A New Approach to International Arbitrage Pricing





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    • The authors are from the Fuqua School of Business, Duke University. We thank Tom Keller and Bob Winkler for their help in obtaining the Morgan Stanley weekly data, Peter Muoio and George Tauchen for sharing their data with us, seminar participants at the 1992 Econometric Society summer meeting in Seattle, the Department of Economics at Duke University, the London Business School, the City University Business School, the 1992 Society of Economic Dynamics and Control winter meeting in Anaheim, the March 1993 NBER Asset Pricing Conference at Cambridge, and the Wharton School, for their comments, and Akhtar Siddique for computational assistance. Detailed comments by René Stulz and an anonymous referee have considerably improved the paper. The Isle Maligne Fund, the Business Associates Fund, and the Futures and Options Research Center (FORCE) of the Fuqua School of Business supported this research.


This paper uses a nonlinear arbitrage-pricing model, a conditional linear model, and an unconditional linear model to price international equities, bonds, and forward currency contracts. Unlike linear models, the nonlinear arbitrage-pricing model requires no restrictions on the payoff space, allowing it to price payoffs of options, forward contracts, and other derivative securities. Only the nonlinear arbitrage-pricing model does an adequate job of explaining the time series behavior of a cross section of international returns.