The Forward- and the Equity-Premium Puzzles: Two Symptoms of the Same Illness?
AbstractWe build a pricing kernel using only US domestic assets data and checkwhether it accounts for foreign markets stylized facts that escape consumptionbased models. By interpreting our stochastic discount factor as the projection ofa pricing kernel from a fully specified model in the space of returns, our results indicatethat a model that accounts for the behavior of domestic assets goes a longway toward accounting for the behavior of foreign assets. We address predictabilityissues associated with the forward premium puzzle by: i) using instrumentsthat are known to forecast excess returns in the moments restrictions associatedwith Euler equations, and; ii) by pricing Lustig and Verdelhan (2007)'s foreigncurrency portfolios. Our results indicate that the relevant state variables that explainforeign-currency market asset prices are also the driving forces behind U.S.domestic assets behavior.
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Bibliographic InfoPaper provided by FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil) in its series Economics Working Papers (Ensaios Economicos da EPGE) with number 697.
Date of creation: 12 Aug 2009
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- Matos, Paulo & Costa, Carlos Eugênio da & Issler, João Victor, 2007. "The Forward- and the Equity-Premium Puzzles: Two Symptoms of the Same Illness?," Economics Working Papers (Ensaios Economicos da EPGE) 649, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
- Costa, Carlos E. da & Issler, João Victor & Matos, Paulo F., 2010. "The forward- and the equity-premium puzzles: two symptoms of the same illness?," Economics Working Papers (Ensaios Economicos da EPGE) 712, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
- Costa, Carlos Eugênio da & Issler, João Victor & Matos, Paulo F., 2012. "The Forward- and the Equity-Premium Puzzles: Two Symptoms of the Same Illness?," Economics Working Papers (Ensaios Economicos da EPGE) 732, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
- NEP-ALL-2009-08-30 (All new papers)
- NEP-DGE-2009-08-30 (Dynamic General Equilibrium)
- NEP-IFN-2009-08-30 (International Finance)
- NEP-UPT-2009-08-30 (Utility Models & Prospect Theory)
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- Hanno Lustig & Adrien Verdelhan, 2005. "Investing in Foreign Currency is like Betting on your Intertemporal Marginal Rate of Substitution," Boston University - Department of Economics - Working Papers Series WP2005-040, Boston University - Department of Economics.
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