The Forward- and the Equity-Premium Puzzles: Two Symptoms of the Same Illness?
AbstractUsing information on US domestic financial data only, we build a stochasticdiscount factor—SDF— and check whether it accounts for foreign marketsstylized facts that escape consumption based models. By interpreting ourSDF as the projection of a pricing kernel from a fully specified model in thespace of returns, our results indicate that a model that accounts for the behaviorof domestic assets goes a long way toward accounting for the behavior offoreign assets prices. We address predictability issues associated with the forwardpremium puzzle by: i) using instruments that are known to forecastexcess returns in the moments restrictions associated with Euler equations,and; ii) by comparing this out-of-sample results with the one obtained performingan in-sample exercise, where the return-based SDF captures sourcesof risk of a representative set of developed and emerging economies governmentbonds. 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 732.
Date of creation: 24 Apr 2012
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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 Eugênio da & Issler, João Victor & Matos, Paulo F., 2009. "The Forward- and the Equity-Premium Puzzles: Two Symptoms of the Same Illness?," Economics Working Papers (Ensaios Economicos da EPGE) 697, 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).
- NEP-ALL-2012-05-08 (All new papers)
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