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International Asset Pricing with Recursive Preferences

Authors

  • RICCARDO COLACITO,

  • MARIANO M. CROCE

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    • Both authors are affiliated with the University of North Carolina at Chapel Hill, Kenan-Flagler Business School. We would like to thank Cam Harvey, an anonymous Associate Editor, and an anonymous referee. We are grateful to Ravi Bansal, Robert Barro, Leonid Kogan, Deborah Lucas, Nick Roussanov, Tom Sargent, Andreas Stathopoulos, Chris Telmer, Stijn Van Nieuwerburgh, Adrien Verdelhan and Amir Yaron for their invaluable feedback. We also thank the seminar participants at the 2012 Center of European Policy Research Summer Meetings, the 2012 Society of Financial Studies Finance Cavalcade conference, the 2012 Texas Finance Festival, the Society for Economic Dynamics Meeting in Cyprus, the Bank of Chile, the 2010 American Economic Association Meeting, the 2011 Western Finance Association meetings, the 2009 University of North Carolina Jackson Hole Conference, CREATE Business School, New York University–Stern School of Business, and Wharton Business School. Some of the work on this paper was completed while Colacito was visiting Stern Business School and Croce was visiting Wharton Business School. All remaining errors are our own.


ABSTRACT

Focusing on data from the United States and the United Kingdom, we document that both the anomaly identified by Backus and Smith, which concerns the low correlation between consumption differentials and exchange rates, and the forward premium anomaly, which concerns the tendency of high interest rate currencies to appreciate, have become more severe over time. Taking into account different capital mobility regimes, we show that these anomalies turn into general equilibrium regularities in a two-country and two-good economy with Epstein and Zin preferences, frictionless markets, and correlated long-run growth prospects.

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