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Model-Free International Stochastic Discount Factors

Author

Listed:
  • Mirela Sandulescu

    (University of Lugano and Swiss Finance Institute)

  • Fabio Trojani

    (University of Geneva and Swiss Finance Institute)

  • Andrea Vedolin

    (Boston University)

Abstract

We provide a theoretical characterization of international stochastic discount factors (SDFs) in incomplete markets under different degrees of market segmentation. Using 40 years of data on a cross-section of countries, we estimate model-free SDFs and factorize them into permanent and transitory components. We find that large permanent SDF components help to reconcile the low exchange rate volatility, the exchange rate cyclicality, and the forward premium anomaly. However, integrated markets entail highly volatile and almost perfectly comoving international SDFs. In contrast, segmented markets can generate less volatile and more dissimilar SDFs. In quest of relating the SDFs to economic fundamentals, we document strong links between proxies of financial intermediaries' risk-bearing capacity and model-free international SDFs. We interpret this evidence through the lens of an economy with two building blocks: limited participation by households and financiers who face an intermediation friction.

Suggested Citation

  • Mirela Sandulescu & Fabio Trojani & Andrea Vedolin, 2018. "Model-Free International Stochastic Discount Factors," Swiss Finance Institute Research Paper Series 18-18, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1818
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    More about this item

    Keywords

    Stochastic Discount Factor; Exchange Rates; Market Segmentation; Market Incompleteness; Financial Intermediaries;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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