Y., 2003, Consumption-based asset pricing, In G. Constantinides, M. Harris and R. Stulz, eds, Handbook of the economics of finance, Vol. IB, North-Holland, Amsterdam, 803-887. 13. Campbell, J. Y., and J. H. Cochrane, 1999, By force of habit: A consumption-based explanation of aggregate stock market behavior, Journal of Political Economy, 107, 205-252. 14. Chan, Y. L., and L. Kogan, 2002, Catching up with the Joneses: Heterogeneous preferences and the dynamic of asset prices, Journal of Political Economy, 110, 1255-1285. 15. Coakley, J., F. Kulasi and R. Smith, 1998, The Feldstein-Horioka puzzle and capital mobility: A review, International Journal of Finance and Economics, 3, 169-188. 16. Cochrane, J. H., 1991, Production-based asset pricing and the link between stock returns and economic fluctuations, Journal of Finance, 46, 207-234. 17. Cochrane, J. H., 1997, Where is the market going? Uncertain facts and novel theories, Economic Perspectives Federal Reserve Bank of Chicago, 21(6). 18. Cochrane, J. H., 2006, Financial markets and the real economy, In J. H. Cochrane, eds, Financial markets and the real economy, Volume 18 of the International library of critical writings in financial economics, London: Edward Elgar. 19. Constantinides, G. M., 1990, Habit formation: A resolution of the equity premium puzzle, Journal of Political Economy, 98, 519-543. 20. Constantinides, G. M., and D. Duffie, 1996, Asset pricing with heterogeneous consumers, Journal of Political Economy, 104, 219-240. 21. Crucini, M., 1992, International risk sharing: A simple comparative test, Mimeo, Ohio State Univeristy. 22. Dumas, B., 1989, Two-person dynamic equilibrium in the capital market, Review of Financial Studies, 2, 157-188. 23. Dumas, B., 1994, Partial equilibrium versus general equilibrium models of the international capital market, In F. Van Der Ploeg, eds., The handbook of international macroeconomics, Oxford, UK, basil Blackwell. 24. Eichengreen, B., and A. K. Rose, 2001, Staying afloat when the wind shifts: External factors and emerging-market banking crises, In Calvo, G. A., M. Obstfeld and R. Dornbusch, eds., Money, factor mobility and trade: Essays in honor of Robert A. Mundell, The MIT Press. 25. Epstein, L. G., and S. E. Zin, 1989, Substitution, risk aversion, and the temporal behavior of asset returns: A theoretical framework, Econometrica, 57, 937-968. 26. Epstein, L. G., and S. E. Zin, 1991, Substitution, risk aversion, and the temporal behavior of asset returns: An empirical investigation, Journal of Political Economy, 99, 263-286. 27. French, K. R., and J. M. Poterba, 1991, Investor diversification and international equity markets, American Economic Review, 81 (May), 222-226. 28. Gould, J. P., 1968, Adjustment costs in the theory of investment of the firm, Review of Economic Studies, 35, 47-56. 29. Hansen, L. P., T. J. Sargent, and T. Tallarini, 1998, Robust permanent income and pricing, Review of Economic Studies, 66, 873-907. 30. Hayashi, F., 1982, Tobin’s marginal q and average q: A neoclassical interpretation, Econometrica, 50 (January), 213-234. 31. Heaton, J., and D. Lucas, 1996, Evaluating the effects of incomplete markets on risk sharing and asset pricing, Journal of Political Economy, 104, 443-487. 32. Jermann, U., 1998, Asset pricing in production economies, Journal of Monetary Economics, 41, 257-275. 33. Kahneman, D., and A. Tversky, 1979, Prospect theory: An analysis of decision under risk, Econometrica, 47, 263-291. 34. Kaminsky, G. L., and C. M. Reinhart, C.A. Vegh, 2004, When it rains, it pours: Procyclical capital flows and macroeconomic policies, NBER working paper, No. 10780. 35. Karolyi, G. A., and R. M. Stulz, 2003, Are financial assets priced locally or globally? In G. Constantinides, M. Harris and R. Stulz, eds, Handbook of the economics of finance, Vol. IB, North-Holland, Amsterdam, 976-1020. 36. King, R., C. Plosser and S. Rebelo, 1988, Production growth and business cycle I: The basic neoclassical model, Journal of Monetary Economics, 21, 195-232. 37. Kydland, F. E., and E. C. Prescott, 1982, Time to build and aggregate fluctuations, Econometrica, 50 (6), 1345-1370. 38. Lettau, M., 2003, Inspecting the mechanism: Closed-form solutions for asset prices in real business cycle models, Economic Journal, 113, 550-575. 39. Li, Y., 2005, Global asset returns and risk sharing under habit formation, Mimeo, California State University. 40. Li, Y., and M. Zhong, 2004, The predictability international stock returns under habit formation and idiosyncratic risks, Mimeo, California State University. 41. Lintner, J., 1965, The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets, Review of Economics and Statistics, 47, 13-37. 42. Lucas, R. E., 1967, Adjustment costs and the theory of supply, Journal of Political Economy, 75, 321-334. 43. Lucas, R. E., 1978, Asset prices in an exchange economy, Econometrica, 46, 1429-1446. 44. Lucas, R. E., and E. C. Prescott, 1971, Investment under uncertainty, Econometrica, 39, 659-682. 45. Mankiw, N. G., 1986, The equity premium and the concentration of aggregate shocks, Journal of Financial Economics, 17, 211-219. 46. Mankiw, N. G., and S. Zeldes, 1991, The consumption of stockholders and non-stockholders, Journal of Financial Economics, 29, 97-112. 47. Mehra, R., and E. C. Prescott, 1985, The equity premium: A puzzle, Journal of Monetary Economics, 15, 145-161. 48. Neumeyer, P. A., and F. Perri, 2004, The business cycle in emerging economies, the role of the interest rates, NBER working paper, No. 10387. 49. Obstfeld, M., and K. Rogoff, 1996, Foundations of international Macroeconomics, The MIT Press. 50. Restoy, F., and G. M. Rockinger, 1994, On stock market returns and returns on investment, Journal of Finance, 49 (2), 543-556. 51. Rouwenhorst, G., 1995, Asset pricing implications of equilibrium business cycle models, In T.F. Cooley, eds, Frontiers of business cycle research, Princeton, Princeton University Press. 52. Sachs, J. D., and X. Sala-I-Martin, 1992, Fiscal federalism and optimum currency areas, In M. B. Canzoneri, V. U. Grilli, and P. R. Masson, eds., Establishing a central bank: Issues in Europe and lessons from the U.S. Cambridge, UK, Cambridge University Press. 53. Sharpe, W. F., 1964, Capital asset prices: A theory of market equilibrium under conditions of risk, Journal of Finance, 19, 425-442. 54. Siegel, J. J., 1972, Risk, interest rates and the forward exchange, Quarterly Journal of Economics, 86 (May), 303-309. 55. Stockman, A. C., and H. Dellas, 1989, International portfolio nondiversification and exchange rate variability, Journal of International Economics, 26 (May), 271-289. 56. Stockman, A. C., and L. L. Tesar, 1995, Tastes and technology in a two-country model of the business cycle: Explaining international comovements, American Economic Review, 85 (March), 168-185. 57. Stulz, R. M., 1994, International portfolio choice and asset pricing: An integrative survey, NBER working paper, No. 4645. 58. Tesar, L. L., and I. Werner, 1995, Home bias and high turnover, Journal of International Money and Finance, 14 (August), 467-492. 59. Treadway, A., 1969, On rational entrepreneurial behavior and the demand for investment, Review of Economic Studies, 36, 227-240. 60. Uhlig, H., 1999, A toolkit for analyzing nonlinear dynamic stochastic models easily, In R. Marimon and A Scott, eds, Computational methods for the study of dynamic economics, Oxford, Oxford Univeristy Press. 61. Uribe, M., and V.Z. Yue, 2006, Country spreads and emerging countries: Who drives whom, Journal of International Economics, 69 (June), 6-36. 62. Uzawa, H., 1969, Time preference and the penrose effect in a two-class model of economic growth, Journal of Political Economy, 77, 628-652. 63. Weil, P., 1989, The equity premium puzzle and the risk-free rate puzzle, Journal of Monetary Economics, 24, 401-421.