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On the Asset Market View of Exchange Rates

Author

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  • A Craig Burnside
  • Jeremy J Graveline

Abstract

If the asset market is complete, then the difference between foreign and domestic agents’ log intertemporal marginal rates of substitution (IMRSs) equals the log change in the real exchange rate. This equation is frequently used to argue that changes in real exchange rates reflect differences between agents’ required compensation for exposure to asset return uncertainty. We show that the relative returns on frictionlessly traded assets are only reflected in the common component of agents’ IMRSs, not in differences. Instead, when this equation does offer insights, frictions in the goods market are the source of economic distinction between agents.Received December 10, 2013; editorial decision November 5, 2018 by Editor Geert Bekaert. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Suggested Citation

  • A Craig Burnside & Jeremy J Graveline, 2020. "On the Asset Market View of Exchange Rates," The Review of Financial Studies, Society for Financial Studies, vol. 33(1), pages 239-260.
    • Handle: RePEc:oup:rfinst:v:33:y:2020:i:1:p:239-260.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhz049
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    Cited by:

    1. Mikhail Chernov & Drew Creal, 2023. "International Yield Curves and Currency Puzzles," Journal of Finance, American Finance Association, vol. 78(1), pages 209-245, February.
    2. Hassan, Ramin & Loualiche, Erik & Pecora, Alexandre R. & Ward, Colin, 2023. "International trade and the risk in bilateral exchange rates," Journal of Financial Economics, Elsevier, vol. 150(2).
    3. Gurdip Bakshi & Xiaohui Gao & George Panayotov, 2021. "A Theory of Dissimilarity Between Stochastic Discount Factors," Management Science, INFORMS, vol. 67(7), pages 4602-4622, July.
    4. Branger, Nicole & Herold, Michael & Muck, Matthias, 2021. "International stochastic discount factors and covariance risk," Journal of Banking & Finance, Elsevier, vol. 123(C).

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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